Stocks rebound from sell-off The major benchmarks overcame an early sell-off to end the week flat to modestly higher. On Monday, the S&P 500 Index recorded it biggest daily drop since May 12 and briefly dipped below its 100-day moving average, a closely watched technical level. Longer-term bond yields rose sharply over the week, helping financials shares by holding the promise of improving banks’ lending margins. Energy stocks also outperformed within the S&P 500, while utilities shares lagged. The decidedly downbeat start to the week appeared to be due to several factors. Primary among them, seemingly, were fears that a possible default by China’s second-largest property developer—and the world’s most heavily indebted one—might set off a global financial “contagion” similar to what followed the collapse of Lehman Brothers in September 2008. Stocks regained a large portion of their losses on Wednesday, however, which T. Rowe Price traders attributed to news of a restructuring plan for Evergrande, along with a capital injection into the Chinese banking system (see below). Tapering on the horizon, but jobs data could be key The other closely watched event of the week was the Federal Reserve’s two-day policy meeting that concluded Wednesday. As was widely expected, policymakers announced that they would soon consider tapering the central bank’s purchases of Treasuries and mortgage-backed securities, a move that would reduce some downward pressure on longer-term interest rates. In his post-meeting conference, Fed Chair Jerome Powell reiterated that he would be looking for continued improvement in the labor market before acting, although he did not need to see a “knockout” report for September. The Fed also released its quarterly survey of individual policymakers’ forecasts of future official short-term interest rates. The survey showed a small increase in their median rate expectations, which some investors interpreted as a modestly hawkish signal. According to the Federal Open Market Committee’s (FOMC’s) updated Summary of Economic Projections, officials’ projections for the timing of an interest rate liftoff are now evenly split between 2022 and 2023. Additionally, a majority of officials now anticipate at least three quarter-point rate hikes by the end of 2023. Housing sales strengthen but remain well below 2020 peak The week’s jobs data appeared to defy hopes for a resurgence in the labor market, with first-time jobless claims rising to 351,000, well above consensus forecasts and the highest number in a month. IHS Markit’s survey of both manufacturing and services sector activity in September also came in modestly below expectations but still indicated healthy expansion, especially in the former. Conversely, housing data mostly came in on the upside, with both housing starts and permits easily surpassing expectations. New home sales in August also hit their highest level (740,000) in four months, although they remained well below their peak a year earlier (977,000). The coming wind-down of the central bank’s monthly asset purchases and mildly hawkish revisions to its interest rate forecasts helped push the yield on the benchmark 10-year U.S. Treasury note significantly higher later in the week. (Bond prices and yields move in opposite directions.) On Friday, the 10-year yield hit an intraday peak of around 1.47%, its highest level since the start of July, on the eve of the rebound in coronavirus cases. Our fixed income traders pointed to several other factors behind the rise as well, however, including the rebound in U.S. equities, concerns surrounding inflation risks in the eurozone, and profit-taking from investors who had bet on a flattening of the yield curve, or a narrowing of the difference between short-term and long-term rates. The broad municipal bond market registered modestly negative returns through most of the week but fared better than U.S. government debt. Amid upward pressure in Treasury rates, benchmark yields on AAA rated municipals increased for the first time in several weeks, albeit modestly. However, our traders reported that higher-yielding offerings in the primary market garnered solid demand. Sentiment improves toward corporate bonds According to our traders, investment-grade corporate bond spreads—the additional yield offered over Treasuries and an inverse measure of the sector’s relative appeal—opened the week wider amid subdued overnight demand from Asia. Later in the week, however, investment-grade corporates experienced strong demand as the Treasury sell-off intensified, and spreads tightened on above-average trading volumes. Meanwhile, high yield bonds traded lower as the week began amid concerns about China volatility, the possibility of Fed tapering, global growth expectations, and headwinds for President Joe Biden’s spending agenda. However, our traders reported that sentiment improved and new issuance picked up as broader risk markets rallied following Fed commentary from the FOMC meeting.
Shares in Europe advanced as optimism about a continuing economic expansion offset concerns about a gradual withdrawal of central bank support. However, lingering worries about Chinese property developer Evergrande curbed gains. In local currency terms, the pan-European STOXX Europe 600 Index ended 0.31% higher. Major indexes also rose. Germany’s Xetra DAX Index added 0.27%, France’s CAC 40 Index rose 1.04%, and Italy’s FTSE MIB Index gained 1.01%. The UK’s FTSE 100 Index climbed 1.26%. Norwegian, UK central banks strike more hawkish stance Norway became the first Group of Ten (G10) country to tighten its monetary policy, with the central bank raising its key short-term lending rate by a quarter point to 0.25% from 0.00%. Norges Bank Governor Oystein Olsen said there would probably be another rate increase in December. The Bank of England (BoE) kept its key rate unchanged at 0.10%, although two policymakers voted for an early end to the quantitative easing program. The accompanying statement also indicated that some developments, including upside risks to the inflation outlook, had strengthened the case for tightening. In a letter to the Chancellor of the Exchequer explaining why inflation was above the 2% target, Governor Andrew Bailey said that the BoE now expects “inflation could remain above 4% into the second quarter of 2022.” T. Rowe Price International Economist Tomasz Wieladek said that some BoE policymakers could vote for a rate increase in November, and he believes that the whole Monetary Policy Committee could vote for one in February. Eurozone business activity loses steam Growth in eurozone economic activity slowed noticeably in September from July’s 15-year high, while input prices jumped to a 21-year high. The early headline number for IHS Markit’s composite Purchasing Managers’ Index (PMI) came in at 56.1—down from the final readings of 59.0 in August and 60.2 in July. (PMI readings greater than 50 indicate an expansion in economic activity levels.) The pace of growth slowed further in both the manufacturing and services sectors. IHS Markit attributed the deceleration to demand peaking in the second quarter, supply chain bottlenecks, and concerns about the spread of the coronavirus. All these factors appeared to erode business expectations. The PMI report for the UK painted a similar picture of slower economic activity and rising input prices. The flash composite index hit 54.1 in August—down from 54.8 in the preceding month—mainly due to a marked loss of momentum in the manufacturing sector, which offset an increase in services sector growth. German election too close to call Germany headed into a general election Sunday with the final opinion polls showing the Social Democrats (SPD) just clinging to their lead over the conservative Christian Democratic Union (CDU) and Christian Social Union (CSU). The Greens stayed ahead of the pro-business Free Democrats and the far-right Alternative for Germany (AfD).
Japanese stocks posted losses in a volatile, holiday-shortened trading week. Japan’s stock markets were closed on Monday for Respect for the Aged Day and on Thursday for Autumnal Equinox Day. The Nikkei 225 Stock Average closed at 30,248.81, modestly lower for the week, just off its 31-year high recorded earlier in the month. The yen traded near JPY 110 versus the U.S. dollar, while the yield of the 10-year Japanese government bond finished the week at 0.055%. Taro Kono is the leading candidate to succeed PM Suga The latest Kyodo News poll shows that Vaccination Minister Taro Kono is viewed by the ruling Liberal Democratic Party (LDP) members as the favored candidate to replace outgoing Prime Minister Yoshihide Suga as the party leader in the September 29 presidential election. The winner of the LDP election will become prime minister as the party holds a majority in both chambers of parliament. Campaigning for the LDP presidential election began on Friday, September 17. If Kono, who has a substantial lead, can secure better than 50% support from the LDP diet (382 members) and the rank-and-file members (also 382 votes), then no runoff election would be necessary. Kono is known for his reform-minded views. He has been outspoken in escalating Japan’s coronavirus vaccination efforts and has advocated for drastic changes to Japan’s pension system, which have been well received. His policies suggest that he’d be supportive of additional stimulus measures and the central bank’s current policy stance. As expected, the BoJ holds rates steady The Bank of Japan (BoJ) made no changes to its long- and short-term interest rate policy at the September policy meeting and confirmed its stance on maintaining asset purchases at current levels. Forward policy guidance allowed that the current policies would remain in force until the 2% inflation target was achieved. There were no major revisions to the board’s economic assessment, which stated that “Japan’s economy has picked up as a trend, although it has remained in a severe situation due to the impact of COVID-19 at home and abroad.” The central bankers noted supply-side constraints on exports and production. While the BoJ views the pandemic’s effects as transitory, it remains watchful of the impact on private sector growth expectations. OECD trims its Asia and global economic growth forecasts The Organization for Economic Cooperation and Development (OECD) lowered its real (inflation-adjusted) gross domestic product (GDP) growth forecast for Asia in the September Interim Report from its May forecast. The reduction reflects rising inflation and supply chain disruptions. Japan’s GDP forecast was trimmed to 2.5% in 2021 but revised up to 2.1% in 2022, the slowest growth rate among all major developed economies. The global GDP growth target was lowered to 5.7% in 2021.
Mainland Chinese stocks ended a holiday-shortened week broadly flat from the prior Friday’s close after being closed Monday and Tuesday for the Mid-Autumn Festival. The market’s subdued performance was noteworthy after Hong Kong’s Hang Seng Index fell more than 3.0% on Monday amid the mounting debt crisis surrounding China’s Evergrande Group. A series of large cash injections by China’s central bank during the week helped ease worries about a disorderly debt resolution for the indebted developer. However, some of Evergrande’s offshore bondholders did not receive their portion of USD 83.5 million in interest payments by a Thursday deadline in U.S. time, Reuters reported on Friday, citing unnamed sources. The company now enters a 30-day grace period, after which it will be considered in default if that period passes without payment. Chinese officials aiming for orderly default for Evergrande Many analysts believe that China’s government will step in to contain the financial fallout ensuing from an Evergrande bankruptcy or default. Moreover, many believe systemic risk is unlikely as Evergrande's outstanding debt amounts to a negligible amount of the country’s total banking assets. Beijing is reportedly aiming for a “marketized default” for Evergrande, a term that some believe means an orderly market exit and well-managed restructuring. The company has many assets it can sell to reduce its debt, ranging from core property assets to an electric vehicle business and a property services unit. However, some analysts are concerned that the longer the government refrains from a public intervention, the more risk it poses to China’s economy. In the bond market, the yield on the 10-year Chinese government bond rose two basis points to 2.92% amid concerns over the potential costs to Beijing of an Evergrande rescue. Comments from the State Council, China’s cabinet, seemed to suggest that the infrastructure spending could be accelerated in the near term to support economic growth. In currency trading, the renminbi was flat against the U.S. dollar, trading at 6.463 per dollar late Friday afternoon in Shanghai.
OTHER KEY MARKETS
RUSSIA Russian stocks, as measured by the Russian Trading System (RTS) Index, returned about 0.1%. Over the previous weekend, Russia held its regular parliamentary elections to the State Duma, the 450-seat lower house of the legislature. With virtually all of the votes counted, the results indicate that the United Russia party, which supports President Vladimir Putin, is the big winner and will retain its constitutional majority, though it did lose some seats. Candidates from four other political parties—the Communist Party of Russia, Liberal Party, Just Russia, and New People—received at least 5% of the total ballots that were cast, so these parties will have smaller blocs of seats in the Duma. According to T. Rowe Price sovereign analyst Peter Botoucharov, the most controversial part of the election involved several single mandate districts in Moscow, where the early vote count favoring alternative candidates was reversed to United Russia mainly due to delayed electronic voting. Botoucharov notes that there have been some minor postelection protests mainly coming from the left of the political spectrum. Nevertheless, as a result of the election, he believes that United Russia's constitutional majority will allow the government to implement the constitutional changes that citizens approved in a referendum last year. Also, he believes that Russia's macroeconomic framework is likely to remain unchanged and that it will continue to be based on three primary pillars: a fiscal policy aimed at a stable tax system and a budget that is balanced or in surplus, an inflation-targeting monetary policy based on having positive real (inflation-adjusted) interest rates, and a managed process of deleveraging the sovereign and corporate sector that maintains the country’s budget and current account surpluses. TURKEY Turkish stocks, as measured by the BIST-100 Index, returned about -2.5%. Turkey’s central bank reduced its one-week repo auction rate on Thursday from 19.0% to 18.0%. This surprised many investors, who expected no change in rates at this time. T. Rowe Price’s Botoucharov believes the rate cut decision demonstrates the central bank’s lack of a consistent policy framework. It also casts doubt on policymakers’ stated commitment to keeping the key interest rate above inflation. The headline consumer price index is currently at a year-over-year rate of 19.25%. In addition, the rate cut decision is reflective of policymakers’ preference for weakening the Turkish lira—in order to make Turkish exports more competitive on world markets—and prioritizing economic growth. While Turkey's current macroeconomic conditions are weak—which is not surprising in light of a 14-month tightening cycle that lifted interest rates more than 1,000 basis points (10 percentage points)—Botoucharov believes that the current economic environment is more balanced compared with similar situations in the past. For example, the current account deficit is smaller, and the central bank’s gross foreign exchange reserves have increased somewhat from 2017–2018 levels. In addition, credit growth has decelerated to a year-over-year rate of roughly 12% to 15% versus more than 50% in 2020.