A Safe Pair Of Hands?

Week Ending 14th October, 2022

Japan:

We are now starting to see Japanese retail investors begin their quest for higher yields – and this will be another boost for the USD. Retail FX deposits have jumped +8.3% YTD as local Japanese investors are switching from a weakening Yen (Y) and a zero-yielding local bond market to overseas markets where yields are attractive. The yield differential between Japan and US 10y bonds is 3.75%, well past the perceived threshold of 3%. FX margin trading volume reached a record high of Y1,229tn in June. In August it was Y1,159tn. Through margin trading, retail investors can borrow up to 25X their cash. Households held Y1,102tn in cash and deposits (a record). Speaking of the US$...

UK:

The GBP dropped sharply on 14th October and is down -1.50% at 1.1158 vs the USD. The reason? An eventful week (again!) that saw Finance Minister Kwasi Kwarteng leave the IMF meeting in Washington early to supposedly work on a medium-term fiscal plan due to be delivered at the end of this month (brough forward from 23rd Nov). Instead, he was dismissed en-route after less than six weeks in office – the second shortest stay of any Chancellor. His replacement is Jeremy Hunt, previously Health Minister and Foreign Minister. He is considered to be a safe pair of hands.

It has been a volatile week with warnings from the Bank of England (BoE) to Pension Funds (PFs), to “get the job done” – a reference the Bank was done extending bond purchases beyond today (Friday). PFs have been scrambling to raise cash following the bond carnage in the aftermath of the mini-budget (23rd Sept). The rise in US Treasury bonds are being partly blamed on the UK bond rout as these PFs sell bonds to meet margin calls. The BoE sought to calm markets by announcing a doubling in size of the bond market purchases to £10bn earlier in the week and has thus far bought far less than the minimum daily limit. It’s hard to see how the BoE can call a complete halt to asset purchases and simply push ahead with rate hikes given the lack of stability in bond markets, the deficit gap being faced by PFs and fragility of the UK consumer. All this is weighing on the GB£ and there’s no immediate solution. Let’s wait for the budget – some tough love is called for in which any giveaways must be funded by takeaways.

Credit Suisse latest:

The bank is believed to be facing a capital shortfall of between CHF4bn to CHF8bn. Shares are down some -50% YTD while its market value stands at CHF12bn. Management has said it is considering all options to bridge the gap rather than being cash dilutive.

Lastly, US inflation:

Not only did the headline rise more than expected but the core inflation rate is red hot driven by the jump in food prices (+0.8% m/m to 11.2% y/y) and shelter which rose 0.7% m/m to 6.6% y/y. Transportation services jumped 1.9% m/m to 14.6% y/y while Medical care services rose 1% m/m. This in a month where gasoline prices fell nearly -5%. With the 8th November midterm elections nearing, no wonder Biden is making inflation noises about (1) gasoline prices still being too high and looking to take action next week and (2) seeking to sign an Exec. Order to drive down the cost of prescription drugs.

Healthcare, food and rent are dominating headlines. 65mn Americans are on Medicare programmes. Back in August he signed a $430bn Inflation Reduction Act authorising federal government to negotiate prices and cap prescription drug prices. When you consider all these measures, the powerful US$ (which is curbing import prices), easing supply chains and some early signs of moderation in the job market – you have to wonder how much further will the Fed hike rates? A 0.75% hike in November is a certainty. December? Fed futures are pointing to another 0.75%.

MARKET SUMMARY

For w/e 14th Oct, equity and bond funds faced outflows of -$7.3bn and -$14.27bn respectively. Europe felt the brunt (-$7bn). The UK Gilts crisis has forced Treasury yields up too on fears UK pension funds might have to conduct fire sales. MM funds saw big inflows.