29.09.2022 BOE Is In The game. Will Fed Follow?

Stock bulls see the Bank of England blink first as they step back in to stabilize its bond markets. The intervention in Britain came after a central bank committee warned of the risks to financial stability from disruption in the government bond market.

What happened in UK?

The biggest problems stem from a sharp rise in bond yields that has created massive margin calls for big investment firms, including pension funds.

That led to a lot of funds trying to sell bonds in order to raise cash and risked sparking a downward spiral. The Bank of England is now a buyer of bonds at “whatever scale necessary” and is delaying the start of its quantitative tightening (QT) program – aka its plan to unwind its securities holdings.

The lack of liquidity in Britain’s bond markets highlights a similar issue that some fear we could see happening in other parts of the world. This means that central banks might not be able to be as hawkish as some bears have been thinking.

Will Fed follow BOE? 

Keep in mind, in the USA the US Federal Reserve continues to hike rates at a historically fast clip while also working to reduce its balance sheet.

The Fed is now allowing its holdings of Treasury securities to drop by up to -$30 billion per month by letting them mature without replacement, and its mortgage-backed securities (MBS) to drop by up to -$17.5 billion a month.

The program has already dramatically reduced liquidity in US Treasury markets and some worry things could get dangerously volatile as “Quantitative Tightening” (QT) continues to drain money from the system. 

Keep in mind, government debt markets across the world are experiencing extreme degrees of volatility right now, meaning bears believe there’s a heightened risk that something could break and possibly spark a wider crisis across global financial markets.

On the flip side, as I mentioned above, bulls believe the risks of extreme volatility and illiquidity in US bond markets could prompt the Fed to pause some of its tightening plans sooner than currently anticipated. The Fed did reverse course on its asset reductions during its first and only attempt at QT back in 2019.

Several Fed officials have noted that the Fed’s aggressive pace of tightening does pose some risks, including recession, but most right now believe “inflation” is the bigger threat to both economic and market stability.

Data to watch 

Investors get an update on inflation on Friday from the PCE Prices Index. Wall Street expects the year-over-year headline rate to fall again for August but the “core” rate, which strips out food and energy prices, is expected to climb from +4.6% to +4.8%.

Today, the final read of Q3 Gross Domestic Product (GDP) is the data highlight. On the earnings front, Bed Bath & Beyond, CarMax, Carnival, Micron, and Nike results are due today, which we mistakenly had slated for yesterday…sorry for any confusion.

Turning to geopolitical headlines, the US yesterday joined most other governments around the world in condemning Russia’s moves to take over separatist-backed regions of eastern Ukraine after holding what the White House called “illegal and illegitimate” referendums. Officials say the vote was orchestrated by the Kremlin and could represent a major escalation of the war if Russia tries to claim that Ukraine is attacking what is now Russian territory. At least that is the theory. Ukraine is asking for significantly more military support from the US and other NATO allies and there is talk of more US and EU sanctions against Russia as well.

Who would have ever guessed a year ago we would be sitting here today with the US dollar at twenty year highs, the 30-year mortgage up at 7%, money in a 2-Year Treasury earning +4%, inflation at multi-decade highs, and Russia in a full blown war trying to take over Ukraine.

BOE Is In The game. Will Fed Follow?

Wishing you a great week!