Markets – Bad news is bad news
Markets are turning weaker as recession fears mount. Weak manufacturing data in Europe, rising unemployment rate in US, and the absence of fiscal stimulus in China are turning into broad equity weakness. A poor US earnings season is adding to concerns. July data published on Friday showed an increase to the US unemployment rate to 4.3%, the highest from October 2021. 12-months ahead US growth now trails 1%, not a recession level but well below trend. We still don’t see the current set of data as recessionary but recognise risks have increased. The debacle in risk assets is turning into a proper de-grossing of carry trades and popular risk positions, as the Japanese Yen strength forces sales in assets like Japanese and US equities. This market dynamic amplifies the reaction to weaker but not disastrous data. Global equities are now 5% lower from the peak, and moves have been particularly violent in Europe and US last week. Credit spreads started widening, but are still shy of recession levels. Rates, on the other hand, are pricing a bleaker outlook. The US curve is disinverting quickly, and now prices 125bp in cuts in 2024, of which 50bp in September. We continue to see potential for downside in risky assets but start finding rates markets overpriced.
Fed – Cuts at the horizon
At its July meeting, the Federal Reserve has guided markets for a beginning of its cutting cycle in September. The statement sounded neutral, but Chairman Powell guided for a cut under the baseline scenario in September. The discussion quickly moved to timing and pace, revealing FOMC being comfortable in starting cuts in summer, with a potential explicit announcement at the Jackson Hole meetings in late August. The meeting took place before poor labor market data was released; hence more dovish commentary could follow in the next few days. The Fed has changed the balance of risks from inflation to growth, de facto kicking off a new phase in the monetary cycle.
BoJ – A new era
The Bank of Japan surprised markets by hiking interest rates 15bp to 0.25% at the July meeting. The central bank also announced a reduction in bond purchases by 50% over the next two years, in line with market expectations. The announcement come at a time where the Ministry of Finance has repeatedly attempted to defend the currency, and right before the Fed was widely expected to turn move dovish. It thus represents a line in the sand when it comes to FX policy, similarly to the abandonment of yield curve control policy implemented in March 2023. The Japanese Yen snapped quickly from 160 to 147 over the past two weeks, but remains deeply undervalued, and underowned by both domestic and international investors. The currency is thus likely to appreciate more as the central bank continues to normalise policy.
Algebris Investments’ Global Credit Team
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