Marketmind: Dysfunction and intervention

[September 29, 2022]  A look at the day ahead in U.S. and global markets from Mike Dolan.

Amid all the chaos in British bond markets, the forced intervention by the Bank of England to buy gilts has given some investors a crumb of comfort about the limits of central bank tightening.

The bad news was that the BoE's extraordinary move to buy long-term gilts in a "whatever it takes" operation on Wednesday - postponing for at least a month its planned "quantitative tightening" bond sale plan, and all while it's raising interest rates - was rooted in a market malfunction that threatened the stability of the UK pension fund industry and mortgage market.

If, as many believe, central banks will tighten credit to get across inflation until something breaks, then some see this week's UK moment as a note of caution for all major central banks about the limits of tightening. Cold comfort maybe, but enough to drag bond yields back and lift stocks briefly around the world.

Others assume this is an idiosyncratic British event, with recessionary implications that have seen the UK yield curve between 2 years and 30 years invert this week for the first time since the banking crash of 2008. While 30-year gilt yields steadied just below 4% on Thursday after their 100bp swoon the previous day, the pound was sliding again and UK midcap stocks dropped.
 

The calm is clearly fragile. UK Prime Minister Liz Truss and her ministers stressed on Thursday the government will not reverse the economic plan for slashing taxes into the inflation surge, a plan that sparked the gilt market turmoil and sent the pound into tailspin since last Friday.

That's even as former Bank of England boss Mark Carney became the latest influential figure to criticise the scheme for operating at cross purposes to the BoE's inflation fight.

But as Britain grappled with its crisis, the euro zone also faced the prospect of another steep rise in interest rates as German states recorded a jump in inflation readings close to 10% this month

Germany's 10-year government bond yield rose to the highest in more than a decade as a result, with several European Central Bank officials calling for a second jumbo 75bp interest rate rise in a row at the bank's next policy meeting.

Easing inflation in Spain was better news.

British pound banknote is pictured through broken glass in this illustration taken, June 25, 2021. REUTERS/Dado Ruvic/Illustration

But Germany's main economic institutes said the impact of the energy crisis and high inflation would see the economy contract by 0.4% in 2023, compared to their prior forecast for growth of 3.1%.

Elsewhere, retail stocks were under the cosh. Shares of Sweden's H&M fell 4.5% after the world's second-biggest fashion retailer said profits were hit by soaring input costs, slowing consumer spending and its exit from Russia. Market leader Inditex, the owner of Zara, slipped 2.2%, while the wider STOXX retailers index <.SXRP> slid 4.3%. And Next dropped 10.2% after the British clothing retailer cut forecasts, saying August trading was below expectations as cost of living pressures climbed.

U.S. stock futures were back in the red ahead of the open, with 10-year Treasury yields climbing again despite a sharp retreat from 4% on Wednesday. The dollar pushed higher again too.

Key developments that should provide more direction to U.S. markets later on Thursday:

* Bank of England deputy governor for Markets and Banking David Ramsden, Bank of England policymaker Silvana Tenreyro speak

* European Central Bank Vice President Luis de Guindos, ECB chief economist Philip Lane, ECB board member Fabio Panetta, ECB board member Elizabeth McCaul, ECB board member Frank Elderson; and ECB Council members Mario Centeno, Martins Kazaks, Gedeminas Simkus and Madis Muller all speak; Bank of Spain chief Pablo Hernandez de Cos speaks

* San Francisco Federal Reserve President Mary Daly, Cleveland Fed chief Loretta Mester

* Central Bank of Mexico releases Monetary policy statement

* U.S. Q2 corporate profits, final Q2 GDP data. Weekly jobless claims report

* U.S. Corporate Earnings: Nike, Micron Technology, Carmax

(By Mike Dolan, Editing by Hugh Lawson; [e-mail]. Twitter: @reutersMikeD)

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