Your weekly economic update from the team at FXD Capital
This week saw a record for outflows from bond funds. EFGR Global estimated that investors sold $108 billion of bond funds and ETFs, nearly four times higher than the previous high mark. The main focus of selling has been in junk and investment-grade corporate bond instruments.
With equity markets also facing downward pressure ($20 billion of outflows), the question is, where is the money going?
The answer is into money market funds, which have soaked up $231 billion of inflows in the past two weeks alone. It’s an interesting contrast to last year when the pandemic first hit. A year ago, there was a mini liquidity crisis, where everything sold off across the board, and only short-dated government bonds or gold provided safety nets. A year later, we aren’t in a liquidity crisis so much; it’s more a taper-tantrum-meets-market-rotation situation. Liquidity then was first-degree; everyone wanted quick access to their assets. Liquidity is now second-degree, where the mass-shift to money-market instruments is causing distortions in the spreads of market assets.
Assets shifting into money market funds indicates a willingness to wait and see whether yields keep rising before redeploying cash.
Coincidence, or causation, but Marcus’ popular retail savings rate announced plans to lower its rate 10bp this week. Indicative of broader bank liquidity, the fall seems correlated. Banks are soaking up all the market outflows and are sitting on large cash deposits from corporates and retail customers.
The US ten-year Treasury yield now sits at 1.73%, rising almost 10bps on the week.
In other intriguing news, New Zealand announced its central bank would expand its remit to targeting house prices; its economy has a sustained house price boom and chronic supply shortages. It will be interesting to see whether other central banks adopt such a policy.
The MPC voted in unison to keep the UK base rate at 0.1% and maintain its quantitative easing target of purchasing an additional £150 billion of government debt. The meeting minutes showed positive sentiment towards UK economic recovery, noting that “near term economic activity had been positive”. Andy Haldane, the BoE’s chief economist, juxtaposed the current economic state with that of a coiled spring in his prediction for a rapid-fire recovery.
As a sign of the more benign inflation considerations of the UK, 10-year gilts did show the upward variance of 10bps on the week but currently sit at 0.837%, 3bps higher from Monday’s level. Although, markedly higher than the 0.45% yield recorded at the February meeting before the recent sell-off.
By May, the MPC will provide more colour about the UK economy’s recent inflation characteristics. Minutes show the body is sanguine about the medium-term inflation outlook, with the expectation
that it will jump from its 0.7% January print in the spring, once last year’s petrol price drops fall out of the basket.
Data from the Federal Reserve’s last meeting published on Wednesday. One such pertinent point was that output is predicted to grow by 6.5% in 2021, the fastest pace since the era of Ronald Reagan in 1984. 2022 has 3.3% growth earmarked, before dropping down to 2.2% in 2023
The Fed has been poker-faced about recent surges in inflation expectations. Sustained reflation to the economy is unlikely to be maintained; while everyone is looking to go on holiday and visit their favourite restaurant, it is likely to be a short-term fervour before people revert to historic tendencies once normalcy is resumed.
US markets continued to whipsaw, with the NASDAQ index acting as an adverse proxy to any moves in yields. Some expect the 10-year rate to reach a psychological level of 2% as the time to draw a line in the sand and move on as the new normal.
News from the ECB this week suggested that it may afford banks more time to benefit from capital relief by accelerating their recognition of bad loans. It’s a widespread call to compare European banks’ balance sheets to zombies, often carrying legacy loans marked at par with little chance of recovery nor opportunity for booking new business. Only nine out of 115 banks took an offer last year to increase loan loss provisions booked against capital buffer relief measures.
Just last year, the ECB released data of a scenario where non-performing loans at European banks reached €1.4 trillion, a rate higher than in 2008. Look towards restrictions on banks paying out dividends as an incentive to encourage them to repair balance sheets once and for all.
This week, Greece sold its first 30-year bond since 2008, raising €2.5 billion at a yield of 1.956%. The rise comes amongst record orders for eurozone government debt, with Spain and Italy also recording recent oversubscribed issues. The supply of new bond issues has been constrained by banks, who hoover up demand with the ample liquidity offered to repo them back to the ECB. As a result, syndicated deals have become more popular by allowing other market participants to club together to gain a piece of the action.
All the best for the week ahead,
Our weekly column is written by Alex Graham, Economic Advisor to FXD Capital. Originally a bank treasurer, Alex’s weekly roundup intends to provide a conversational, top-down view of what is going on in world macroeconomics and how it impacts business on the ground level.
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