A research paper published at Harvard University is advocating that central banks should buy bitcoin
BTCUSD,
+2.41%
as a hedge against sanctions by other countries.
The paper, titled “Hedging Sanctions Risk: Cryptocurrency in Central Bank Reserves,” was authored by Ph.D. candidate Matthew Ferranti from Harvard’s economics department, and likens central banks’ gold reserves to potential bitcoin holdings.
Ferranti points out that central banks in countries across the globe should look into holding bitcoin as a hedge against possible financial sanctions. He gives the example of the unprecedented financial sanctions levied against Russia by the U.S. and many western nations following its invasion of Ukraine — billions in Russian assets were frozen after the Ukraine war began.
“Sanctions risk may diminish the appeal of U.S. Treasuries, propel broader diversification in central bank reserves, and bolster the long-run fundamental value of both cryptocurrency and gold,” Ferranti writes.
In the paper, Ferranti says El Salvador is a model for central banks owning bitcoin. The country, headed by bitcoin bull Nayib Bukele, has purchased millions of dollars worth of the crypto and has even made bitcoin an official national currency.
See also: ‘We just bought the dip’: El Salvador expands bitcoin holdings
Since the inception of popular cryptos like bitcoin and ether
ETHUSD,
+3.74%,
part of its appeal has been the lack of involvement from central banks, in favor of the decentralized nature of the digital asset.
In the wake of the recent crypto winter and collapse of popular crypto exchange FTX, as well as financial issues for crypto companies Voyager and Celsius, some crypto bulls have called for increased regulation and transparency for the industry.
The paper comes after FTX struggled with liquidity issues in November, eventually leading to a bankruptcy filing. Sam Bankman-Fried resigned as CEO and later apologized for the collapse of his former company.
See: Why do people invest in crypto? ‘It’s partly fraud and partly delusion,’ says Charlie Munger.
Also see: Tom Brady, Steph Curry and Kevin O’Leary set to lose big from FTX bankruptcy filing
Bitcoin’s price is down over 70% over the past year, and the price for ether is also down over 70% over the same period. The total market cap for all crypto nearly hit $3 trillion during parts of 2021, but is now around $800 billion.
Some investors are on edge that the Federal Reserve may be overtightening monetary policy in its bid to tame hot inflation, as markets look ahead to a reading this coming week from the Fed’s preferred gauge of the cost of living in the U.S.
“Fed officials have been scrambling to scare investors almost every day recently in speeches declaring that they will continue to raise the federal funds rate,” the central bank’s benchmark interest rate, “until inflation breaks,” said Yardeni Research in a note Friday. The note suggests they went “trick-or-treating” before Halloween as they’ve now entered their “blackout period” ending the day after the conclusion of their November 1-2 policy meeting.
“The mounting fear is that something else will break along the way, like the entire U.S. Treasury bond market,” Yardeni said.
Treasury yields have recently soared as the Fed lifts its benchmark interest rate, pressuring the stock market. On Friday, their rapid ascent paused, as investors digested reports suggesting the Fed may debate slightly slowing aggressive rate hikes late this year.
Stocks jumped sharply Friday while the market weighed what was seen as a potential start of a shift in Fed policy, even as the central bank appeared set to continue a path of large rate increases this year to curb soaring inflation.
The stock market’s reaction to The Wall Street Journal’s report that the central bank appears set to raise the fed funds rate by three-quarters of a percentage point next month – and that Fed officials may debate whether to hike by a half percentage point in December — seemed overly enthusiastic to Anthony Saglimbene, chief market strategist at Ameriprise Financial.
“It’s wishful thinking” that the Fed is heading toward a pause in rate hikes, as they’ll probably leave future rate hikes “on the table,” he said in a phone interview.
“I think they painted themselves into a corner when they left interest rates at zero all last year” while buying bonds under so-called quantitative easing, said Saglimbene. As long as high inflation remains sticky, the Fed will probably keep raising rates while recognizing those hikes operate with a lag — and could do “more damage than they want to” in trying to cool the economy.
“Something in the economy may break in the process,” he said. “That’s the risk that we find ourselves in.”
‘Debacle’
Higher interest rates mean it costs more for companies and consumers to borrow, slowing economic growth amid heightened fears the U.S. faces a potential recession next year, according to Saglimbene. Unemployment may rise as a result of the Fed’s aggressive rate hikes, he said, while “dislocations in currency and bond markets” could emerge.
U.S. investors have seen such financial-market cracks abroad.
The Bank of England recently made a surprise intervention in the U.K. bond market after yields on its government debt spiked and the British pound sank amid concerns over a tax cut plan that surfaced as Britain’s central bank was tightening monetary policy to curb high inflation. Prime minister Liz Truss stepped down in the wake of the chaos, just weeks after taking the top job, saying she would leave as soon as the Conservative party holds a contest to replace her.
“The experiment’s over, if you will,” said JJ Kinahan, chief executive officer of IG Group North America, the parent of online brokerage tastyworks, in a phone interview. “So now we’re going to get a different leader,” he said. “Normally, you wouldn’t be happy about that, but since the day she came, her policies have been pretty poorly received.”
Meanwhile, the U.S. Treasury market is “fragile” and “vulnerable to shock,” strategists at Bank of America warned in a BofA Global Research report dated Oct. 20. They expressed concern that the Treasury market “may be one shock away from market functioning challenges,” pointing to deteriorated liquidity amid weak demand and “elevated investor risk aversion.”
Read: ‘Fragile’ Treasury market is at risk of ‘large scale forced selling’ or surprise that leads to breakdown, BofA says
“The fear is that a debacle like the recent one in the U.K. bond market could happen in the U.S.,” Yardeni said, in its note Friday.
“While anything seems possible these days, especially scary scenarios, we would like to point out that even as the Fed is withdrawing liquidity” by raising the fed funds rate and continuing quantitative tightening, the U.S. is a safe haven amid challenging times globally, the firm said. In other words, the notion that “there is no alternative country” in which to invest other than the U.S., may provide liquidity to the domestic bond market, according to its note.
YARDENI RESEARCH NOTE DATED OCT. 21, 2022
“I just don’t think this economy works” if the yield on the 10-year Treasury
TMUBMUSD10Y,
4.228%
note starts to approach anywhere close to 5%, said Rhys Williams, chief strategist at Spouting Rock Asset Management, by phone.
Ten-year Treasury yields dipped slightly more than one basis point to 4.212% on Friday, after climbing Thursday to their highest rate since June 17, 2008 based on 3 p.m. Eastern time levels, according to Dow Jones Market Data.
Williams said he worries that rising financing rates in the housing and auto markets will pinch consumers, leading to slower sales in those markets.
Read: Why the housing market should brace for double-digit mortgage rates in 2023
“The market has more or less priced in a mild recession,” said Williams. If the Fed were to keep tightening, “without paying any attention to what’s going on in the real world” while being “maniacally focused on unemployment rates,” there’d be “a very big recession,” he said.
Investors are anticipating that the Fed’s path of unusually large rate hikes this year will eventually lead to a softer labor market, dampening demand in the economy under its effort to curb soaring inflation. But the labor market has so far remained strong, with an historically low unemployment rate of 3.5%.
George Catrambone, head of Americas trading at DWS Group, said in a phone interview that he’s “fairly worried” about the Fed potentially overtightening monetary policy, or raising rates too much too fast.
The central bank “has told us that they are data dependent,” he said, but expressed concerns it’s relying on data that’s “backward-looking by at least a month,” he said.
The unemployment rate, for example, is a lagging economic indicator. The shelter component of the consumer-price index, a measure of U.S. inflation, is “sticky, but also particularly lagging,” said Catrambone.
At the end of this upcoming week, investors will get a reading from the personal-consumption-expenditures-price index, the Fed’s preferred inflation gauge, for September. The so-called PCE data will be released before the U.S. stock market opens on Oct. 28.
Meanwhile, corporate earnings results, which have started being reported for the third quarter, are also “backward-looking,” said Catrambone. And the U.S. dollar, which has soared as the Fed raises rates, is creating “headwinds” for U.S. companies with multinational businesses.
Read: Stock-market investors brace for busiest week of earnings season. Here’s how it stacks up so far.
“Because of the lag that the Fed is operating under, you’re not going to know until it’s too late that you’ve gone too far,” said Catrambone. “This is what happens when you’re moving with such speed but also such size, he said, referencing the central bank’s string of large rate hikes in 2022.
“It’s a lot easier to tiptoe around when you’re raising rates at 25 basis points at a time,” said Catrambone.
‘Tightrope’
In the U.S., the Fed is on a “tightrope” as it risks over tightening monetary policy, according to IG’s Kinahan. “We haven’t seen the full effect of what the Fed has done,” he said.
While the labor market appears strong for now, the Fed is tightening into a slowing economy. For example, existing home sales have fallen as mortgage rates climb, while the Institute for Supply Management’s manufacturing survey, a barometer of American factories, fell to a 28-month low of 50.9% in September.
Also, trouble in financial markets may show up unexpectedly as a ripple effect of the Fed’s monetary tightening, warned Spouting Rock’s Williams. “Anytime the Fed raises rates this quickly, that’s when the water goes out and you find out who’s got the bathing suit” — or not, he said.
“You just don’t know who is overlevered,” he said, raising concern over the potential for illiquidity blowups. “You only know that when you get that margin call.”
U.S. stocks ended sharply higher Friday, with the S&P 500
SPX,
+2.37%,
Dow Jones Industrial Average
DJIA,
+2.47%
and Nasdaq Composite each scoring their biggest weekly percentage gains since June, according to Dow Jones Market Data.
Still, U.S. equities are in a bear market.
“We’ve been advising our advisors and clients to remain cautious through the rest of this year,” leaning on quality assets while staying focused on the U.S. and considering defensive areas such as healthcare that can help mitigate risk, said Ameriprise’s Saglimbene. “I think volatility is going to be high.”
LONDON—Central banks around the world moved Thursday to combat the effects of a soaring dollar and rising inflation, joining the Federal Reserve in risking a recession to rein in climbing prices.
In a flurry of central bank meetings from Norway to South Africa, many raised rates by larger-than-expected margins in a day that analysts at ING billed as “Super Thursday.”
The Bank of England raised its key interest rate for the seventh consecutive time Thursday. Before the news came out, the British pound briefly touched its lowest point in 37 years against the dollar before recovering some of its losses to reach $1.13.
Even some countries that didn’t move rates—the
Bank of Japan
left its policy rate at its previous low level—took other action to ease the growing inflation pressure.
Japan said Thursday it intervened in currency markets to sell dollars and buy yen, the first such intervention in 24 years, to slow the recent fall in the Japanese currency. The yen fell to 145.87 to the dollar, its weakest level since 1998, before the intervention. It then surged to hit 141 yen, though still far off the 115 yen mark at which the dollar was trading earlier this year.
Haruhiko Kuroda, governor of the Bank of Japan, kept the central bank’s ultralow interest rates in place on Thursday.
Photo:
/Bloomberg News
Japanese Finance Minister
Shunichi Suzuki
later said the government would act again if needed, without indicating the size of the intervention. “Although foreign-exchange rates in principle should be determined in the market, we cannot stand by idly when speculative and excessive moves repeatedly occur,” he said.
The central bank meetings, mostly pre-scheduled, came after the Fed announced its 0.75-point increase the day before and capped a bustling week of global monetary policy tightening. Many central bank officials struggling with a crisis of public confidence after initially arguing that inflationary rises would be temporary, are now racing to raise interest rates to catch up with soaring prices, but not so fast that they trigger unnecessary economic pain.
Switzerland’s central bank joined the stampede toward higher rates by announcing an interest-rate increase that will put its benchmark lending rate above 0% for the first time since 2014, bringing an end to Europe’s last remaining experiment in setting negative interest rates. Sweden’s Riksbank lifted rates by 1 percentage point earlier this week, its largest increase in almost three decades.
The Bank of England was among the last to adjust rates higher, raising its key interest rate for the seventh consecutive time Thursday. Before the news came out, the British pound briefly touched its lowest point in 37 years against the dollar before recovering some of its losses to reach $1.13.
The outlier was Turkey, which appeared unconcerned with the spreading inflation threat. Its central bank cut its benchmark interest rate to 12% from 13%, despite inflation surpassing 80% in August and prompting a renewed slide in the value of its currency. Turkish President
Recep Tayyip Erdogan
has long pressured the bank to keep interest rates low and adhere to his contrarian views that high interest rates encourage rather than prevent inflation. Turkey’s lira then fell to another record low.
Among the nine members of the Bank of England’s monetary policy committee, seven voted for the half-point rate increase to 2.25%, while one voted for a smaller quarter-percentage point rise, and one other pushed for a larger three-quarter-point jump in interest rates. The split views highlight the competing concerns and conflicting economic signals central bank officials the world over are facing, but which are particularly pronounced in the U.K., which is wrestling with its worst inflation increase in roughly four decades.
How have China, Mexico and Greece handled inflation, and where does the U.S. fit in? WSJ’s Dion Rabouin explains.
Central bank officials are particularly worried about how higher interest rates might buffer the nation’s economy and exacerbate a cost-of-living crisis.
The latest economic data pointed to tentative signs that inflation in the U.K. was slowing, but also presented weaker-than-expected readings on gross domestic product. As in the U.S., a tight labor market and low unemployment have been a source of strength despite broad economic weakness.
In coming to their decision Thursday, BOE officials eschewed the option of a larger rate rise which some were expecting. The bank has continued to exhibit greater caution in the fight against inflation than central bankers elsewhere who are increasingly following the Federal Reserve’s strategy of lifting interest rates by 0.75 percentage point or more at a time.
“They are walking exactly the same tightrope at the BOE but the calculus is a lot more about how fragile the economy is, even though the U.K. has one of the worst inflation problems of the G-10,” said Altaf Kassam, head of investment strategy for Europe, the Middle East and Africa at State Street Global Advisors.
By opting for the half-point increase, BOE officials pointed to recent government measures to cap soaring energy bills that are expected to help alleviate one of the biggest contributors to U.K. inflation.
The Bank of England said consumer price rises in the U.K. will peak at just under 11% in October.
Photo:
Chris Ratcliffe/Bloomberg News
At its last meeting, the bank had warned that inflation would peak above 13%. The bank said Thursday that the recently announced cap would likely mean consumer-price rises will peak at just under 11% in October but inflation could remain in double digits for months before falling. The government assistance would likely mean consumers spend more at a later date, adding to inflation in the medium term.
The bank also plowed ahead with plans to begin selling its portfolio of U.K. government bonds. The sales, totaling 80 billion pounds, equivalent to $90.2 billion, over the next 12 months, come just as the U.K. government is expected to borrow more to fund a yet-to-be-announced bumper spending plan.
The bank’s half-point rise also means officials opted to disregard recent criticism that they weren’t being tough enough on the inflation surge. U.K. Prime Minister
Liz Truss,
who recently took office, has said she would review the bank’s inflation-fighting mandate. Meanwhile, the BOE’s own surveys have shown public confidence in the central bank’s ability to control inflation has fallen to a record low.
The keenly anticipated meeting came a week later than initially planned after it was postponed during a period of national mourning following the death of Queen Elizabeth II.
Quantitative monetary easing is credited for juicing stock market returns and boosting other speculative asset values by flooding markets with liquidity as the Federal Reserve snapped up trillions of dollars in bonds during both the 2008 financial crisis and the 2020 coronavirus pandemic in particular. Investors and policy makers may be underestimating what happens as the tide goes out.
“I don’t know if the Fed or anybody else truly understands the impact of QT just yet,” said Aidan Garrib, head of global macro strategy and research at Montreal-based PGM Global, in a phone interview.
The Fed, in fact, began slowly shrinking its balance sheet — a process known as quantitative tightening, or QT — earlier this year. Now it’s accelerating the process, as planned, and it’s making some market watchers nervous.
A lack of historical experience around the process is raising the uncertainty level. Meanwhile, research that increasingly credits quantitative easing, or QE, with giving asset prices a lift logically points to the potential for QT to do the opposite.
Since 2010, QE has explained about 50% of the movement in market price-to-earnings multiples, said Savita Subramanian, equity and quant strategist at Bank of America, in an Aug. 15 research note (see chart below).
BofA U.S. Equity & Quant Strategy
“Based on the strong linear relationship between QE and S&P 500 returns from 2010 to 2019, QT through 2023 would translate into a 7 percentage-point drop in the S&P 500 from here,” she wrote.
Archive: How much of the stock market’s rise is due to QE? Here’s an estimate
In quantitative easing, a central bank creates credit that’s used to buy securities on the open market. Purchases of long-dated bonds are intended to drive down yields, which is seen enhancing appetite for risky assets as investors look elsewhere for higher returns. QE creates new reserves on bank balance sheets. The added cushion gives banks, which must hold reserves in line with regulations, more room to lend or to finance trading activity by hedge funds and other financial market participants, further enhancing market liquidity.
The way to think about the relationship between QE and equities is to note that as central banks undertake QE, it raises forward earnings expectations. That, in turn, lowers the equity risk premium, which is the extra return investors demand to hold risky equities over safe Treasurys, noted PGM Global’s Garrib. Investors are willing to venture further out on the risk curve, he said, which explains the surge in earnings-free “dream stocks” and other highly speculative assets amid the QE flood as the economy and stock market recovered from the pandemic in 2021.
However, with the economy recovering and inflation rising the Fed began shrinking its balance sheet in June, and is doubling the pace in September to its maximum rate of $95 billion per month. This will be accomplished by letting $60 billion of Treasurys and $35 billion of mortgage backed securities roll off the balance sheet without reinvestment. At that pace, the balance sheet could shrink by $1 trillion in a year.
The unwinding of the Fed’s balance sheet that began in 2017 after the economy had long recovered from the 2008-2009 crisis was supposed to be as exciting as “watching paint dry,” then-Federal Reserve Chairwoman Janet Yellen said at the time. It was a ho-hum affair until the fall of 2019, when the Fed had to inject cash into malfunctioning money markets. QE then resumed in 2020 in response to the COVID-19 pandemic.
More economists and analysts have been ringing alarm bells over the possibility of a repeat of the 2019 liquidity crunch.
“If the past repeats, the shrinking of the central bank’s balance sheet is not likely to be an entirely benign process and will require careful monitoring of the banking sector’s on-and off-balance sheet demandable liabilities,” warned Raghuram Rajan, former governor of the Reserve Bank of India and former chief economist at the International Monetary Fund, and other researchers in a paper presented at the Kansas City Fed’s annual symposium in Jackson Hole, Wyoming, last month.
Hedge-fund giant Bridgewater Associates in June warned that QT was contributing to a “liquidity hole” in the bond market.
The slow pace of the wind-down so far and the composition of the balance-sheet reduction have muted the effect of QT so far, but that’s set to change, Garrib said.
He noted that QT is usually described in the context of the asset side of the Fed’s balance sheet, but it’s the liability side that matters to financial markets. And so far, reductions in Fed liabilities have been concentrated in the Treasury General Account, or TGA, which effectively serves as the government’s checking account.
That’s actually served to improve market liquidity he explained, as it means the government has been spending money to pay for goods and services. It won’t last.
The Treasury plans to increase debt issuance in coming months, which will boost the size of the TGA. The Fed will actively redeem T-bills when coupon maturities aren’t sufficient to meet their monthly balance sheet reductions as part of QT, Garrib said.
The Treasury will be effectively taking money out of economy and putting it into the government’s checking account — a net drag — as it issues more debt. That will put more pressure on the private sector to absorb those Treasurys, which means less money to put into other assets, he said.
The worry for stock-market investors is that high inflation means the Fed won’t have the ability to pivot on a dime as it did during past periods of market stress, said Garrib, who argued that the tightening by the Fed and other major central banks could set up the stock market for a test of the June lows in a drop that could go “significantly below” those levels.
The main takeaway, he said, is “don’t fight the Fed on the way up and don’t fight the Fed on the way down.”
Stocks ended higher on Friday, with the Dow Jones Industrial Average
DJIA,
+1.19%,
S&P 500
SPX,
+1.53%
and Nasdaq Composite
COMP,
+2.11%
snapping a three-week run of weekly losses.
The highlight of the week ahead will likely come on Tuesday, with the release of the August consumer-price index, which will be parsed for signs inflation is heading back down.
Investors will watch for another gauge of U.S. inflation in the week ahead after the stock market was rattled by the Federal Reserve ramping up its hawkish tone and suggesting large interest rate hikes are coming to get an overheating economy under control.
“We’re probably seeing peak hawkishness right now,” said James Solloway, chief market strategist and senior portfolio manager at SEI Investments Co., in a phone interview. “It is no secret that the Fed is way behind the curve here, with inflation so high and so far only one 25 basis-point increase under their belt.”
Fed Chair Jerome Powell said April 21 during a panel discussion hosted by the International Monetary Fund in Washington that the central bank isn’t “counting on” inflation having peaked in March. “It is appropriate in my view to be moving a little more quickly,” Powell said, putting a 50 basis-point rate hike “on the table” for the Fed’s meeting early next month and leaving the door open to more outsize moves in the months ahead.
U.S. stocks closed sharply lower after his remarks and all three major benchmarks extended losses Friday, with the Dow Jones Industrial Average booking its largest daily percentage drop since late October 2020. Investors are grappling with “very strong forces” in the market, according to Steven Violin, a portfolio manager at F.L.Putnam Investment Management Co.
“The tremendous economic momentum from the recovery from the pandemic is being met with a very rapid shift in monetary policy,” said Violin by phone. “Markets are struggling, as we all are, to understand how that’s going to play out. I’m not sure anyone really knows the answer.”
The central bank wants to engineer a soft landing for the U.S. economy, aiming to tighten monetary policy to fight the hottest inflation in about four decades without triggering a recession.
The Fed “is partly to blame for the current situation as its exceedingly accommodative monetary policy over the last year has left it in this very tenuous position,” wrote Osterweis Capital Management portfolio managers Eddy Vataru, John Sheehan and Daniel Oh, in a report on their second-quarter outlook for the firm’s total return fund.
The Osterweis portfolio managers said the Fed can raise the target fed funds rate to cool the economy while shrinking its balance sheet to lift longer maturity rates and contain inflation, but “sadly, implementation of a dual-pronged quantitative tightening plan requires a level of finesse that the Fed is not known for,” they wrote.
They also raised concern over the Treasury yield curve’s brief, recent inversion, where shorter-term yields rose above longer-term yields, calling it “a rarity for this stage of a tightening cycle.” That reflects “a policy error,” in their view, which they described as “leaving rates too low for too long, and then potentially hiking too late, and probably too much.”
The Fed last month hiked its benchmark interest rate for the first time since 2018, raising it by 25 basis points from near zero. The central bank now appears to be positioning to front-load its rate hikes with potentially larger increases.
“There’s something in the idea of front-end loading,” Powell remarked during the panel discussion on April 21. James Bullard, president of the Federal Reserve Bank of St. Louis, said April 18 that he wouldn’t rule out a large hike of 75 basis points, though that is not his base case, The Wall Street Journal reported.
Read: Fed funds futures traders see 94% likelihood of 75 basis point Fed hike in June, CME data shows
“It’s very likely that the Fed is going to move by 50 basis points in May,” but the stock market is having a “bit harder time digesting” the notion that half-point increases also could be coming in June and July, said Anthony Saglimbene, global market strategist at Ameriprise Financial, in a phone interview.
The Dow
DJIA,
-2.82%
and S&P 500
SPX,
-2.77%
each tumbled by nearly 3.0% on Friday, while the Nasdaq Composite
COMP,
-2.55%
dropped 2.5%, according to Dow Jones Market Data. All three major benchmarks finished the week with losses. The Dow fell for a fourth straight week, while the S&P 500 and Nasdaq each saw a third consecutive week of declines.
The market is “resetting to this idea that we’re going to move to a more normal fed funds rate much quicker than what we probably” thought about a month ago, according to Saglimbene.
“If this is peak hawkishness, and they push really hard at the offset,” said Violin, “they perhaps buy themselves more flexibility later in the year as they start to see the impact of very quickly getting back to neutral.”
A faster pace of interest rate increases by the Fed could bring the federal funds rate to a “neutral” target level of around 2.25% to 2.5% before the end of 2022, potentially sooner than investors had been estimating, according to Saglimbene. The rate, now in the range of 0.25% to 0.5%, is considered “neutral” when it is neither stimulating nor restricting economic activity, he said.
Meanwhile, investors are worried about the Fed shrinking its roughly $9 trillion balance sheet under its quantitative tightening program, according to Violin. The central bank is aiming for a faster pace of reduction compared to its last effort at quantitative tightening, which roiled markets in 2018. The stock market plunged around Christmas that year.
“The current anxiety is that we’re headed to that same point,” said Violin. When it comes to reducing the balance sheet, “how much is too much?”
Saglimbene said that he expects investors may largely “look past” quantitative tightening until the Fed’s monetary policy becomes restrictive and economic growth is slowing “more materially.”
The last time the Fed tried unwinding its balance sheet, inflation wasn’t a problem, said SEI’s Solloway. Now “they’re staring at” high inflation and “they know they have to tighten things up.”
Read: U.S. inflation rate leaps to 8.5%, CPI shows, as higher gas prices slam consumers
At this stage, a more hawkish Fed is “merited and necessary” to combat the surge in the cost of living in the U.S., said Luke Tilley, chief economist at Wilmington Trust, in a phone interview. But Tilley said he expects inflation will ease in the second half of the year, and the Fed will have to slow the pace of its rate hikes “after doing that front-loading.”
The market may have “gotten ahead of itself in terms of expectations for Fed tightening this year,” in the view of Lauren Goodwin, economist and portfolio strategist at New York Life Investments. The combination of the Fed’s hiking and quantitative tightening program “could cause market financial conditions to tighten” before the central bank is able to increase interest rates by as much as the market expects in 2022, she said by phone.
Investors next week will be watching closely for March inflation data, as measured by the personal-consumption-expenditures price index. Solloway expects the PCE inflation data, which the U.S. government is scheduled to release April 29, will show a rise in the cost of living, partly because “energy and food prices are rising sharply.”
Next week’s economic calendar also includes data on U.S. home prices, new home sales, consumer sentiment and consumer spending.
Ameriprise’s Saglimbene said he’ll be keeping an eye on quarterly corporate earnings reports next week from “consumer-facing” and megacap technology companies. “They’re going to be ultra-important,” he said, citing Apple Inc.
AAPL,
-2.78%,
Meta Platforms Inc.
FB,
-2.11%,
PepsiCo Inc.
PEP,
-1.54%,
Coca-Cola Co.
KO,
-1.45%,
Microsoft Corp.
MSFT,
-2.41%,
General Motors Co.
GM,
-2.14%
and Google parent Alphabet Inc.
GOOGL,
-4.15%
as examples.
Read: Investors just pulled a massive $17.5 billion out of global equities. They’re just getting started, says Bank of America.
Meanwhile, F.L.Putnam’s Violin said that he is “pretty comfortable staying fully invested in equity markets.” He cited low risk of recession but said he prefers companies with cash flows “here and now” as opposed to more growth-oriented businesses with earnings expected far out in the future. Violin also said he likes companies poised to benefit from higher commodity prices.
“We’ve entered a more volatile time,” cautioned SEI’s Solloway. “We really need to be a little bit more circumspect in how much risk we should be taking on.”
WASHINGTON—A federal appeals court reversed the convictions of two former
Deutsche Bank AG
traders found guilty of rigging a global lending benchmark, overturning one of the U.S. government’s highest-profile court victories linked to the 2008 financial crisis.
The decision Thursday dealt a blow to the legacy of an investigation that Washington poured resources into after the financial crisis, when prosecutors were criticized for not pursuing enough cases against individual traders and executives. The cases focused on how traders and brokers world-wide influenced the daily London interbank offered rate, known as Libor, which helped set the value of lucrative derivatives they traded and made banks appear healthier.
Thursday’s reversal shows how difficult it has been for prosecutors to use broadly written antifraud laws to punish traders operating in sophisticated markets where standards of conduct weren’t always clear. A panel of the U.S. Court of Appeals for the Second Circuit found evidence used to convict Matthew Connolly and Gavin Black wasn’t enough to stand up fraud and conspiracy charges. A jury in New York had convicted the two men in 2018.
The Manhattan-based appeals court in 2017 also tossed Libor-related verdicts against two traders who had worked at Rabobank Group.
The court action Thursday means every Libor trial conviction in the U.S. has now been overturned. Six other traders from Rabobank and Deutsche Bank pleaded guilty in the U.S. to Libor-related misconduct from 2014 to 2016. Many convictions in the U.K. stand, including that of Tom Hayes, a former star trader at
UBS Group AG
, who was found guilty of rigging Libor and served more than five years in prison before being released last year.
Libor, a gauge of the rates at which banks could borrow from other banks, was published for many years by the British Bankers’ Association. The BBA’s version of Libor was vulnerable to manipulation because traders could influence the rates submitted by their banks.
Financial markets have since started a shift away from Libor in favor of a new reference rate that is calculated based on actual trades. U.S. banks weren’t allowed to issue new debt tied to Libor beginning in January.
A series of Wall Street Journal articles in 2008 raised questions about whether global banks were manipulating the interest-rate-setting process by lowballing Libor to avoid looking desperate for cash during the financial crisis.
The three judges wrote that prosecutors hadn’t proved that Messrs. Connolly and Black made false statements—a requirement for proving fraud—when they gave input related to what Deutsche Bank should submit to the BBA.
The government’s case, according to the judges, depended on the flawed idea that there was one true Libor rate that Deutsche Bank should have offered, when in fact the number was a hypothetical measure influenced by many factors.
Prosecutors didn’t present evidence suggesting that Deutsche Bank couldn’t actually have borrowed at the rates it submitted, the judges wrote. While nudging Libor one way or another to make money might be wrong, the submissions weren’t false if the bank could have gotten cash at those rates, according to the panel.
The BBA’s own instructions for submitting Libor around the time of the financial crisis didn’t prohibit taking a bank’s derivatives bets into consideration. In effect, the judges wrote, prosecutors tried to criminalize conduct that was just unseemly.
“In some ways, these reversals underscore what a screwed-up benchmark Libor was to begin with, when you are not being asked to submit actual offers or bids, but just hypotheticals,” said Aitan Goelman, a former director of enforcement for the Commodity Futures Trading Commission, a civil regulator that fined many banks for Libor violations. “It almost begged to be manipulated.”
Mr. Black, a U.K. citizen who had worked for the bank in London, was sentenced in November 2019 to three years of probation including nine months of home confinement, which he was allowed to serve in his home country. Mr. Connolly, who worked for Deutsche Bank in New York, was sentenced to two years of probation including six months of home confinement.
“We have long maintained that Gavin Black committed no crime, and we are deeply appreciative that the Court of Appeals carefully reviewed the record and reached the same conclusion,” said Seth Levine, a lawyer for Mr. Black at Levine Lee LLP. “This is a case that never should have been brought, and the court has now vindicated Mr. Black’s position.”
“We are elated that Matt Connolly has been fully exonerated in this contrived case that never should have been brought,” said Kenneth Breen, a lawyer at Paul Hastings LLP for Mr. Connolly.
Deutsche Bank in 2015 agreed to pay $2.5 billion in fines to resolve Libor charges in the U.S. and the U.K., and a London unit of the bank pleaded guilty in the U.S. to one count of wire fraud.
Spokesmen for Deutsche Bank and the Justice Department declined to comment.
Istanbul’s stock market was twice forced to halt trading and the Turkish lira continued to fall Friday as concerns deepened that recent interest-rate cuts could cause an inflationary spiral.
Turkey’s benchmark Borsa Istanbul 100 index sank 8.5% Friday in its worst day since March, triggering two circuit breakers that halted trades. The lira lost as much as 8% of its value against the dollar, despite Turkey’s central bank intervening to arrest the decline in the country’s currency.
The crash followed another decision by the central bank on Thursday to cut interest rates under pressure from President
Recep Tayyip Erdogan,
who favors lower rates as a part of a vision to grow the Turkish economy. Mainstream economists have urged the government to raise interest rates to control Turkey’s rising inflation, which reached more than 21% last month, according to official statistics.
The lira’s continuing decline is increasingly squeezing ordinary Turks, who have seen their savings evaporate. It is also adding to pressure on the banking system, which has high levels of foreign-currency-denominated loans to repay within the next 12 months. As of September, the loans equaled about 11% of Turkey’s gross domestic product, according to Capital Economics.
“We are astonished to watch the central bank releasing its precious foreign exchange resources to the market today after it cut rates yesterday,” said
Erdal Bahcivan,
chairman of the board of the Istanbul Chamber of Industry, in a tweet.
Friday’s decision to intervene in the currency market was the fifth time that the central bank has stepped in to prop up the lira this month. It cited “unhealthy price formations in exchange rates,” in a statement declaring the intervention.
Economists estimate that Turkey’s central bank has more foreign-currency liabilities than assets, giving it little firepower to steady the lira through intervention. Despite the central bank selling assets Friday after the lira fell past 17 to the dollar, the currency began to slide again hours later.
“The diminishing impact of intervention is really telling,” said
Paul McNamara,
an emerging-market fund manager at GAM. “With this kind of intervention, the trouble is the market knows the level of reserves they have. It’s not like Russia or Brazil—countries that really have a lot of foreign currency they can throw at this.”
The lira has lost more than half its purchasing power against the dollar this year, much of that decline in the past month, a dramatic unraveling reminiscent of past emerging-market crises in places such as Argentina and Lebanon.
The plummeting lira makes it more likely that Turkey will need to implement capital controls—measures to restrict or even prohibit the flow of money out of the country—to keep the lira from being heavily sold, Mr. McNamara said.
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Turkey’s ability to impose such controls is complicated by the country’s consistent need for foreign currencies as banks and companies need to repay or service debts. Investors see few other options for Turkey to stabilize the lira, expecting that Mr. Erdogan won’t want to raise interest rates. The Turkish president has fired a series of central bank governors and other senior officials who opposed his unorthodox view of the economy.
The loss of confidence in Turkey’s monetary policy has also put pressure on other parts of the market.
Turkish stocks had seen a strong run before Friday. Locals might have preferred to put their savings into stocks rather than other assets as inflation has risen, investors said, because companies can increase prices alongside inflation, boosting returns.
“Generally, a little bit of inflation is good for equities,” said
Daniel Wood,
a portfolio manager at William Blair Investment Management. “Once you get concerned about hyperinflation, that’s bad for companies.”
Shortly after Thursday’s rate raise, Mr. Erdogan also announced an increase in Turkey’s minimum wage, which could also stoke inflation, Mr. Wood said. Concerns over unbridled inflation might have prompted some investors to sell shares.
The cost of insuring against default on $10,000 of five-year Turkish dollar-denominated bonds using derivatives contracts called credit default swaps climbed to about $525 a year Friday, from about $380 a year at the end of June, according to FactSet. Investors buy these swaps if they think the price for insuring against a default will rise further.
“The upheaval in the markets and the level that foreign currencies reached worries many of our companies and affects them negatively,” said
Rifat Hisarciklioglu,
president of the Union of Chambers and Commodity Exchanges of Turkey.
As the Federal Reserve and other central banks around the world deal with rising inflation amid the economic recovery from the pandemic, Turkey — where the rate is currently over 20% — offers a warning. Soaring inflation has led to economic turmoil after years of broad growth. Photo: Sedat Suna/Shutterstock
Write to Caitlin Ostroff at caitlin.ostroff@wsj.com and Jared Malsin at jared.malsin@wsj.com
Get out your popcorn, and get your trading apps open — after months in the waiting, Federal Reserve Chair Jerome Powell is set to deliver remarks on the economic outlook at the Kansas City Fed’s Jackson Hole economic symposium.
Expect him to inch up to the line, but not quite announce, that the Fed will end its bond-buying program. The delta variant has supressed progress on a number of economic indicators, ranging from airline travel to purchasing manager gauges of activity, so Powell will have reason to say, let’s wait for another month or two of data before committing to a taper.
But there’s another reason why the Fed should wait — the framework that Powell himself introduced at last year’s Jackson Hole, called average inflation targeting. “We will seek to achieve inflation that averages 2% over time. Therefore, following periods when inflation has been running below 2%, appropriate monetary policy will likely aim to achieve inflation moderately above 2% for some time,” he said in 2020.
Now Powell didn’t actually define the “time” element. If time means three years, inflation is still below target, as the chart shows. “It is needless to say that the hurdle rate for rate hikes due to inflation is extremely high under the new Fed framework and that this year’s US treasury rates move was unwarranted,” said Mondher Bettaieb-Loriot, head of corporate bonds at Vontobel Asset Management.
Bettaieb-Loriot may not be correct in his call that tapering’s unlikely before well into 2022; after all, during the July meeting in which “most” Fed officials said it would make sense to start reducing purchases, the 3-year rolling average of inflation was below target. Put another way, the Fed’s commitment to its new framework has been shaky. It will be interesting to see whether Powell makes a fresh commitment to it, or not.
The buzz
The Powell speech is due at 10 a.m. Eastern, and a gaggle of other policymakers will be interviewed on the major business news networks through the day. Ahead of that, there’s data on the PCE price index for July, as well as trade in goods data from July.
There were a number of corporate earnings releases delivered late Thursday. Gap
GPS,
-4.11%
surged as the retailer’s earnings came in well ahead of estimates, with online sales now representing a third of total revenue. Peloton Interactive
PTON,
-1.86%
shares slumped on the exercise bike company’s outlook and price cuts. Enterprise software provider VMware
VMW,
+0.20%
also slumped after its latest results.
The two U.S. major makers of personal computers, HP
HPQ,
-0.99%
and Dell
DELL,
-0.50%,
also reported results, with HP missing estimates on sales. Read: The PC boom is wobbly as the most important time of year approaches
Apple
AAPL,
-0.55%
will allow app makers to direct consumer payments outside of its App Store, a response to a number of antitrust lawsuits against it.
Microsoft
MSFT,
-0.97%
has warned thousands of its cloud customers that their databases may have been exposed to intruders, according to an email obtained by Reuters.
Tesla
TSLA,
-1.41%
is trying to sell electricity directly to consumers in Texas, according to Texas Monthly.
China plans to ban U.S. initial public offerings for data-heavy tech firms, The Wall Street Journal reported.
Evacuations resumed in Afghanistan after the deadly bombings in Kabul.
The markets
U.S. stock futures
ES00,
+0.26%
YM00,
+0.20%
nudged higher ahead of the Powell speech. The yield on the 10-year Treasury
TMUBMUSD10Y,
1.345%
slipped to 1.34%.
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Turkey’s currency tumbled almost 8% on Monday, putting it on course for its biggest single-day selloff since 2018, following the abrupt ouster of the central-bank governor last week.
The lira fell to as low as 8.280 a dollar from 7.219, before regaining some ground to trade at about 7.7865 a dollar, according to FactSet. Turkey’s stocks also plunged.
The turmoil comes after President Recep Tayyip Erdogan on Friday unexpectedly fired Naci Agbal, the central-bank governor who had repeatedly raised interest rates in an effort to tame inflation since his appointment in November. Foreign investors say the move renewed concerns that the central bank has lost its independence from political influence, diminishing policy makers’ credibility and sapping appetite for Turkish assets.
The new governor, Sahap Kavcioglu, Sunday tried to reassure markets by saying taming inflation is the bank’s main objective. He also pledged to foster economic stability by lowering borrowing costs and bolstering growth. Money managers are concerned that he might allow the currency to depreciate, and accept elevated inflation levels, to lower interest rates.
“We’re really trying to gauge what the level of commitment to the lira is,” said Simon Harvey, senior foreign-exchange market analyst at broker Monex Europe. “We know in Turkey that interest rates are politically sensitive.”
European stocks traded higher on Thursday ahead of a European Central Bank decision, as investors celebrated an easing in bond yields.
Up six of the last eight sessions, the Stoxx Europe 600
SXXP,
+0.26%
edged up 0.2%.
The yield on the U.S. 10-year Treasury
TMUBMUSD10Y,
1.491%
fell below 1.5% for the first time in a week after U.S. core consumer prices saw a muted rise in February, taking air out of the fears of inflation that had recently worried traders. ECB President Christine Lagarde is to further explain the central bank’s worry that rising bond yields could interfere with monetary policy, at a news conference following the policy decision.
“While we do not expect the central bank to announce new measures, ECB President Christine Lagarde will strike a dovish tone, emphasizing the flexibility embedded in its pandemic QE [quantitative easing] program to front-load asset purchases as needed,” said economists at research service TS Lombard.
U.S. stock futures
ES00,
+0.73%
were stronger, particularly the technology-heavy Nasdaq-100
NQ00,
+1.81%,
which closed lower on Wednesday.
In Europe, tech stocks including microchip equipment maker ASML
ASML,
+2.64%,
technology investor Prosus
PRX,
+2.68%
and microchip maker Infineon Technologies
IFX,
+3.23%
advanced.
Banks including HSBC
HSBA,
-1.98%
and Barclays
BARC,
-1.53%
traded lower as yields fell.
Also read: Eurozone banks are showing life after 15 rough years. Will the ECB snuff out the rally?
Engine maker Rolls-Royce
RR,
+2.08%
rose 1%. The struggling company, which reported an underlying £4 billion loss in 2020, says it expects to be free cash flow positive in the second half of the year.
