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With Fed taper expected, investors brace for rate hikes on horizon

By Karen Pierog and Saqib Iqbal Ahmed

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With Fed taper expected, investors brace for rate hikes on horizon
© Reuters. FILE PHOTO: Federal Reserve Chair Jerome Powell testifies during a Senate Banking, Housing and Urban Affairs Committee hearing on the CARES Act, at the Hart Senate Office Building in Washington, DC, U.S., September 28, 2021. Kevin Dietsch/Pool via REUTERS

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By Karen Pierog and Saqib Iqbal Ahmed

(Reuters) -As the U.S. Federal Reserve gears up to taper its huge asset purchases, investors reeling from gyrations in the bond market are scanning the road ahead for signs of how effectively the central bank can tighten policy to deal with stubbornly high inflation.

At their meeting this week, Fed policymakers are expected to give the green light to reducing the central bank’s bond purchases which have seen it hoover up $120 billion a month in government-backed bonds in a bid to steady the economy after the hit from the pandemic.

The move, which is anticipated to commence in mid-November or mid-December, has been widely telegraphed. Still, the Treasury market has churned over the past week as investors positioned for tighter policy. Investors have sharply increased expectations that inflation would force the Fed to raise rates sooner and faster than projected. Short-term rates have risen and the yield curve flattened.

“Once you get by the taper the next big event is if-and-when the Fed does look to actually tighten going forward, and that puts more importance on effectively every major economic data point that comes out,” said Chuck Tomes, associate portfolio manager at Manulife Asset Management in Boston. “There could be more volatility events around all of those major economic data points.”

The gyrations in the bond market likely have already caused some leveraged hedge funds to suffer losses, Bank of America (NYSE:) warned in a report. The moves could also reflect investors unwinding positions to prevent deeper losses, Deutsche Bank (DE:) said.

Wall Street banks, meanwhile, are intensifying preparations for tapering to ensure they are able to handle spikes in market volatility.

There could still be surprises. Not tapering at this point could substantially steepen the U.S. Treasury yield curve, while a faster-than-expected tapering program would lead to a substantial flattening, according to Steve Bartolini, portfolio manager for U.S. core bond strategy at T. Rowe Price.

The Fed’s communication this time around stands in contrast to 2013 when bond yields rose dramatically during the so-called “taper tantrum” after then-Fed chief Ben Bernanke unexpectedly told lawmakers the central bank could slow its pace of asset purchases that had been propping up markets. Benchmark 10-year U.S. Treasury yields rose from around 2% in May 2013 https://www.reuters.com/article/us-usa-fed-2013-timeline/key-events-for-the-fed-in-2013-the-year-of-the-taper-tantrum-idUSKCN1P52A8 to around 3% in December.

While the move is not as extreme so far, the U.S. bond market is on track for its first annual loss since 2013.

PRICE WORRIES

Investors are keenly focused on rising inflation and look to the Fed meeting to see if Chair Jerome Powell’s stance that higher prices will moderate on their own over time may be wavering.

“It’s the labor, the inflation, it’s the consumer that we are mostly concerned about,” said Tom Martin, senior portfolio manager at Globalt Investments in Atlanta, who thinks that long-term bond yields may fall once the taper announcement is made as rising short-term borrowing costs act as a headwind to growth.

“We are concerned that the central bank could make a policy error and raise rates sooner than they should,” said Martin, who said he’s been “positioned for interest rates to not rise for quite some time and we stand by that positioning.”

Stephen Tally, chief operating officer at Leo Wealth, said the risk was “inflation is not as transitory as we’ve been led to believe” and that “pushes the Fed farther and faster than they want to go.”

Inflation expectations spiked last week with 5- and 10-year breakeven inflation rates hitting their highest levels in more than a decade.

“Where it’s going to be more dicey is how (Powell) dances with the word transitory and puts a definition around that maybe in terms of a time frame,” said Lon Erickson, a portfolio manager at Thornburg Investment Management.

Sit Investment Associates Senior Portfolio Manager Bryce Doty said he has been tweaking portfolios recently with an eye on rising inflation.

“I think you still need to be heavily invested in TIPS and anything that offers some inflation protection,” Doty said.

Powell, whose uncertain renomination as Fed chair has also played into market moves, puts rate hikes in a separate box from tapering, with higher interest rates dependent on a return to full employment and inflation reaching the Fed’s 2% goal, while moderately exceeding that level for some time.

Investors have been closely watching monthly jobs reports, with October’s due Friday.

“After a pretty weak September number are they relying on that October number before they start to really get deep into discussions around rate hikes?,” said Jason England, global bonds portfolio manager at Janus Henderson Investors.

Economy

Rough gas storage facility UK to be mothballed

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Rough gas storage facility UK

Rough gas storage facility UK, which was mothballed in 2017 due to safety concerns, will resume operations due to the country’s energy crisis. According to The Telegraph, Centrica, which owns the facility, is ready to begin filling it in early September.

The Occupational Safety and Health Administration has already approved the storage facility’s reopening. Now Centrica needs to coordinate state support and get the go-ahead from the North Sea Transition Authority. According to the authors, both of these tasks “do not appear to be problematic” for the company.

At the same time, the newspaper reports that Rough will initially operate at only a quarter of its capacity. A total of about 3.4 billion cubic meters of natural gas could be pumped there. According to the newspaper’s calculations, a partial return to service would increase the current total volume of blue fuel stored in Great Britain to 1.6 billion cubic meters.

“We can bring Rough back into service by increasing its capacity in stages each winter,” Centrica said.

Economists predict that in January 2023, electricity bills in the UK for local households could rise to more than three thousand pounds per year.

Earlier we reported that the U.S. economy was falling for the second quarter in a row.



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Economy

Will the decline in the US economy begin to slow? The economy is falling for the second quarter in a row. What does it mean?

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decline in the US economy begins to slow

Will the decline in the US economy begin to slow? Compared to the first quarter of 2022, U.S. GDP has fallen by 0.9% year on year, said the country’s Commerce Department. At the same time, the economy was supposed to show growth of 0.3 p. p. This was the second decrease in the year – in the first quarter of 2022; it decreased by 0.3 p p. compared to the previous quarter. The decline in real GDP reflects a decline in private investment in inventories and fixed capital, as well as reduced spending and investment by the federal government.

Decline in the US economy becoming stronger or weaker? 

Despite the decline in real GDP, the Commerce Department reported a 7.8% ($465.1 billion) year-over-year increase in GDP at current prices, as well as an increase in exports and personal consumption expenditures (PCE) related to Americans’ domestic and foreign travel.

Consumer spending, which accounts for two-thirds of U.S. GDP, increased 1% in Q2 after rising 1.8% a quarter earlier. Business fixed investment fell 3.9% and federal government spending declined 1.9%. Exports jumped 18% last quarter, while imports rose only 3.1%.

Economists at Deutsche Bank predicted recessions in the U.S. and Germany on July 15. In their opinion, markets were seriously changed after the data publication on July 13, which showed an acceleration of consumer price growth in the USA. The futures-markets dynamics allow for an almost 100% probability of a recession in the American economy till the end of 2022.

A report from the International Monetary Fund on July 12 stressed that the U.S. will find it “increasingly difficult” to avoid a recession. The Institute worsened its estimates of the economy: the growth forecast for 2022 was decreased from 2.9% to 2.3%; the real GDP growth expectation for 2023 was decreased from 1.7% to 1%.

The Fed is raising the rate at an accelerated pace: at the last meeting – immediately by 0.75 bp to 1.75%, which was the biggest increase since 1994. However, the current prime rate (1.58%) remains very low – far below both the neutral level (2.5%), and the inflation rate (9.1% in annual terms in June). Most analysts expect the Fed to have to raise the rate to at least 3.75-4% at the end of the year.

We should not expect that the very fact of a recession in the U.S. will have a strong negative impact on other developed world economies. The effect will strongly depend on the depth of the crisis. In any case, the severity of the recession will not be comparable to the Great Depression, when for four years there was a rapid drop in GDP.

Earlier we reported on whether Europe is in a recession.

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Economy

Is Europe in a recession now: the consequences are listed

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is there a recession in Europe

Is Europe in a recession now? The depth of the recession in the eurozone will depend on the pace as well as the extent of the economic decline, which can be tried to regulate by raising key interest rates. The consequences of a recession could be a drop in personal income and a rise in unemployment. 

The euro zone economy is very likely to face a recession, according to 60 percent of experts surveyed by Bloomberg. That number has risen from 45 percent in the last survey and 20 percent since the Russian invasion of Ukraine.

Is there a recession in Europe? 

Is there a recession in Europe? There are different variations on the speed at which the eurozone is going into this dynamic. Most markets will show zero or negative growth in the third quarter. Naturally, this will have an immediate impact on equity and commodity markets. This, in turn, will lead to big changes in the economy.

Different countries, regions and markets will go into recession unevenly. Most likely, the USA will show one more quarter of negative growth rates, which will be a clear indicator of a departure into this phase. The same is likely to be true for Europe.

There is no recession in China, but the growth rate is already declining. This is also a significant factor which will affect the global economy. The depth of the failure will depend on how the authorities of different countries will react to what is happening: whether they will slow down the increase in rates; whether they will manage to achieve a balance. This will have an impact on the price of raw materials, unemployment, etc.

No precise predictions are impossible to make at the moment: we will have to wait for statistics for the third quarter or at least for August.

Earlier we reported on an unexpected threat to the U.S. economy



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