The UK saga
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Highlights
BoE vs. UK mini-budget
The BoE (Bank of England) hiked 50bps and announced the intention to start active Quantitative Tightening (QT, selling GBP 80bn worth of bonds over 12 months). The day after, the new Government announced a mini-budget which includes the biggest tax cuts since 1972 and debt issuance estimates raising by GBP 72bn, to a total GBP 234bn. Chancellor Kwarteng said that more tax cuts are coming in 2023. At the same time, BoE announced that no action would be taken, and the UK finance ministry promised a debt sustainability analysis. BoE Chief Economist Huw Pill affirmed that a ‘significant policy response’ was needed to offset the tax cuts. The IMF criticized the tax cuts. Finally on Wednesday, BoE intervened in 20Y+ Gilt markets, buying by daily auction GBP5bn worth of bonds until October 14 and suspended QT debt sales. The intervention was mainly driven by concern from market participants about sizeable margin calls to UK ‘liability-driven’ pension funds.
PBoC intervenes
After the interventions from the Bank of Japan and the Bank of England, the People’s Bank of China (PBoC) is stepping up action to tackle economic problems. China's central bank will allow some cities to cut mortgage rates for first time home buyers and will expand a lending program to ensure delivery of delayed housing projects. It also told major state-owned banks to prepare to sell dollars to support the yuan. The Chinese renminbi has depreciated significantly against the US dollar, breaching the 2019-2020 lows around CNY7.20 per USD.
Market update
The UK saga
The S&P 500 closed the week at 3,585.62, -2.91% lower. The Dow Jones closed at 28,725.51, -2.92%, with the Nasdaq lower by -2.69%. The volatility index VIX closed the week at 31.62 up from 29.92. The Euro Stoxx 600 slipped -0.65%.
The 10-year UST closed at 3.83% up from 3.68% a week before. The yield curve steepened with the yield spread between the 3-month and 10-year UST at +54bps. US Corporate Bond spreads: Investment Grade widened 26bps at 214bps and High Yield tightened 53bps at 585bps. German 10-year Bunds yield closed at +2.11% up from +2.02% a week before. In Europe, Corporate Investment Grade spreads widened 24bps at 240bps and High Yield spreads widened 71bps at 680bps.s.
The US Dollar Index (DXY) depreciated -0.95% last week and closed at 112.12. The Euro closed at 0.9802 (+1.19% weekly); the Yen depreciated -1.00%, closing at 144.74 and the Swiss Franc depreciated -0.53%, closing at 0.9870. Gold closed at $1,660.61 appreciating +1.01%. Oil was up, Brent closed at $87.96 (+2.10%) and WTI at $79.49 (+0.95%).
Macroeconomy
Fed speakers
During a New York Fed conference, Fed Vice Chair Lael Brainard said that "monetary policy is focused on restoring price stability in a high-inflation environment". She added that as the effect of tighter financial conditions plays out, "monetary policy will need to be restrictive for some time to have confidence that inflation is moving back to target. For these reasons, we are committed to avoiding pulling back prematurely". We heard from other Fed speakers during the week. James Bullard said that the FOMC "is expecting a fair amount of additional moves this year". Mary Daly said: doing too little could mean "harsher measures later", projected rate hikes are "necessary and appropriate", but need to be "on watch" for signs that enough has been done. Loretta Mester also said her rate path is "higher" than median path, rates "still not in restrictive territory". She also said that she does not see distress in US financial due to the rate hikes. As per the CME Group Fedwatch tool, there is a 57% probability of a 75bps hike in Nov. 2. As per Bloomberg Fed Funds futures tool, investors expect a 68bps hike in Nov. 2 and a 47bps hike in Dec. 14.
Inflation in Europe
Euro area headline inflation rose from 9.1% to 10.0% y-o-y in September, above consensus of 9.7%. Core inflation rose from 4.3% to 4.8% y-o-y, above consensus of 4.7%. German inflation (HICP) reached 10.9% y-o-y in September. The main drivers were the energy and food prices, but core inflation rose as well as the government’s fuel discount and the €9 transport ticket were ended. The September German IFO survey slid to its lowest point since May 2020. The four leading German institutes have now slashed their growth forecasts for 2023 and expect a GDP growth contraction. Spanish inflation decreased to 9.3% y-o-y, down from 10.5% in August, due to lower electricity, fuel and transportation prices. Inflation in France came in at 6.2% y-o-y. The decrease was mainly driven by energy prices and a drop in certain tourism-related services prices.
US PCE
The US Commerce Department indicated that household spending rose by 0.4% in August, after falling a revised 0.2% in July. Core PCE (Personal consumption expenditures price index), which is a key Fed focus and which excludes food and energy, rose 4.9% y-o-y vs. the 4.7% consensus. Spending on services, including transport and utilities, rose strongly in August while gas prices fell.
China economic data
Chinese official manufacturing PMI improved in September and came back to the expansionary territory (50.1). However, the Caixin (Markit) PMI dropped further in the contraction zone to 48.1. The divergence likely reflects the two surveys’ different sampling biases and the fact that state-owned large enterprises are doing better than private companies, which are generally smaller. The improvement in official manufacturing PMI likely was mainly domestic driven. New export orders weakened further, indicating more softness in Chinese export growth ahead. The official non-manufacturing PMI dropped notably by 2 points to 50.6 in September. The construction sub-index remains at elevated levels (60.2), likely reflecting the government’s stimulus in the infrastructure space, but the services sub-index dropped below 50 again (48.9).
What to watch
- Monday: US ISM manuf. index (Apr.)
- Tuesday: Australia RBA decision (May); Euro area: final PMIs, M3 (Mar.), Bank Lending Survey (Q1), flash HICP (Apr.); US durable goods (Mar.)
- Wednesday: US FOMC decision (May); US ISM non-manufacturing index (Apr.)
- Thursday: Norway Norges Bank decision (May); Euro area ECB decision (May); US trade balance (Mar.)
- Friday: Germany factory orders (Mar.); US: nonfarm payrolls (Apr.)