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Analysis: Traders ready for wilder swings as rate rises stoke volatility

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© Reuters. FILE PHOTO: A specialist trader works on the floor of the New York Stock Exchange, August 21, 2015. REUTERS/Brendan McDermid

By Dhara Ranasinghe, Saikat Chatterjee and Davide Barbuscia

LONDON/NEW YORK (Reuters) – Traders in the world’s largest markets are having to navigate wild intra-day swings and shrinking deal sizes as central banks rapidly withdraw stimulus measures, in a small-scale reminder of a pandemic-driven financial seize-up just two years ago.

The U.S. Federal Reserve said in a report this week that liquidity had “deteriorated” further than what might be expected at current levels of volatility, with noticeably poor conditions in treasury, commodity and equity markets.

The onset of the coronavirus pandemic triggered a market crisis in March 2020 as investors dumped riskier assets, prompting global policymakers to pump in a total of $15 trillion, the equivalent of more than a sixth of the world economy, to help them regain stability.

If markets are too unstable, the ability of central banks to transmit their monetary policy effectively is reduced and the Fed’s wording is being read as a warning by some.

Liquidity had already been progressively more constrained after post-2008 regulations curbed the market-making and risk-taking ability of the world’s biggest banks.

But this year’s pinch is down to rapid interest rate rises by central banks and their efforts to cut balance sheets swollen by huge bond-buying programmes, with liquidity shortfalls now particularly acute in bond markets.

It is also evident in the Cboe Volatility Index, known as Wall Street’s “fear gauge” which is up 14% this week alone. But at just over 34 points, the VIX remains below peaks of almost 90 hit during the outbreak of the COVID-19 crisis in 2020 and the global financial crisis in 2008.

Central bank balance sheets set to get smaller https://fingfx.thomsonreuters.com/gfx/mkt/akpezybwgvr/cbanks1205.PNG

DEPTH DEPRESSED

As of next month the Fed will start selling down its bond holdings, which is likely to mean even thinner trading volumes.

Bethany Payne, bond portfolio manager at Janus Henderson Investors, said “the risk of hitting bond market air-pockets has increased” of the possibility of big sudden price swings.

“Bond market depth remains depressed year to date, as liquidity is withdrawn from the system,” she said, citing the combination of monetary tightening, inflation, Russia’s invasion of Ukraine, and the Fed’s bond sale plans.

One indicator of the scale of the volatility are German 10-year bond futures, which are showing an average daily gap between the highest and lowest prices that is higher than any year in the past five, Refinitiv data shows, while Bund volatility in March was the highest since 2020.

Volatility in German Bund futures has jumped https://graphics.reuters.com/GLOBAL-BONDS/zjvqkjqyxvx/chart.png

The picture is similar in the $20 trillion U.S. Treasury market, which Steven Abrahams at brokerage Amherst Pierpont said results from the Fed’s “withdrawal of liquidity by design”.

“There are more investors that just aren’t sure where the curve is going to go next, that has taken some of the capital out of the market, and traders are seeing it in kind of jumpier moves in yields during the day as well,” Abrahams said.

Various indexes illustrate the shape market liquidity is in, with Abrahams’ analysis showing Treasury liquidity at its tightest since March 2020.

And a Goldman Sachs (NYSE:GS) indicator based on inputs from over 30 different markets shows Treasuries leading recent liquidity tightening.

Another from Cross-Border Capital, which the consultancy says leads markets by 6-12 months, is at a three-year low.

Bond volatility https://fingfx.thomsonreuters.com/gfx/mkt/akpezybrqvr/bond%20volatility.JPG

‘BE MORE CAREFUL’

Greater volatility appears to be filtering into currency markets, where average daily turnover on the world’s most-traded exchange rate pair, euro/dollar, is down to 4,500 trades on the EBS multi-dealer platform, from nearly 6000 in March.

Lower turnover can increase volatility, with a gauge of expected swings in the euro on a one-month horizon recently hitting two-year highs above 12%, Refinitiv data shows.

That often leaves traders struggling to execute larger trades and can cause a small number of trades to move prices.

“If you look at the screens, they are relatively normal. But we know that if anyone wants to trade a big size, that (market) depth will be challenged,” Chris Huddleston, CEO at brokerage FXD Capital in London, said, adding trading would get harder as interest rate hikes gather pace.

Suhail Shaikh, CIO at Fulcrum Asset Management in London, estimates volatility is already between the 90th and 95th percentile in the context of asset classes’ own history.

But market nervousness is partly because “risk officers are pointing out the Fed has been making loud noises about liquidity, which is not common for the Fed to do,” Shaikh said.

“So we are just moving on from there being no worries to ‘be more careful,'” he added.

Economy

World Bank to offer $30 billion as Ukraine war threatens food security

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© Reuters. FILE PHOTO: The United States Department of the Treasury is seen in Washington, D.C., U.S., August 30, 2020. REUTERS/Andrew Kelly

By David Lawder

BONN (Reuters) -The World Bank said on Wednesday it will make $30 billion available to help stem a food security crisis threatened by Russia’s war in Ukraine, which has cut off most grain exports from the two countries.

The total will include $12 billion in new projects and over $18 billion funds from existing food and nutrition-related projects that have been approved but have not yet been disbursed, the bank said.

“Food price increases are having devastating effects on the poorest and most vulnerable,” said World Bank Group President David Malpass said in a statement. “To inform and stabilize markets, it is critical that countries make clear statements now of future output increases in response to Russia’s invasion of Ukraine.”

The bank said the new projects are expected to support agriculture, social protection to cushion the effects of higher food prices on the poor, and water and irrigation projects. The majority of resources going to Africa and the Middle East, Eastern Europe and Central Asia, and South Asia.

These areas are among the hardest hit by the impact of the war in Ukraine on grain supplies. Countries such as Egypt are highly dependent on Ukrainian and Russian wheat and are scrambling for supplies as Russia has blockaded Ukraine’s agricultural exports from Black Sea ports and has imposed domestic export restrictions.

The World Bank’s plans were the largest component of a U.S. Treasury Department report summarizing food security action plans from international financial institutions released on Wednesday.

The European Bank for Reconstruction and Development plans to make 500 million euros ($523.50 million) available for food security and trade finance for agricultural and food products, out of a 2 billion euro package for Ukraine and neighboring countries affected by the war, the Treasury report said. Ukraine would get 200 million euros and neighboring countries would get 300 million euros.

The International Monetary Fund will provide financing support through its normal channels, which are limited by countries’ shareholdings and whether their debt is deemed sustainable.

($1 = 0.9551 euros)

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Economy

Exclusive-Japan Inc turns against central bank’s monetary stimulus, Reuters survey shows

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© Reuters. FILE PHOTO: A businessman walks near the Bank of Japan headquarters in Tokyo, Japan, Feb. 15, 2016. REUTERS/Thomas Peter

By Tetsushi Kajimoto

TOKYO (Reuters) – More than 60% of Japanese companies want the central bank to end its policy of massive monetary easing this fiscal year due to pain from the weak yen, with roughly a quarter calling for it to take action now, a Reuters survey shows.

Less than a year ago, Japan Inc had enthusiastically backed the Bank of Japan’s policy but this year’s rapid slide in the yen to a two-decade low has jacked up prices of fuel and raw materials imports, lifting not only corporate costs but also hitting household spending.

This month the yen hit a fresh low of 131.34 to the dollar, a 14% decline since the start of the year.

“Any weakening of the yen beyond 125 to the dollar is excessive and policymakers should take action in some way, including – but not limited to – hiking rates,” one manager at a chemicals maker wrote in the monthly Reuters Corporate Survey.

Twenty-four percent of respondents said the central bank should abandon large-scale monetary stimulus now, while 23% said by the end of the first half in September.

All in all, 64% want large-scale stimulus gone by March when the fiscal year ends and that number jumps to 84% for April when BOJ Governor Haruhiko Kuroda serves out his term.

While Kuroda has said the yen’s moves have been rapid, he argues that a weak yen on the whole benefits the economy. In stark contrast to shifts to interest hikes in other parts of the world, Kuroda has also said the central bank will continue with monetary powerful easing given the impact of the pandemic and tepid inflation.

Of those respondents keen to see a change in BOJ policy, 58% want to see negative rates scrapped, 35% want interest rates hiked and 25% are eager to see the bank drop or change its 2% inflation target. Multiple answers were allowed for this question.

The results of the April 26-May 13 poll of 500 large and midsize non-financial firms, which saw 230 firms respond, represent a major U-turn from July when the survey last asked comparable questions about monetary policy.

At that time, 72% of Japanese firms saw a positive impact from BOJ policy with a majority saying ultra-low rates should continue for another 3-4 years.

The sharpness of the currency’s decline has outweighed the benefits normally associated with a weaker yen, namely the inflation of profits earned abroad when repatriated and longer term the ability to export more cheaply. Japanese exporters have also continued to shift production abroad.

“As the production shift continues, the impact on the economy from higher raw materials costs and other imports from the weaker yen is greater than the apparent increase in profits for exporters,” said one manager at a retailer.

Respondents reply to the survey on condition of anonymity.

BOJ SLAMMED

Some managers were withering in their criticism of BOJ policy, expressing concern the weak yen could ultimately erode Japan’s economic might.

“The easing policy has turned out to be nothing but a stupid plan that weakens national power,” one manager at a services firm wrote.

The survey also found firms wary of boosting capital spending due to the impact of the weak yen and rising input costs. Almost a half of them plan to keep business investment flat this fiscal year while another 14% expect it to decline.

The survey also showed that China’s anti-COVID measures – including a lockdown in Shanghai – have hurt nearly two-thirds of Japanese firms. Ten percent said they were suffering a “big impact” on business.

“Imports of China-produced car parts have stopped, putting downward pressure on car output,” a chemicals maker manager wrote.

($1 = 129.02 yen)

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Economy

Brazil’s govt will maintain GDP outlook for 2022 and 2023 -sources

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© Reuters. FILE PHOTO: Consumers shop at a weekly street market in Rio de Janeiro, Brazil, September 2, 2021. REUTERS/Ricardo Moraes

By Marcela Ayres

BRASILIA (Reuters) – Brazil’s Economy Ministry will hold its economic growth outlook at 1.5% in 2022 and 2.5% in 2023, two officials told Reuters on Wednesday, forecasting activity ahead of market projections due to labor market strength and growing private investments.

The ministry will update its forecasts for economic indicators on Thursday and inflation figures are expected to be lifted from the previous outlook, in March, when the IPCA consumer price index was seen at 6.55% this year.

Data will be used in the bi-monthly income and expenditure report calculations, scheduled for Friday.

Economists have been increasing their forecasts for this year’s GDP, bringing the numbers closer to those forecast by the government.

Analysts say demand in the country has been helped by greater fiscal stimulus, following an increase in a cash transfer program to poorer people. In addition, the job market has shown signs of strength and the Omicron coronavirus wave has not knocked social mobility as feared.

However, they say expectations for 2023 have deteriorated, with aggressive central bank monetary tightening to tame inflation set to affect activity from the second half of the year onwards.

The central bank has raised interest rates to 12.75% from a record-low 2% in March 2021, and has already signaled another likely hike in June.

Goldman Sachs (NYSE:GS) and Credit Suisse now see Brazil’s GDP rising 1.25% and 1.4% this year, respectively, against previous 0.6% and 0.2% projections. For 2023, Goldman Sachs lowered its forecast to 0.9% from 1.2%, while Credit Suisse cut its outlook to 0.9% from 2.1%.

Bank of America (NYSE:BAC) projected on Tuesday that Brazil will grow 1.5% in 2022 from 0.5% earlier. However, expansion is now seen at 0.9% in 2023, from 1.8% previously.

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