24 October, 2022 - Central Banks at center-stage once again.



The ECB meeting on Thursday and the FED meeting on Wendesday of next week are going to be closely watched again. In the ECB's case a , second in a row, increase of 75bps is a done deal, but the markets will look for hints on what the central bank will also do on the 15th of December, when the final meeting of 2022 is to be held. The market has already priced that the terminal rate would be closer to 3%, so we have still a long way to go if this were to prove correct. According to most analysts and some ECB officials the 2.5% terminal rate looks, however, most appropriate. The FED meeting is also going to deliver a 75bps increase the following week, with the market now pricing a terminal rate of 5% early next year. Again, with the market having already discounted a 75bps increase also for December, any hint that the actual increase could be 50bps instead of 75bps will create the ground for a relief rally in equities and bonds towards year-end.


The Bank of England confirmed it will begin the process of selling bonds it accumulated under its quantitative easing program on 1st of November. Its statement came after a prior Financial Times report said the Bank would delay asset sales due to recent market volatility, which it denied. A slight change vs the original plan is the focus on short and medium-term bonds, leaving out of their sales schedule the longer-term bonds in order to avoid further market turbulence which could impact again the pension funds.


At the same time Mrs. Truss announced her resignation after just a few weeks in office, during which the UK bond market almost broke down and the GBP fell to its lowest level ever. The resignation brought more volatility in the UK markets, which quickly spilled over to all asset classes globally. Former Chancellor (Finance Minister) Sunak appears to be the top candidate and the next PM should be in office by the end of this week.


Equities rallied in a volatile week and despite the new highs in bond yields. This was a very interesting development, showing that the parallel sell-off in bonds and equities this year has created tremendous opportunities in both asset classes, on a long-term basis. US equities rallied by 5% and the S&P500 is now almost 7% higher than the recent low. October is living up to its expectations for being a month which registers lows, even if these are for a short-term. Europe moved higher by about 2% on average, as the UK turmoil held back any enthusiasm.


The US retail investor seems to be capitulating. According to various surveys which were published this week, the retail investors have increased significantly their selling of US stocks in the last month, as the market moved to a new low. This could be a positive, contrarian sign, as typically the mass of retail investors enters the markets close to their highs and exits it close to the lows. A capitulation of the retail investor is needed to mark the bottom as always, and maybe we are getting some first signs of it.


The US housing market continued to deteriorate fast, according to the September data. The National Association of Home Builders (NAHB) Index dropped much more than expected to 38, which is the lowest level since 2012, if one excludes the brief drop close to 30 in April/May of 2020, during the first lockdowns. Housing Starts also dropped by 8% vs the previous month and although Building Permits rebounded slightly, they remain close to a 2-year low. With mortgage rates close to 7%, up from 3% at the start of the year, housing is the first sector to have visibly entered a recession in the US.


Oil prices continue to be a "battlefield" between OPEC and the US. Prices have fallen by more than 10% after the OPEC meeting which decided a cut in production, in order to maintain the prices a high level. At the same time, the US administration is having active talks with US oil companies to convince them to invest and increase production, in order to prevent prices from moving higher. Those talks include incentives in the form of "promises" that the US will buy the excess oil from them if prices fall below a certain level (70$ is mentioned). These purchases by the US government will take place in order to rebuild their strategic reserves, which are now about 400bn barrels , down from almost 600bn a few months ago, as the US government has released into the market 180bn barrels. This "bras-de-fer" between the east and the west has a lot more episodes ahead.


Bond yields moved higher with no major news, other than the BoE news mentioned above. The 10-year US yield rose by more than 25bps to 4.25% but in early Friday it had risen risen all the way to 4.40%. Reports that FED officials are watching the situation in the markets with nervousness gave rise to the "peak-hawkishness" scenario, which we have been talking about in the last few weeks. The drop in yields was sudden which spilled over to equities very quickly. The German 10-year yield rose to 2.45%, little lower than the high of 2.50% of the week.


The USD weakened further, albeit at a very slow pace. This can be considered another sign that financial markets are looking ahead in a slightly more positive way than at the end of September when the EURUSD touched 0.95 and the DXY (Dollar Index) reached a 20-year high. A lot will depend on what the ECB does and says on Thursday to get any meaningful movement in EUR's direction in the short-term. The EURUSD finished the week close to 0.9800.


We are entering the busiest period for the 3rd quarter corporate results, including the big technoloy names in the US, this week. Up until now, the picture does not look that bad, with some exceptions as always. Some of the early focus has been on the banks, where Net Interest Margin and Net Interest Income have tended to come in stronger due to higher interest rates. From the Consumer staples sector it is again becoming apparent that up to now companies have demonstrated pricing power, which has helped to offset the otherwise underwhelming volume performance. A major headwind facing a wide range of US based companies seems to be the USD strength, where guidance has reflected even more pressure in Q4. On the contrary, USD strength is going to help many European companies to show much better results than otherwise and this is the main reason why profits seem to be holding up well.


In corporate news, Nestlé posted solid revenue growth of 8.5% in the 3rd quarter. It is worth noting however, that 7.5% of the growth was attributed to price increases and "real" growth was the remainining 1%, which is much lower than the usual 3-5% growth the company enjoys. This shows that even for food-related companies there is a limit to how much of the increased cost can be passed on to consumers, before they reduce significantly their spending. This is also good news for inflation in the months ahead. (see also chart of the week). Netflix posted strong subscriber growth, after two consecutive quarters of losing clients and its shares moved higher by more than 10%. Netflix belongs in the beaten-down communications sector (along with the likes of Google, Facebook and Disney), which look very attractive on a longer-term basis. Bank of America and Goldman sachs posted strong results, as all other US banks that have reported so far, helped by the rise in interest rates but also by the volatility in the bond markers which has made the volume in bond trading increase.

 

Chart of the Week :

Approaching the tipping point for inflation



This chart is very revealing as to why inflation has stayed high, despite some visible drop in prices of certain categories. The explanation is the following: While declining prices for gas and certain other physical products have cooled consumer goods inflation (the blue line), rising prices for consumer services — which account for a larger share of spending — are still rising (yellow line). But perhaps this is about to change. In September, consumers’ purchasing behavior showed that higher services inflation has not gone unnoticed. In a reversal from earlier this year, when consumers were most inclined to reduce discretionary goods purchases, services categories registered the highest index scores for Price Sensitivity and Substitutability in September. This latest development suggests that recent increases in inflation may be slowing the ongoing reallocation of goods spending to services . And this means that the yellow line should start declining soon, bringing overall inflation down finally.


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