Stock Market News Today 2018/08/28
What does the flattening US yield curve tell us?
Jay Powell, the Federal Reserve chair opened the annual central banking symposium in Jackson Hole on Friday with a keynote speech, that affirmed a slow and gradual pace of interest rate tightening. That suggests two more tightening moves beckon this year, in September and December pushing the upper band of the fed funds rate to 2.50 per cent.
Mr Powell highlighted no sign of inflation accelerating beyond 2 per cent and that helps explain why the 10-year Treasury yield remains below 3 per cent and why the yield curve has flattened so much in recent months.
The flattening yield curve also has support, given the recent string of US economic data that has arrived below forecasts and was highlighted by Citi’s surprise index. As the Fed has steadily pushed up the cost of overnight borrowing — with a further rise to an upper band of 2.25 per cent expected next month — so the yield curve between the two-, and 10-year Treasury notes has flattened from above 0.8 percentage points a year ago, to inside 0.2 percentage points on Friday after Mr Powell’s speech.
A flattening yield is characteristic of a late-cycle economy and in spite of the Trump administration’s massive tax cut and stronger GDP prints, the bond market thinks the story for 2019 is one of weaker economic growth and lower inflation. With the Fed looking to continue tightening, there is a strong chance of the yield curve turning negative and such an occurrence will mark the moment when the bond market says the central bank has gone too far and is making a policy error. A negative 2/10s Treasury curve for much of 2006 into 2007 was an warning signal that rougher water beckoned for the economy and risk assets.
Now a number of officials at the US central bank are watching the curve. Last week Raphael Bostic, president of the Atlanta Fed, wrote a blog post about what the current slope of the yield curve tells us, while the July/August meeting minutes noted: “policymakers should pay close attention to the slope of the yield curve in assessing the economic and policy outlook’’.
Speaking on CNBC at Jackson Hole, James Bullard, president of the St Louis Fed, said on Friday that there is no good reason to take on the yield curve and possible recession risk.
So we are heading to possibly a key moment in the coming weeks should the 2/10s curve turn negative?
‘’Whether it’s the wobble in global growth outside of the US, jitters in emerging markets, lowflation, or the simple fact that if the Fed hikes long enough monetary policy eventually tightens, at some point the Committee will take a breather,’’ note analysts at BMO Capital Markets. The bank has four base cases for a pause — “inflation fails to sustainably make it to the fabled land of the 2-handle, the curve inverts, financial conditions tighten too quickly, or the economic outlook deteriorates’’.
Are markets waking up torisk of no-deal Brexit?
A sombre mood has settled over sterling during the summer. After a sharp 5.4 per cent fall in the last two weeks of April, driven by the dollar’s surge, the pound has slowly but surely fallen by broadly the same amount over the subsequent 16 weeks.
That mirrors Brexit developments, which have amounted to nothing substantively negative in the summer period nor anything that suggests a breakthrough.
That backdrop ensures that any time the pound looks set for a rally, usually on the back of favourable data or hawkish Bank of England commentary, it comes unstuck. Investors are caught in a bind — they have no love for sterling but are not yet prepared to abandon all hope. As forex analyst Stephen Gallo at Bank of Montreal said sterling’s trade value is “already quite weak”.
Market commentators think this betwixt and between sentiment cannot last much longer. The pound is edging back towards 12-month lows against the euro. There are also signs of nervousness in options pricing — three-month implied volatility in sterling against the dollar has been gathering pace in August.
This week should see publication of further technical papers from the Brexit secretary on the consequences of a no deal. And the calendar from September onwards — party conferences, Brexit talks, EU emergency summits — ensures that Brexit politics will dominate market attention and heighten sterling volatility.
Are Italian bank funding costs sustainable?
Intesa Sanpaolo reopened the unsecured funding market for Italian banks this week, breaking a four-month long drought in the issuance of senior bonds from the country’s lenders.
It does not take a bank-funding expert to work out why no Italian lender had dared to venture into this market since April. The political turmoil surrounding the formation of Italy’s populist government the following month drove a severe rout in Italian sovereign debt, which has persisted into the summer.
For Italy’s lenders, it is not just that these sovereign bond ruptures cause a ripple effect. Despite the efforts of EU policymakers to break the so-called “doom loop” between eurozone countries and their banking systems, Italian banks are still massive holders of BTPs.
UniCredit, for example, held €55bn of Italian sovereign bonds at the end of June, outweighing its €45bn buffer of common equity tier one capital. No wonder the Italian bank’s chief executive said in May that the sell-off in the country’s government debt was “not justified.”
Intesa’s debt raise will rightly be considered a success in Turin, with Italy’s largest domestic lender raising €1bn of new debt on the back of €1.7bn of demand. Its funding costs have increased significantly, however. Intesa’s last euro senior bond, a 10-year deal raised in March, came at 77 basis points over the mid-swaps benchmark. On Thursday it had to pay 188 basis points over the same benchmark of five-year money.
While one of Italy’s top-tier lenders can withstand such a rise in its funding costs, the read across for where the country’s second- and third-tier lenders can raise new debt is troubling.