The Fed doubled monthly taper to $30 billion, which, if uninterrupted, will wind down QE by the FOMC’s March 17th meeting. The S&P500 briskly popped 1.6% on the news. In response to the market jump, a pundit commented: “They did what was expected. It’s going to add to the credibility for the Fed and that will be on balance neutral to positive for the markets.” Wednesday afternoon’s rally – and, more generally, the week’s volatility – had much more to do with Friday’s December expiration of options and derivatives than Federal Reserve credibility. The S&P500 dropped 1.9% in Thursday and Friday trading.
It was another volatile week for global markets, stoked by a combination of central bank meetings and heightened Covid anxieties.
December 16 – Financial Times (Chris Giles and James Pickford): “The Bank of England has raised interest rates from 0.1% to 0.25% in its first increase in more than three years, saying that the risks of inflation required it to take pre-emptive action even as the UK is engulfed by the Omicron wave of coronavirus. Surprising financial markets… for the second consecutive month and voting 8-1 in favour of higher interest rates, the bank’s Monetary Policy Committee decided it could no longer wait before seeking to cool spending in the economy. After the meeting Andrew Bailey, BoE governor, said: ‘We’ve seen evidence of a very tight labour market and we’re seeing more persistent inflation pressures’. Admitting that inflation was heading up to around 6%, the governor added: ‘We’re concerned about inflation in the medium term. And we’re seeing things now that can threaten that. So that’s why we have to act.’”
December 16 – Financial Times (Martin Arnold and Tommy Stubbington): “The European Central Bank said it would scale back its crisis bond-buying in response to soaring inflation, but committed to continue asset purchases for at least 10 months and ruled out raising interest rates next year. The decision, which contrasts with a more aggressive withdrawal of crisis support by the US Federal Reserve and Bank of England this week, led to a fall in eurozone bond markets on Thursday as investors absorbed the ECB’s plan to sharply reduce its bond purchases in 2022. Christine Lagarde… said the eurozone economy had recovered enough to allow a ‘step-by-step reduction in the pace of asset purchases’. But she added: ‘Monetary accommodation is still needed for inflation to stabilise at our 2% inflation target over the medium term.’”
Clinging to her uber dovish pre-commitment to no rate hikes in 2022, Christine Lagarde ensures contentious Governing Council meetings, along with more German “madam inflation” rebuke. Lagarde must have one eye fixated on a vulnerable European banking system loaded with periphery debt (i.e. Greece, Italy, Portugal, Spain…). While the Fed and ECB meetings went off as anticipated, the Bank of England surprised the markets with a rate increase despite a record surge in Covid infections. Principled Central Banking.
Powell was widely lauded for his press conference performance. It didn’t hurt that he faced a steady stream of soft-ball questions. For posterity, I’ll chronicle his cogent comments on the labor market, which have evolved remarkably over the past two FOMC meetings.
Powell: “Well, the labor market is, by so many measures, hotter than it ever ran in the last expansion, if you think about it. The ratio of job openings, for example, to vacancies is at all-time highs, quits — the wages, all those things are even hotter. But what would it take for labor force participation to move up more? You know… “Why is it low?” that is the question. So, there are a bunch of answers and all of them probably have some validity. Part of it will be that for certain people, they don’t want to go back in the labor force because either they’re medically vulnerable or they’re not comfortable going back while COVID is still everywhere. That’s one thing. The lack of availability of childcare made for caretakers is certainly part of it, not just for children, but for older people. It has been pointed out by many that the stock market is high people’s portfolios are stronger, they may go back to being a one-income rather than a two-income family. The same thing with people’s houses, people buy… with leverage, and the house price increases, the equity they have in their home might have doubled. And they might reach the same conclusion. And people have savings on their balance sheet because of forced savings that — because they couldn’t spend on travel and things like that – and also because of government transfers. So, for all of those reasons, and it’s hard to know exactly the part each of them plays, we have a situation where we’ve had a shock to labor force participation that is not unwinding as quickly as many had expected.”
December 16 – Financial Times (Rich Miller, Steve Matthews and Christopher Condon): “Federal Reserve Chair Jerome Powell signaled on Wednesday that inflation is now enemy No. 1 to keeping the U.S. economic expansion on track and returning the labor market to something approaching ebullient pre-pandemic levels. In an abrupt policy pivot, the Fed sped up the drawdown of its asset-purchase program and laid out a road map for a series of interest-rate increases over coming years, starting with three hikes in 2022. Powell also raised the possibility that the central bank might begin to withdraw liquidity from the financial system before too long by reducing its massive balance sheet.”
The above article ran with the headline, “Powell Declares Inflation Big Threat as Fed Signals Rate Hikes.” And while stocks initially surged, the bond market had a muted response to Powell. Ten-year Treasury yields ended the week down eight bps to 1.40%. With the Fed now promptly winding down QE and apparently soon to commence a rate hike cycle, such low Treasury – and global – yields remain somewhat of a conundrum.
From the Credit Bubble analytical perspective, Treasury, Bund, and “developed” yields more generally confirm the view that the global central bank community’s so-called “tightening” cycle will be curtailed by faltering Bubbles.
December 14 – Reuters (Liangping Gao and Ryan Woo): “China’s property market suffered more headwinds in November, with home prices, sales, investment and construction all falling, weighed by weak demand and a cash crunch among developers… ‘Cities of all classes are under pressure,’ said Yan Yuejin, director of… E-house China Research and Development Institution. ‘The current scale of market supply is large and demand is weak. The key is to accelerate inventory de-stocking to stabilise home prices…’ ‘For the supply side, new construction starts as measured by floor area tumbled 21.03% on year in November, down for the eighth month, while property investment by developers fell 4.3%.’”
Rocked by troubles at Shimao (yields surging to 130% Wednesday after closing the previous week at 30%), Chinese developer bonds gave back much of last week’s policy-induced rally. Shimao was considered one of the more financially stable developers, with yields beginning October at 5.5%.
December 16 – Bloomberg: “China Fortune Land Development Co. said it has been unable to get hold of a money manager that it gave $313 million for investment, the latest blow for the debt-laden developer. Fortune Land has ‘lost contact’ with China Create Capital Ltd., a British Virgin Islands-registered firm to which it handed over $313 million in 2018 in hopes of receiving an annual return of 7%-10% through 2022, it said in a filing…”
How rotten are some of these developers – and high-yield Chinese Credits more generally? An index of Chinese high-yield dollar bonds saw yields this week jump 150 bps to 21.6%, giving up much of the previous week’s rally. Whether it’s apartment sales and prices, property investment or industrial production, recent data confirm waning Chinese growth. At a disappointing 3.9% (expectations 4.7%), November Retail Sales adjusted for inflation were barely positive year-on-year.
Especially late in the week, global markets were rocked by the prospect of a rapidly building wave of Omicron infections. China’s Shanghai Composite was down 1.16% in Friday trading. While China’s “zero tolerance” policy has been highly effective in containing the Delta variant, Omicron’s timing is problematic.
Future historians will surely identify the pandemic as a pivotal development in a cycle of extraordinary global innovation and excess. Covid erupted at the tail end of a historic Bubble, with late-cycle fragilities particularly apparent within Chinese and U.S. Bubbles (Fed QE commenced in September 2019). Omicron’s timing is similarly opportunistic. With inflation raging globally, central banks have begun pulling back unprecedented global monetary inflation. The Fed and others are reducing bond purchases, while the Bank of England and scores of developing central banks have commenced rate normalization.
December 17 – UK Guardian: “The UK reported 93,045 new Covid cases today, breaking the daily record for the third consecutive day. There were also 111 new Covid deaths reported and 7,611 patients in hospital, 875 of whom were on beds with ventilators. It comes after yesterday there were 88,376 new cases reported and 78,610 new cases the day before, both breaking all previous pandemic records.”
At this point, let’s assume that Omicron symptoms are less severe than Delta’s. But it’s transmissibility that today poses major global risks. Studies suggest most populations are highly exposed to infection. The variant has been shown to evade immunity, both from vaccines and previous infections. Booster shots should provide significant protection, though only about 17% of the U.S. population is today fully vaccinated.
A Bloomberg summary (Trevor Bedford): “U.K. data show increased household transmission risk, increased secondary attack rates (such as the chance of each case infecting another individual) and increased growth rates compared to delta. That means omicron is likely to out-compete delta and predominate there, the UKHSA said Dec. 8. A previous Covid-19 recovery provides little shield against infection with the omicron variant, a research team from Imperial College London showed… Having had Covid probably offers only 19% protection against omicron, the study showed Dec. 17. That was roughly in line with two doses of vaccine, which the team estimated were as much as 20% effective against omicron. Adding a booster dose helped dramatically, blocking an estimated 55% to 80% of symptomatic cases.”
Covid highlights from Bloomberg: “New York state is experiencing a dramatic spike in Covid-19 cases. The state reported 21,027 new cases Friday…, surpassing the previous record of 19,942 set in January. Of the roughly 263,500 people tested, 7.98% were positive for the virus. The rapid rise comes in lockstep with the emergence of the omicron variant…”
“Positive tests from Cornell University students show a high rate of omicron transmission among 18-to-24 year-olds… Among a batch of 115 positive cases, prioritized for sequencing due to the rapid spread observed, all showed infection from the omicron variant…”
“Texas has seen a 43% rise in new cases in the past week as hospitals in some regions of the second-largest U.S. state grapple with the latest wave. There were 5,011 new cases reported in the past 24 hours, a 17% increase in one day…”
With Delta surging nationally and warnings of an imminent spike in Omicron infections (with already stressed hospitals), the return of mandates, restrictions, and canceled entertainment and sporting events – there’s some dread that we’re returning to the March 2020 nightmare. But experts counter that we are today so much better prepared than at the start of the pandemic (i.e. vaccines, therapeutics, knowledge and experience, etc.). I do, however, fear that pandemic fatigue and some dismissiveness now associated with Covid – especially Omicron with its seemingly mild symptoms – leave us awfully vulnerable.
Global markets appear acutely vulnerable. Crisis dynamics took a turn for the worse in Turkey. The lira sank another 15.4% this week, pushing the currency’s November/December decline to 41.5% (down 54.7% y-t-d). Turkey’s central bank intervened for the fifth time this month to support the lira, further depleting already sparse international reserves. Turkey’s $125 billion of short-term foreign-denominated debt looms large. Turkish lira bond yields surged 79 bps Friday to a record 21.4%. Turkey’s sovereign CDS spiked 78 higher this week to an 18-year high 578 bps. Ominously, the Turkish equities melt-up reversed sharply lower in Friday trading, with trading halts triggered twice before stocks ended the session down 8.5%. Who’s next?
The faltering Chinese Bubble unleashed contagion upon the emerging markets. Ongoing QE from the Fed, ECB and others (not to mention booming U.S. markets and economic growth) have so far helped to cushion the blow. Perceptions that Beijing has everything under control further explain the relatively moderate contagion dynamic.
Going forward, Omicron’s pandemic invigoration has the potential to spur a more forceful global de-risking/deleveraging dynamic. While Turkey took the brunt, this week saw the Columbian peso drop 3.2%, the Brazilian real 1.4%, Russian ruble 1.1%, Hungarian forint 1.0% and Polish zloty 0.8%. Local currency yields surged 40 bps in Brazil, 25 bps in Czech Republic, and 11 bps in Indonesia.
I’ll note a couple Friday Bloomberg headlines, “The Fed’s Talk of Raising Rates Has Made Them Go Down Instead,” and “Rates Market Calls Fed’s Bluff After Historical Hawkish Pivot.” Five-year Treasury yields this week dropped eight bps to 1.18%, with two-year yields declining two bps to 0.64%. My headline chuckle of the week was courtesy of Dow Jones: “Federal Reserve Officials Complete Policy Pivot in Face of High Inflation.”
Much premature for mission accomplished. I don’t fault the bond market for assuming the Fed’s “tightening” cycle goes nowhere. After all, unfolding global contagion and “risk off” could stop the Fed’s timid little tip-toeing in its tracks. The stock market, of course, is cocksure the Fed will continue to do whatever it takes to sustain the forever bull market. Our central bank for a while now has ensured that disregarding risk pays off handsomely.
It was 22 months ago (2/21/20) that I titled a CBB “Pandemic Risk Rising.” The S&P500 traded that Friday at an all-time high. Clearly, escalating risks were being completely disregarded. I’m going this week with “Pandemic Risks Rising – Again.” I hope this analysis turns out embarrassingly amiss.
After being first identified in South Africa just four weeks back, Omicron is now spreading in at least 77 countries. Seventeen days ago, the first case was detected in the U.S. It’s speedily made its way to at least 40 states. Worse yet, Omicron launched its exponential growth right into the holiday season and winter months – collaborating with dangerous Delta (with national hospitalizations up 20% over the past week). Models warn of the potential for daily infections to surpass a mind-numbing 500,000. Hospitals across the country already face acute fatigue, along with shortages of nurses and other healthcare professionals.
Let’s assume that Omicron symptoms are less severe and lethal. But that wouldn’t diminish myriad risks to the economy and markets. Even if governments are determined to refrain from painful lockdowns, a massive wave of infections would create challenges for many businesses to continue with normal operations. If Covid is running rampant, would people rationally choose to hole up in the safety of their homes? Many are making such decisions in London and throughout the UK.
I worry about already stretched supply chains. In the event of mass infections of a highly transmissible virus, scores of manufacturers may struggle to maintain adequate staffing. Workers in meat and food processing plants might not be falling seriously ill as in the initial Covid wave, but positive test results would nonetheless send them into quarantine. Can we keep our depleted truck-driver force healthy? Everyone is determined to do everything possible to ensure our schools remain open. Mild symptoms or not, a massive wave would prove too much to bear. How about travel and leisure? We’re all sick and tired of Covid and want our normal lives back. We can’t allow mild “flu” symptoms to hold us back. And this is exactly the mindset that could provide Omicron an opening not enjoyed by Alpha or Delta.
How about global supply chains? What’s unfolding in the UK and Europe is frightening. Asia is struggling even before Omicron takes hold. A Thursday headline: “South Korea Reimposes COVID-19 Curbs Amid ‘Mayhem’ at Hospitals.” After so successfully containing Covid earlier in the pandemic, the virus is now spiraling out of control in South Korea.
And what if China’s “zero tolerance” strategy backfires – perhaps epically? A Friday headline: “China Manufacturing Hub Locks Down Over Coronavirus, Threatening Economy.” Omicron’s extraordinary transmissibility will only compound containment challenges. The effectiveness of China’s vaccines in protecting against Omicron is in doubt, while “zero tolerance” policies have spawned a population with minimal acquired natural immunity. Also, throw the population density of Chinese cities into the analytical mix. And it’s now only about six weeks until the Beijing Winter Olympics.
It’s not unreasonable to assume China won’t be able to hold the virus in check. That would mean lockdowns and an economic body blow to a fragile system already in concussion protocol. There is tremendous national pride in hosting the Olympics. But come February, will Beijing be willing to take the risk?
In the event of a powerful wave, I worry about supply chains both domestic and international. We all remember panic buying of toilet paper early in the pandemic. We’ve all experienced the inability to purchase various products previously in abundant supply. Whether households or businesses, “just in time inventory” has revealed its shortcomings. Inflationary dynamics have taken root. The psychological elements are in place for a bout of stocking up to unleash panicked hoarding.
The probabilities of a problematic Big Wave are rapidly increasing. Pandemic Risks Rising – Again. And if this scenario materializes, Fed policymaking will emerge as one of the great risks. Safe to say taper will be heaved out the window. If markets buckle under the weight of another March 2020-type de-risking/deleveraging, will the Fed’s Trillions again rise to the rescue of (ever larger) Bubble markets? And what might that mean for already powerful inflationary dynamics and hoarding?
Original Post 18 December 2021
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Categories: Doug Noland