Market movers today
- While global risk sentiment, stagflation risk and developments in the Chinese real estate market will take centre stage today we do have a range of central bank meetings to follow.
- First comes the Riksbank meeting. In short, we expect the Riksbank to leave policy rates unchanged and maintain a fully flat rate path at zero. That said we acknowledge that recent developments and not least the August inflation print could trigger a slight hiking bias in the very long-end of the rate path. For more information on the Riksbank please see our Scandi section.
- We expect the Hungarian central bank to keep the policy rate unchanged at 1.5% while consensus is looking for a hike to 1.75%. Either way, it is not a big market event.
- Besides that US data on building permits and housing starts in August are due out 14:30 CEST.
- At a meeting ending early Wednesday we expect the Bank of Japan will keep its QQE with yield curve control policy unchanged. With the economy still hampered from the lockdown, it is wait and see mode until pandemic programmes can be withdrawn next year.
The 60 second overview
Markets sentiment suffers …: Global risk sentiment has taken a big hit over the last week. Sour sentiment has continued this week with equities moving lower across sectors, option volatilities moving higher across markets, credit spreads widening, core yields declining and long-end inflation expectations stalling. Interestingly, we are now also seeing global commodity prices trading on the back foot. Precious metals incl. gold have posted declines amid higher real rates but also industrial metals and energy have come considerably lower from the 2021 peak set earlier in September.
… as growth outlook takes a hit: Key to the change in market sentiment are global growth prospects, the risk of stagflation (see next section) and recently heightened focus on the state of the Chinese real estate sector. The latter is not least a reaction to the country’s second biggest business developer Evergrande struggling to pay upcoming debt payments. While this leaves important contagion risks to follow we think the implied signal of a weak credit impulse from China to the rest of the global economy is as important.
Stagflation: This morning we published a new piece looking at the financial market implications of the stagflation risk scenario (for which we see a probability of 30%). While we think the central banks will be patient with regard to reacting to the high inflation into H1 2022 (especially given the weak underlying economic momentum), we think they will ultimately tighten monetary policy to avoid a de-anchoring of inflation expectations. This would lead to a significant rise in short-end US real rates and stronger USD, which will hit global risk sentiment, sending global equities lower and credit markets spreads wider especially for the high yield segment. While long-end rates would initially increase, we think the significant hit to the global growth outlook will reverse the sell-off in the long-end of rates curves, forcing a flattening of yield curves. For more details, Global Research – Market implications in a global stagflation scenario.
Air travel to the US: The Biden administration has announced that by November fully vaccinated people will be able to travel to the US from anywhere in the world. A negative COVID-19 test taken less than 3 days prior to the test is also a condition next to proof of vaccination. A decision has yet to be announced on which vaccines that will be accepted. Airliners rose on this announcement which we also regard positive for US growth prospects.
European energy crisis: Continental gas and electricity prices continue to move higher leaving the risk of hitting the European recovery post COVID-19 and hampering the prospects of green reforms. Yesterday, the second biggest gas supplier to the EU in Norway announced plans to step up supplies from Friday as Equinor is set to boost production from two North Sea fields. Also governments around Europe – most recently in Spain and Italy – are discussing measures to help consumers and companies via direct aid packages. Critiques argue that governments should not intervene in a market where part of the rise in prices is structural amid politicians combatting fossil fuel investments and raising black energy costs by changing the market for CO2 quotas. Proponents argue that this energy crisis shows the urgency of further investments in sustainable energy.
Equities: Full-blown risk-off struck markets yesterday for a first in a very long time. Risk-off also went cross asset, as investors rotated into cash or bonds and sold off most sectors and stocks. S&P 500 dropped -1.7% (and -2.9% intraday at most) with only 50 out of 500 shares higher. Nasdaq -2.2%, Dow -1.8% and Russell 2000 -2.4%. Implied volatility spiked, with VIX just south of 30 intraday, before falling back to 26. Among sectors, energy, financials (both insurance and banks), autos and materials were hit worst. Interestingly, big tech did not prove much safety, but drove weakness in consumer discretionary. Safe haven sectors such as utilities and health care and consumer staples coped best. Sentiment appears to have stabilised this morning. Chinese markets are still closed for holiday, and newly opened Nikkei is doing a -1.7% catch-up but Hong Kong only -0.3%. US futures point to a rebound with futures nearly 1% higher.
FI: A classical flight to quality theme was playing out in the markets yesterday on the back of the Evergrande story from China. Bunds dropped 4bp while intra-euro area spreads widened across the board, led by Italy where the BTP-Bund spread widened 3bp. Curves flattened from the long end. Swaps underperformed cash bonds massively with the Bund-ASW widened almost 2bp to above the 40bp mark.
FX: Amid the souring global risk sentiment EUR/GBP, EUR/SEK and EUR/NOK all rallied. EUR/USD was little changed.
Credit: Against a decidedly souring sentiment in equity markets, credit held up relatively well yesterday. Though CDS indices seemed to widen dramatically (with Xover and Main 26bp and 6.5bp wider than Friday, respectively), this was to a large extent caused by the index roll. The old series ‘only’ widened 8bp and 1.7bp, respectively. HY bonds widened 5bp and IG actually closed the day around 0.5bp tighter.
Nordic macro
Riksbank will release the Monetary Policy Report at 9.30 CET. With regards to the policy rate path, we have previously argued that the November meeting is a more likely date for the Riksbank to put in a hiking bias at the end of the repo rate path. Following the August inflation data, the probability for this happening now in September has indeed increased, but we stick to our call for this to happen only at the November meeting. Also, we expect the Riksbank to wait until November to announce the QE reinvestment volume and allocation for Q1-22. Our base case for re-investments in 2022 is that the quarterly pace will be kept even and that the allocation will be similar to 2021 with an overweight to covered bonds.
On the macro front, last week’s data will likely lead to an upward revision of the inflation forecast but more modest upward revision of other macro variables such as GDP and unemployment. Market-wise we are already pricing in c.50bp of hikes until the end of 2024, so risk-reward in our view is for the short-end to come lower on a more cautious Riksbank, similar to what we saw after the July MPR.
