Market sentiment remains bitter
Market players today
As global risk sentiment, stagflation risk and developments in the Chinese real estate market take center stage today, we have a series of central bank meetings to follow.
First comes the Riksbank meeting. In short, we expect the Riksbank to leave its policy rates unchanged and maintain a fully flat rate path of zero. That said, we do recognize that recent developments and especially the August inflation impression could trigger a slight upward bias in the very long end of the rate path. For more information on Riksbank, please see our Scandi section.
We are waiting for the hungarian central bank to keep the key rate unchanged at 1.5% while the consensus is looking for an increase to 1.75%. Either way, it’s not a big market event.
In addition to these American data on bbuilding permits and starts in August are expected at 2:30 p.m. CEST.
At a meeting ending early Wednesday, we expect the Bank of Japan will maintain its QQE with an unchanged yield curve control policy. With the economy still hampered by the lockdown, it’s standby mode until pandemic programs can be pulled out next year.
The 60-second preview
Market sentiment suffers: The overall sense of risk has taken a hard hit over the past week. The bitter sentiment continued this week with stocks falling across all sectors, option volatilities on the rise in all markets, credit spreads widening, base yields falling and long-term inflation expectations stalling. Interestingly, we are now also seeing global commodity prices trading lower. Precious metals incl. Gold saw declines amid higher real rates, but industrial metals and energy also fell significantly from the 2021 high set earlier in September.
While the outlook for growth suffers: The outlook for global growth, the risk of stagflation (see next section) and the recent increased attention to the state of the Chinese real estate sector are at the heart of the shift in market sentiment. The latter is not least a reaction to the country’s second-largest corporate developer, Evergrande, who is struggling to pay the next debt payments. While this leaves significant contagion risks ahead, we think the implicit signal of a weak credit boost from China to the rest of the global economy is just as important.
Stagflation: This morning, we published a new article on the implications for financial markets of the stagflation risk scenario (for which we see a probability of 30%). While we believe central banks will be patient in responding to high inflation in the first half of 2022 (especially given the weak underlying economic momentum), we believe they will eventually tighten monetary policy to avoid a de-anchoring of inflation expectations. This would lead to a significant rise in short-term US real rates and a stronger dollar, which would affect global risk sentiment, lowering global equities and widening credit market spreads, especially for the high segment. yield. As long rates rise initially, we believe that the significant impact on the global growth outlook will reverse the downward trend in long yield curves, forcing yield curves to flatten. For more details, Global Research – Market Implications in a Global Stagflation Scenario.
Air travel in the United States: The Biden administration has announced that by November, fully vaccinated people will be able to travel to the United States from anywhere in the world. A negative COVID-19 test taken less than 3 days before the test is also a condition alongside proof of vaccination. A decision has not yet been announced on which vaccines will be accepted. The airlines rose on this announcement which we also see positive for the growth outlook in the United States.
European energy crisis: Continental gas and electricity prices continue to rise, leaving the risk of hurting Europe’s recovery after COVID-19 and hampering prospects for green reforms. Yesterday, the EU’s second-largest gas supplier to Norway announced plans to increase supplies from Friday as Equinor prepares to increase production from two fields in the North Sea. European governments – most recently in Spain and Italy – are also discussing measures to help consumers and businesses through direct aid programs. Critics argue that governments should not intervene in a market where part of the price hike is structural as politicians fight investments in fossil fuels and increase dark energy costs by changing the allowance market. CO2. Proponents argue that this energy crisis shows the urgency to invest more in sustainable energy.
Actions: A real offensive against risk hit the markets yesterday for a first in a very long time. The reduction in risk also turned into cross-assets as investors turned to cash or bonds and sold most sectors and stocks. The S&P 500 fell -1.7% (and -2.9% intraday high) with just 50 out of 500 stocks higher. Nasdaq -2.2%, Dow -1.8% and Russell 2000 -2.4%. Implied volatility soared, with a VIX just south of 30 on an intraday basis, before falling back to 26. Among sectors, energy, financials (both insurance and banking), autos and materials were the most affected. Interestingly, big tech hasn’t proven much safety, but has resulted in weakness in consumer discretionary. Safe-haven sectors such as utilities, health care and consumer staples held up the best. The feeling seems to have stabilized this morning. Chinese markets are still closed for the holidays, and the newly opened Nikkei is catching up -1.7% but Hong Kong only -0.3%. US futures are showing a rebound with futures up nearly 1%.
FI: A classic theme of flight to quality was playing out in the markets yesterday following the Evergrande story from China. Bunds fell by 4bp while intra-eurozone spreads generally widened, leading Italy where the BTP-Bund spread widened by 3bp. Flattened curves from the long end. Swaps massively underperformed cash bonds, with Bund-ASW widening by almost 2bp to surpass the 40bp mark.
FX: Amid embittered global risk sentiment, EUR / GBP, EUR / SEK and EUR / NOK all rallied. EUR / USD was little changed.
Credit: Faced with a decidedly bitter sentiment on the equity markets, credit held up relatively well yesterday. Although the CDS indices appeared to widen considerably (with Xover and Main 26bp and 6.5bp wider than Friday, respectively), this was largely caused by the index rollover. The old series only widened by 8bp and 1.7bp, respectively. HY bonds widened by 5bp and IG closed the day down around 0.5bp.
Riksbank will release the Monetary Policy Report at 9:30 a.m. CET. Regarding the policy rate path, we previously argued that the November meeting was a more likely date for the Riksbank to introduce an upward bias at the end of the repo rate path. Following the August inflation data, the likelihood of this happening now in September has indeed increased, but we are sticking to our call for it to only happen in the November meeting. Additionally, we expect the Riksbank to wait until November to announce the reinvestment volume and QE allocation for Q1-22. Our base scenario for reinvestments in 2022 is that the quarterly pace will be maintained and that the allocation will be similar to 2021 with an overweight in covered bonds.
On the macro front, last week’s data will likely lead to an upward revision in inflation expectations but a more modest upward revision of other macro variables such as GDP and unemployment. From a market point of view, we are already estimating around 50bp increases until the end of 2024, so the risk / return in our view is that the short term drops on a more cautious Riksbank, similar to what we have seen after the July MPR. .