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‘Blue wave’ trade back on after Georgia Senate poll

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The reflation trade in global markets has suddenly been given a big kicker.

With the US Senate run-off elections in Georgia close to giving control of the chamber to Democrats, investors are betting the result will deliver increased spending under president-elect Joe Biden to boost the ailing US and global economies and inflation.

That had been the consensus expectation before November’s election but uncertainty over the Senate outcome led investors to rein in stimulus hopes even as economic clouds grew darker with the spread of the new Covid-19 variant. Now the “blue wave” bets are back on.

“A sweep for the Democrats will probably lead to additional stimulus measures that would likely boost short-term economic growth,” said Steve Chiavarone, portfolio manager at Federated Hermes, in a note.

The US economy had already been expected to rebound in 2021, with the World Bank forecasting a 3.5 per cent expansion after a 3.6 per cent contraction last year.

The Georgia results further bolster the case for owning companies in sectors that can benefit from such growth such as banking, energy and industrials. Higher demand is also expected to boost commodities and emerging markets. The latter would additionally benefit from a weaker dollar if higher inflation erodes the value of the global reserve currency. And higher inflation might also drive down investor demand for US Treasuries.

“Higher growth could also push longer-term interest rates higher — something that is good for financials, but bad for bonds as well as interest rate-sensitive sectors,” said Mr Chiavarone.

The potentially inflationary consequences of greater government spending have not been ignored by the bond and currency markets in recent months.

Expectations of US inflation over the next decade implied by bond trading had risen beyond 2 per cent this week, a level last visited in 2018. In turn, the dollar weakness of late has gained momentum. The dollar index was approaching its lowest level in nearly three years on Wednesday.

But the big market development is that, for the first time since March, the 10-year Treasury yield, a crucial benchmark for financial assets, has risen above 1 per cent. The bond market anticipates more sales of debt to fund a hefty fiscal Biden spending package in the coming months that goes well beyond the $900bn package of support measures passed in December.

Economists at Goldman Sachs expect a Democratic Senate majority to seek “additional fiscal stimulus in the near term” in the region of $600bn or 2.7 per cent of gross domestic product. This would be followed by a limited amount of tax increases and spending rises later in the year.

This sets a challenge for the Federal Reserve. Central bank officials welcome the prospect of higher inflation and have said they are prepared to tolerate a period of core prices running above their 2 per cent target for a yet to be determined period.

But the Fed is also attuned to the problems created by a long period of slumbering inflation and rock-bottom interest rates. Institutional investors have been compelled to pay a premium for faster-growing companies, and aggressive retail investors have fuelled the rally in recent months.

Allowing 10-year yields to rise sharply would run the risk of triggering a big retreat from bonds and tech shares and sparking broader market turmoil.

The likelihood of stronger corporate earnings from improving underlying economic growth will support the prices of equities in general. But that must be weighed against the negative impact that higher interest rates have on expensive tech and growth stocks. The valuation of such stocks can suffer when their future cash flows are discounted by higher rates.

To some extent, this was playing out during early trading in New York on Wednesday with the Russell 2000 index of small-caps up 4.4 per cent, while the tech-heavy Nasdaq was flat.

Ian Lyngen, head of US rates strategy at BMO Capital Markets, said signals from the Fed on how comfortable it was with higher Treasury yields would be critical to the market outlook. “It’s the implied willingness to allow rates to drift higher that will be in question,” he added.

For now both the Fed and investors have some time on their side. But later this year, a stronger economy buoyed by Covid-19 vaccines and hefty government spending will require much higher interest rates and indications of far less monetary support from the Fed.

michael.mackenzie@ft.com



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Pimco’s Ivascyn warns of inflationary pressure from rising rents

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US Inflation updates

A leading US bond manager has warned of inflationary pressure from housing rental costs that could push interest rates higher and overturn a sense of complacency among investors.

The comments by Dan Ivascyn, chief investment officer at Pimco, which has $2.2tn under management, comes after US 10-year interest rates eased in recent months to about 1.25 per cent. Fears of an inflation surge sparked alarm among bond investors at the start of the year and pushed the important benchmark to a peak of 1.75 per cent by the end of March.

“There is a lot of uncertainty on inflation and while our base case is that it proves transitory, we are watching the relationship between home prices and rents,” Ivascyn told the Financial Times. “There may be more sustained inflation pressure from the rental side.”

Owners’ equivalent rent is a key input used for calculating the US consumer price index. As rents become more expensive, investors could become increasingly concerned about “sticky inflation”, pushing the 10-year Treasury yield back towards 1.75 per cent, said Ivascyn. 

Line chart of US 10-year expected rate of inflation showing long-term bond market inflation expectations loiter near decade peaks

The Federal Reserve said in its latest policy statement last week that it had made “progress” towards its goals of full employment and 2 per cent average inflation. Jay Powell, the Fed’s chair, said there was more “upside risk” to the inflation outlook, although he expressed confidence in transitory price pressure over time.

The latest measure of core consumer prices, which is followed by the central bank, ran at 3.5 per cent over the 12 months to June, the fastest pace since July 1991.

“There is a lot of noise and uncertainty in the data” and “the Fed has a difficult job deciphering the economic information coming in”, said Ivascyn.

The fund manager said the potential for much higher bond yields is probably capped by the prospect of the central bank tightening policy in the event of inflation expectations breaking higher.

Bar chart of assets under management ($bn) showing Pimco Income ranks as the largest actively managed bond fund

“We do believe if the Fed sees inflation expectations rise out of their comfort zone, that they will probably act,” said Ivascyn. “That has been the message from Powell’s last two press conferences.”

Pimco expects the central bank will announce a tapering of its current $120bn monthly bond purchases later this year, with a view to starting the process in January. While the policy shift is being “well telegraphed” and data dependent, Ivascyn said higher bond yields and more market volatility were likely.

“This is a tough market environment and it is a time when you want to be careful,” he said, adding that Pimco had been reducing its exposure to interest rate risk as the bond market had pulled borrowing costs lower. 

“Valuations are stretched and it makes sense to adjust our portfolios.”

Ivascyn oversees the world’s largest actively managed bond fund, according to Morningstar. The $140bn Pimco Income Fund co-managed with Alfred Murata, has a total return of 2 per cent this year, versus a slight decline in the Bloomberg Barclays US Aggregate index. Over the past year, the fund has extended its long record of beating its benchmark, according to Morningstar.



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Wall Street stocks follow European and Asian bourses lower

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Equities updates

Wall Street stocks followed European and Asian bourses lower on Friday after markets were buffeted this week by jitters over slowing global growth and Beijing’s regulatory crackdown on tech businesses.

The S&P 500 closed down 0.5 per cent, although the blue-chip index still notched its sixth consecutive month of gains, boosted by strong corporate earnings and record-low interest rates.

The tech-focused Nasdaq Composite slid 0.7 per cent, after the quarterly results of online bellwether Amazon missed analysts’ forecasts. The tech conglomerate’s stock finished the day 7.6 per cent lower, its biggest one-day drop since May 2020.

According to Scott Ruesterholz, portfolio manager at Insight Investment, companies which saw significant growth during the pandemic may see shifts in revenue as consumers move away from online to in-person services.

“[Consumers are] going to start spending more on services, and so those businesses and industries which have benefited in the last year, companies like Amazon, will be talking about decelerating sales growth for several quarters,” Ruesterholz said.

The sell-off on Wall Street comes after the continent-wide Stoxx Europe 600 index ended the session 0.5 per cent lower, having hit a high a day earlier, lifted by a bumper crop of upbeat earnings results.

For the second quarter, companies on the Stoxx 600 have reported earnings per share growth of 159 per cent year on year, according to Citigroup. Those on the S&P 500 have increased profits by 97 per cent.

But “this is likely the top”, said Arun Sai, senior multi-asset strategist at Pictet, referring to the pace of earnings increases after economic activity rebounded from the pandemic-triggered contractions last year. Financial markets, he said, “have formed a narrative of peak economic growth and peak momentum”.

Column chart of S&P 500 index, monthly % change showing Wall Street stocks rise for six consecutive months

Data released on Thursday showed the US economy grew at a weaker than expected annualised rate of 6.5 per cent in the three months to June, as labour shortages and supply chain disruptions caused by coronavirus persisted.

Meanwhile, China’s regulatory assault on large tech businesses has sparked fears of a broader crackdown on privately owned companies.

“It underlines the leadership’s ambivalence towards markets,” said Julian Evans-Pritchard of Capital Economics. “We think this will take a toll on economic growth over the medium term.”

Hong Kong’s Hang Seng index closed 1.4 per cent down on Friday, while mainland China’s CSI 300 dropped 0.8 per cent, after precipitous slides earlier in the week moderated.

Japan’s Topix closed 1.4 per cent lower, after the daily tally of Covid cases in Tokyo surpassed 3,000 for three consecutive days. South Korea’s Kospi 200 dropped 1.2 per cent.

The more cautious investor mood on Friday spurred a modest rally in safe haven assets such as US government debt, which took the yield on the 10-year Treasury, which moves inversely to its price, down 0.04 percentage points to 1.23 per cent.

The Federal Reserve, which has bought about $120bn of bonds each month throughout the pandemic to pin down borrowing costs for households and businesses, said this week that the economy was making “progress” but it remained too early to tighten monetary policy.

“Tapering [of the bond purchases] could be delayed, which in many ways is not bad news for the market,” said Anthony Collard, head of investments for the UK and Ireland at JPMorgan Private Bank.

The dollar, also considered a haven in times of stress, climbed 0.3 per cent against a basket of leading currencies.

Brent crude, the global oil benchmark, rose 0.4 per cent to $76.33 a barrel.

Unhedged — Markets, finance and strong opinion

Robert Armstrong dissects the most important market trends and discusses how Wall Street’s best minds respond to them. Sign up here to get the newsletter sent straight to your inbox every weekday



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US regulators launch crackdown on Chinese listings

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US financial regulation updates

China-based companies will have to disclose more about their structure and contacts with the Chinese government before listing in the US, the Securities and Exchange Commission said on Friday.

Gary Gensler, the chair of the US corporate and markets regulator, has asked staff to ensure greater transparency from Chinese companies following the controversy surrounding the public offering by the Chinese ride-hailing group Didi Chuxing.

“I have asked staff to seek certain disclosures from offshore issuers associated with China-based operating companies before their registration statements will be declared effective,” Gensler said in a statement.

He added: “I believe these changes will enhance the overall quality of disclosure in registration statements of offshore issuers that have affiliations with China-based operating companies.”

The SEC’s new rules were triggered by Beijing’s announcement earlier this month that it would tighten restrictions on overseas listings, including stricter rules on what happens to the data held by those companies.

The Chinese internet regulator specifically accused Didi, which had raised $4bn with a New York flotation just days earlier, of violating personal data laws, and ordered for its app to be removed from the Chinese app store.

Beijing’s crackdown spooked US investors, sending the company’s shares tumbling almost 50 per cent in recent weeks. They have rallied slightly in the past week, however, jumping 15 per cent in the past two days based on reports that the company is considering going private again just weeks after listing.

The controversy has prompted questions over whether Didi had told investors enough either about the regulatory risks it faced in China, and specifically about its frequent contacts with Chinese regulators in the run-up to the New York offering.

Several US law firms have now filed class action lawsuits against the company on behalf of shareholders, while two members of the Senate banking committee have called for the SEC to investigate the company.

The SEC has not said whether it is undertaking an investigation or intends to do so. However, its new rules unveiled on Friday would require companies to be clearer about the way in which their offerings are structured. Many China-based companies, including Didi, avoid Chinese restrictions on foreign listings by selling their shares via an offshore shell company.

Gensler said on Friday such companies should clearly distinguish what the shell company does from what the China-based operating company does, as well as the exact financial relationship between the two.

“I worry that average investors may not realise that they hold stock in a shell company rather than a China-based operating company,” he said.

He added that companies should say whether they had received or were denied permission from Chinese authorities to list in the US, including whether any initial approval had then be rescinded.

And they will also have to spell out that they could be delisted if they do not allow the US Public Companies Accounting Oversight Board to inspect their accountants three years after listing.



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