The Dow Jones industrial average fell back into negative territory Thursday as investors reacted to mixed earnings results from two Dow components and digested last night’s final presidential debate and the European Central Bank’s decision today to keep interest rates and its stimulus plans unchanged.
The Dow was hoping to notch its first three-session winning streak since Sept. 20-22 but failed as the blue-chip index fell 41 points, or 0.2% lower, to 18,162. The Standard & Poor’s 500 stock index was 0.1% lower, and the Nasdaq dropped 0.1%.
American Express (AXP) continued the string of strong third-quarter earnings results from U.S. banks and financial services companies. After last night’s close, AmEx reported earnings and sales results that topped forecasts and also boosted its profit guidance for the remainder of 2016. American Express shares jumped nearly 10%.
Overall, the third-quarter earnings season is off to a better-than-expected start. Eight of the 10 companies that have reported results so far have topped forecasts, helping the S&P 500’s earnings growth rate to tick up to +0.5%, according to earnings-tracker Thomson Reuters. If earnings finish positive, it would mark an end to a profit recession that has seen S&P 500 earnings contract for the prior four quarters.
The first time the ECB officially warned about the dangers of virtual currencies in general, and in particular, bitcoin – what was then a mostly unknown currency trading in the single digits (in USD terms) – was in November 2012 when in a report called “Virtual Currency Schemes” it warned that “in an extreme case, virtual currencies could have a substitution effect on central bank money if they become widely accepted. The increase in the use of virtual money might lead to a decrease in the use of “real” money, thereby also reducing the cash needed to conduct the transactions generated by nominal income. In this regard, a widespread substitution of central bank money by privately issued virtual currency could significantly reduce the size of central banks’ balance sheets, and thus also their ability to influence the short-term interest rates. Central banks would need to look at their existing tools to deal with this risk (for instance, trying to impose minimum reserve requirements on virtual currency schemes).”
Ironically, since then the ECB has moved significantly down the narrative of currency substitution, and in fact, following a recent push to eliminate paper currency (now that the €500 bill is no longer produced) the central bank has been urging for a shift away from real, paper money and into electronic variants.
However, overnight in a surprising reminder how the European central bank feels about bitcoin and other virtual money, the ECB urged EU lawmakers to tighten proposed new rules on digital currencies such as bitcoin, fearing they might one day weaken its own control over money supply in the euro zone.
In other words, first the ECB went after cash; now it is going after all virtual currencies like bitcoin.
According to Reuters, the European Commission’s draft rules, aimed at fighting terrorism, require currency exchange platforms to increase checks on the identities of people exchanging virtual currencies for real ones and report suspicious transactions.
In a legal opinion published on Tuesday, the ECB said EU institutions should not promote the use of digital currencies and should make clear they lack the legal status of currency or money.
EM FX gained a little traction on Friday, but capped a week of steady losses. As the US election and FOMC meeting next month get closer, we believe markets and risk appetite will remain volatile. So far, September data from the US does not suggest any urgency to hike in November, and so we continue to believe that December is most likely for another hike.
Looking at individual countries, South Africa political risk remains high as the feud between Gordhan and Zuma plays out. The Turkish central bank meets, and any jawboning by the government could weigh on the lira. On the other hand, Brazil is likely to continue outperforming, as COPOM is likely to follow up recent fiscal consolidation efforts with the first rate cut of this cycle.
Brazil reports August retail sales Tuesday. COPOM then meets Wednesday and is expected to cut rates 25 bp to 14.0%. Mid-October IPCA inflation will be reported Friday, which is expected to rise 8.3% y/y vs. 8.78% in mid-September. Last week’s cut in fuel prices won’t show up yet, but does suggest falling price pressures ahead. Along with progress on the government spending cap bill, we think developments support a potential 50 bp cut this week.
Colombia reports August retail sales and IP Tuesday. The former is expected at –0.5% y/y and the latter at +3.0% y/y. The economy has softened from both fiscal and monetary tightening, but the recent bounce in oil prices (if sustained) will help boost growth. Inflation peaked and has fallen to 7.3% y/y in September. This is the lowest since December, but remains above the 2-4% target range. We think easing is unlikely until we are well into 2017.
European bond funds suffered their largest withdrawals in more than a year and the redemptions from the continent’s equity funds inched closer to the $100bn mark as a turbulent pound highlighted the risks of the looming UK exit from the EU.
Money managers invested in European stocks recorded $1.1bn of withdrawals in the week to October 12, the 36th consecutive week of outflows, according to fund flows tracked by EPFR. European bond funds, which had benefited from central bank stimulus programmes in the wake of the Brexit vote in June, were hit with $2.2bn of outflows. That marked the largest weekly withdrawal since June 2015.
The flows underline the effect a 6 per cent move in sterling over a two-minute span last Friday has had on investor psyche, accelerating a months-long rotation out of European stock and bond markets. The pound has slid 17 per cent against the US dollar and 15 per cent against a basket of the country’s largest trading partners, Deutsche Bank data show.
“As we get closer and we have timelines set by the government for Brexit, it is much more front of mind, people are pricing that in and you are seeing that reflect in the pound,” said Andrew Lee, who works within UBS Wealth Management’s chief investment office. Brexit is “weighing on people’s minds”, he added.
Concerns have also arisen around the potential for a rise in bond yields should central banks rein in accommodative monetary policies. Investor concern has centred on how and when the European Central Bank will begin to curtail its asset-buying programme.
“I think folks always knew it was going to have a sunset but the feeling is it may be closer than we thought a few months ago,” said Jim Shepard, co-head of investment-grade debt capital markets at Mizuho.
European monetary policy, corporate America, US politics and Chinese growth all demand investor attention next week.
Here’s what to watch in the coming days.
European Central Bank
A recent report that the ECB’s governing council had been discussing tapering its asset-buying programme spooked investors, and they will now tune into Mario Draghi’s press conference on Thursday for clues on how the central bank could move forward. Some economists expect the ECB could announce a six-month extension to the QE programme, which is currently set to expire in March 2017, at its December meeting.
“Nevertheless, given the resilience in growth, the pick-up in inflation, and concerns about the negative side effects of low interest rates and bond yields, we believe a tapering decision on 8 December should not be dismissed easily,” Reinhard Cluse, economist at UBS, said.
Economists expect the central bank will leave its interest rates unchanged next week.
Across the Atlantic US politics and corporate America grab the spotlight. Democratic presidential candidate Hillary Clinton and Republican candidate Donald Trump will face off at the University of Nevada, Las Vegas for the final debate ahead of the 2016 elections. The 90-minute debate will be moderated by Fox News anchor Chris Wallace.
Mr Trump heads to the match-up amid a fresh string of allegations that he groped or sexually assaulted women, following the release of a video earlier this month in which he bragged about groping women. For Mr Trump, who has in recent weeks lost the support of many top Republicans, this could be a final chance to bounce back in the polls.
Low Interest Rates
Vice Chairman Stanley Fischer
40th Annual Central Banking Seminar, FRBNY, October 5, 2016
I would like to thank the Federal Reserve Bank of New York for establishing this seminar 40 years ago and for maintaining it since then. This event has always been a useful forum for sharing knowledge and experiences among the world’s central banks, something that has become especially valuable in the years since the Great Recession. This seminar has also fostered a stronger sense of community among central banks, whose interactions undergird the global financial system.1
I will talk today about an issue that currently confronts almost all central banks: historically low interest rates. Indeed–as shown in figure 1–in an increasing number of countries, they have even dipped below zero. Ultralow interest rates have not been limited to the short end of the yield curve, which is most directly affected by monetary policy. Figure 2 shows that longer-term interest rates–which embed market participants’ expectations of where real short-term rates and inflation are likely to be in the future–have also been exceptionally low.
The low interest rate environment presents us with four key questions: (1) Are ultralow interest rates part of the so-called new normal for the global economy, or are they mostly transitory? (2) How concerned should we be, if at all, about the current interest rate environment? (3) What determines the level of interest rates over the longer run? (4) What can policymakers do about chronically low interest rates?
Despite the weaker than expected US jobs report, the dollar remains firm and EM is ending the week on a soft note. The main culprit was higher US rates, with the 2-year yield moving up to 0.85% and is the highest since early June. Concerns about Brexit impact and as well the health of European banks remain ongoing and could weigh on risk sentiment this coming week. Lastly, oil may come under more pressure after Russia said it sees no deal with OPEC at next week’s World Energy Congress meeting in Turkey.
China returns from a week-long holiday, and markets may be a bit nervous after it reported lower than expected foreign reserves for September. Taken in conjunction with the softer yuan, capital outflows from China may be picking up. Elsewhere, the central banks of Korea, Peru, and Singapore hold policy meetings, though no changes are expected.
China reports September money and new loan data sometime during the week, but no date has been set. It reports September trade Thursday. Exports are expected at -3.3% y/y and imports at +0.7% y/y. It then reports September CPI and PPI Friday, with the former seen rising 1.6% y/y and the latter falling -0.3% y/y. The PBOC has been on hold since October 2015, when it cut its policy rates by 25 bp. If the slowdown remains modest, we do not think PBOC will ease further for fear of encouraging debt-fueled growth. We think the easing cycle is over.
Stressed loans in India’s banking sector crossed $138 billion in June, central bank data reviewed by Reuters shows, an increase of nearly 15 percent in just six months that suggests a state clean-up effort will take longer and cost more than expected.
Fixing the mountain of bad debt weighing down India’s banks is vital for Prime Minister Narendra Modi’s government to revive weak credit and investment growth and put a faltering recovery in Asia’s third largest economy on a firmer footing.
India’s central bank has set a March deadline for banks to fully reveal problem loans on their books. When lenders disclose bad loans, they need to take writedowns that hit their bottom line and eat into equity.
The latest data obtained by Reuters through a right-to-information request showed stressed loans rose to 9.22 trillion rupees ($138.5 billion) as at end-June, from 8.06 trillion rupees ($121 billion) in December.
The end-December $121 billion figure has been cited by the government and bankers as the peak of stressed assets in the banking sector.
Stressed assets include both non-performing loans (NPLs) – defined as those that have not been serviced for 90 or more days – and restructured or rolled over loans, where banks have eased interest rates or the repayment period.
China’s yuan fell to its lowest level in six years early Monday, breaching a key psychological threshold, before erasing the losses on the first day of trading after a week-long holiday.
Traders said the weakening of the yuan reflected strength in the dollar last week, and they did not see any signs of intervention by state banks to support the yuan after it fell.
In mid-July, when the yuan last breached the 6.7 mark, state banks intervened heavily.
Some China watchers have wondered if any signs of yuan weakness following the holiday would signal that Beijing was putting the currency back on a slow depreciation path after holding it steady through September.
The currency fell after the People’s Bank of China set the midpoint at 6.7008 yuan per dollar, its weakest fix since September 2010 and about 0.3 percent weaker than the setting on Sept. 30, before a one-week National Day holiday.
We have a new governor of the Reserve Bank of India, we have a Monetary Policy Committee (MPC), and we have their first statement on monetary policy. It is tempting to read the tea leaves!
The MPC’s statement, with unanimous support, is significant not only for the cut in the policy repo rate but also for the analysis of the economic situation. The statement has come at the end of the first half of the fiscal year and, therefore, it is helpful to understand the state of the economy at the mid-point of the fiscal year which is also the mid-point of the term of the central government.
On the global economy, the outlook is gloomy. Growth has slowed more than anticipated, trade has contracted more sharply, there is rising protectionism, and “an uneasy calm prevails on uncertainty about the stance of monetary policy of systemic central banks”.
State of the economy
On the domestic economy,
- “the outlook for agricultural activity has brightened;
- “the industrial sector has suffered a manufacturing-driven contraction;
- “inflation excluding food and fuel has been sticky around 5%, mainly in respect to education, medical and personal care services;
- “in the manufacturing sector, the persistence of considerable slack…;
- “in the external sector, merchandise exports contracted in the first two months of Q2;
- “subdued domestic demand was reflected in a faster contraction in imports;
- “the decline in remittances and the flattening of software earnings warrants monitoring;
- “while the pace of foreign direct investment slowed compared to a year ago, portfolio flows were stronger.”