September 30, 2022: Global News Roundup
Global financial markets finally get the memo. Kind of.
For months I’ve been wondering when the financial sector would finally catch up to global economic fundamentals, which have been steadily worsening since late last year. It seems this was the week. Kind of. After the US Federal Reserve raised interest rates last Thursday, the global financial sector has been in absolute turmoil trying to understand and price in the reality of a deepening recession alongside volatile and conflict-ridden international politics, massive supply chain disruptions, unsustainable debt burdens and forex crises, persistently high and volatile commodities prices, and confused politicians and central bankers.[1]
The long-overdue reckoning was most visible in the UK this week, the world’s 5th largest economy, where a rate hike last Thursday from the Bank of England combined with an announcement on Friday by Liz Truss’s government of a fiscally expansionary “mini budget” to rattle investors, catalyzing a serious depreciation of the pound sterling (see chart below). By Monday, problems with the sterling had spread to bond markets: “British government bond prices collapsed on Monday, pushing yields to their highest in over a decade, amid speculation that the Bank of England might need to take emergency action after sterling hit a record low against the U.S. dollar overnight.” (Note: Bond yields move inverse to bond prices; yield = coupon/price.)
(Source: “British Pound Crashes to Record Low” by Cornelius Hirsch and James Randerson, Politico Europe, 9/26/2022, here.)
In an extraordinary development, the International Monetary Fund (IMF) publicly condemned the mini-budget and urged its withdrawal, provoking anger from British officials: “The intervention was met with fury inside the Treasury, after a day when markets had calmed and some government bonds had rallied…One Tory MP said: 'At the end of the day it's up to the elected Government to set fiscal strategy’.” The Bank of England announced emergency intervention in bond markets on Wednesday. Among other likely motivations, the potential collapse of pension funds appears to have prompted the BOE’s swift action.
As the UK example indicates, the governments of some of the world’s largest economies are increasingly fearful about being able to finance their massive (and growing) debts, as higher yields weigh on borrowing costs and investor trust in major economies deteriorates. German bond yields rose to historic highs this week. Yields on 10-year US government bonds hit 4%, the highest level since April 2010, dragging yields on Indian bonds right along with them. The Financial Times reports that investors were unsettled by growing problems in the UK and Japan, resulting in a “powerful pullback in the US Treasury market that accelerated after the Federal Reserve last week delivered its third-straight 0.75 percentage point rise…”. Volatility is reducing trading volumes, which increases volatility, generating a “volatility vortex”. Of course, these are issues that smaller economies have been facing for months (e.g. Sri Lanka, Lebanon, Pakistan). In the Philippines, which was already showing signs of distress early in the summer, the Bureau of the Treasury rejected all bids for its 20-year treasury bonds, “as the market demanded higher rates in anticipation of more rate hikes to combat inflationary pressures”.
Things I’m keeping an eye on:
1. The whipsaws in bond, foreign exchange, and other financial markets. By Wednesday evening, stock and bond markets in the UK and elsewhere had rebounded a bit, as had the sterling. But by Thursday, the BOE’s emergency intervention was mostly forgotten. All major indices were down this morning as I finalized this post.
2. Are commodities traders going to get the memo too? Crude prices have been mostly below USD$80/barrel since the Fed hiked rates last week and began to rebound on Wednesday. Don’t forget that crude prices have more than doubled since September 2020, with seemingly lower prices over the past couple of months not actually all that low by historical standards (This is a very similar pattern to that prevailing in global food/ag markets, among other commodities markets, with recent troughs merely denting an otherwise upward price trajectory for the past roughly two years.) With Biden’s Strategic Petroleum Reserve releases likely coming to an end shortly, inventory drawdowns and shuttered refineries, expectations that OPEC+ will commit to new supply cuts in October, the explosions on Monday that destroyed the Nordstream 1 and 2 pipelines, more rounds of EU and US sanctions on Russia, and winter temperatures incoming in northern latitudes, among other potential pressures on global commodity supplies, I anticipate generally rising commodity prices into 2023 and beyond.
3. Situation in the Ukraine. By very large margins, the referenda for four eastern Ukrainian provinces about joining the Russian Federation passed. After congratulating fighters from the east on their bravery, Communist Party faction leader Gennady Zyuganov clearly explained on Wednesday the meaning of the vote for the situation in Ukraine, “Today, it is of principal importance not only to make legal decisions, but also to protect the choice that was made. And our Ministry of Defense, our Commander-in-Chief and everyone responsible for security must understand that, starting tomorrow [the 29th], any shelling of Russian territories gains qualitatively different meaning” (emphasis added). Russia formally annexed the four territories today.
As for the pipeline explosions, the US is vehemently denying involvement, pointing the finger at Russia instead. Europe is investigating. Russia is warning the US to explain itself or face consequences. China is keeping cool about this “unusual incident”.
[1] My mind keeps coming back to a Bloomberg article from 2015, entitled “What will happen to a generation of Wall Street traders who have never seen a rate hike?” It’s not international media, but thought I’d share anyway.