- The narrative remains negative despite favourable data
- Policy makers won’t tighten too early as they tend to fight last year’s battles
- Commercial banks have plenty of scope to expand lending
- Favour economically sensitive sectors and emerging markets
- Also identifying investments that can do well in higher inflation environment or weaker economy
David Jane, manager of Miton’s multi-asset fund range, comments:
“As the long bull market continues, there’s plenty of talk on why it’s going to end, much of it surrounding the reduction of monetary stimulus. So what is the truth behind the fears of rapid tightening leading to a market correction, recession, or according to some pundits, a meltdown?
“In terms of simple interest rate policy, the US equivalent of the Bank of England base rate remains at or below zero in real terms, i.e. hardly tight and in fact still at levels which in the past would have been regarded as very loose. The shape of the curve, the difference between short term interest rates and longer term rates, is regarded as a recession predictor, because markets set the long term rate based on their expectation of short term rates, so a flat or downward sloping curve suggests the Fed will be loosening policy in the future. While the curve is currently flatter than in the recent past, it still implies expectations of economic expansion.
“When we consider liquidity, this is a more intangible concept in some ways, but the simplest measure would be to look at excess bank reserves at the Federal Reserve. The central bank can tighten policy by withdrawing deposits from the system, forcing banks to constrain lending both to the real economy and financial markets.
“Since the era of quantitative easing there has been a huge rise in these reserves (through the mechanism of government purchase of government bonds) and while they’re shrinking, they’re still vast by any historical norm. So this mechanism to tighten is no longer available, or at least a very long way off. In essence, commercial banks have plenty of scope to expand lending.
“Broadening the argument, we can combine with these metrics a number of other indicators such as credit spreads, interbank lending rates and others to get the Bloomberg Financial Conditions Index. This shows that things are as good as they have ever been and accelerating since the start of 2016.
“Looking forward, it’s possible to expect the Fed to continue on its tightening path, but not to the degree which would historically be regarded as tight, and this is in a background of a global financial system where two of the major players, the ECB and BoJ continue to run policy extremely loose.
“Despite this favourable data, the narrative remains quite negative in many quarters, particularly the media. Whether referring to the recent small correction in high yield bonds or any weak day in equities, calling the next bear market remains a fashionable pastime. We would count the narrative as neutral to negative, which with the data being positive would lead us to remain positive on markets, particularly with the benefit of strong affirmation from the current strength.
“More importantly, however, our philosophy of managing not to a base case but to a range of scenarios demands we consider what the bounds are around the base case. To us, it seems less likely that policy makers tighten too early, leading to financial instability and/or a recession, as they tend to fight last year’s battles and the most recent crisis was a financial one. Financial instability is what they most fear and are trying to avoid.
“More likely to us is the scenario that inflation exceeds to the upside as policy remains too loose for too long, particularly as the ECB and BoJ continue to supply liquidity while the Fed attempts to tighten. Ultimately this would lead to later but more aggressive tightening.
“How can we allow for these scenarios in our portfolios? The base case is straightforward, more of the same with rising markets favouring economically sensitive sectors and emerging markets. However, we also need to find investments that can do well in the alternative of higher inflation or a weaker economy.
“If we consider infrastructure assets, we can gain some exposure to rising inflation while being less sensitive to a weaker economy, so we have recently added some of these following a period of weakness. Looking at oil, it can give us upside from rising inflation and a good hedge against potential political risk (in the Middle East and Venezuela), while in the meantime offering some attractive valuations. There are other inflation hedges such as commodities and, of course, gold which also have a role to play.
“The most obvious asset to benefit from our alternative scenarios would be index linked bonds, however, these are not so much a beneficiary of inflation as a play on real yields, and since UK index-linked bonds now trade at negative real yields, we get a return that is baked in to be below inflation. The same goes for longer dated bonds in general, we can get little upside in the event of a weaker economy but significant downside in the event of higher real yields or inflation.
“So, while we can reasonably allow for potential higher inflation than the base case in the portfolios, dealing with a potentially contracting economy is more difficult and the main approach would need to be if the data changed to make this scenario more likely, we would need to change the portfolio. As pragmatists, this approach is one we have always been comfortable with.”
Oil gains as U.S. fuel stocks drop, OPEC+ considers deal rollover
By Stephanie Kelly
NEW YORK (Reuters) – Oil prices rose more than 2% on Wednesday, boosted by a huge drop in U.S. fuel inventories and expectations that OPEC+ producers might decide against increasing output when they meet this week.
U.S. gasoline stocks fell last week by the most on record and refining output fell to a record low in the wake of a deep freeze in Texas that shut production.
Gasoline inventories fell to 243.5 million barrels, the U.S. Energy Information Administration said, while distillate stockpiles fell by the most since 2003 to 143 million barrels.
“This drop is 100% based upon the storm in Texas,” said John Kilduff, partner at Again Capital Markets in New York. “It froze up the entire Texas supply chain and caused a drawdown on available refined product stores.”
Crude inventories rose by 21.6 million barrels, the most on record, to 484.6 million barrels, EIA said. Refining capacity use fell to just 56% of overall capacity, the lowest on record, as the U.S. Gulf Coast’s refining capacity use plunged to 40.9%, the lowest ever.
Brent crude rose $1.30, or 2.1%, to $64.00 a barrel, a 2.1 percent gain by 11:11 a.m. EST (1611 GMT). U.S. West Texas Intermediate (WTI) crude rose $1.55, or 2.6%, to $61.30 a barrel.
Oil prices earlier jumped after Reuters, citing three sources, reported that the OPEC+ group comprising the Organization of the Petroleum Exporting Countries and allies including Russia is considering rolling over production cuts from March into April rather than raising output.
The group had previously been widely expected to ease the production cuts when it meets on Thursday.
Kuwaiti Oil Minister Mohammad al-Fares said the market was being supported by optimism over vaccinations.
Also positive for prices, U.S. President Joe Biden said the United States would have enough COVID-19 vaccines for every American adult by the end of May after Merck & Co agreed to make rival Johnson & Johnson’s inoculation.
Biden said he hoped that the United States would be “back to normal” at this time next year and potentially sooner.
(Reporting by Stephanie Kelly in New York; additional reporting by Bozorgmehr Sharafedin in London and Shu Zhang and Sonali Paul in Singapore; Editing by Edmund Blair and David Goodman)
Stocks edge down as investors hit pause, watch bond yields
By Suzanne Barlyn
NEW YORK (Reuters) – Global equity markets were little changed on Tuesday as Wall Street retreated and investors paused to gauge whether a bond yield jump had run its course, taking stock of gains from Monday’s surge.
The subdued performance of the three major Wall Street indices followed a flat close in Europe and slipping shares in Asia.
“It was such a strong opening to the month yesterday that investors could be short-term focused and saying, ‘Let’s take some of the profits that we saw yesterday,'” said Sam Stovall, chief investment strategist at CFRA Research in New York.
March began with a bang on Monday as global equities markets rose, the S&P 500 had its best day since June 5 and bond markets calmed after a month-long selloff.
In Tuesday late-afternoon trading, the Dow Jones Industrial Average rose 45.37 points, or 0.14%, to 31,580.88, the S&P 500 lost 3.1 points, or 0.08%, to 3,898.72 and the Nasdaq Composite dropped 106.23 points, or 0.78%, to 13,482.60.
The pan-European STOXX 600 index rose 0.19% while MSCI’s gauge of stocks across the globe %.
Emerging market stocks rose 0.05%. MSCI’s broadest index of Asia-Pacific shares outside Japan closed 0.16% lower, while Japan’s Nikkei lost 0.86%.
The European Central Bank should expand bond purchases or even increase the quota earmarked for them if needed to keep yields down, ECB board member Fabio Panetta said on Tuesday, after weeks of steady increases in borrowing costs.
Australia’s central bank on Tuesday affirmed its pledge to keep interest rates at historic lows as policymakers battle to stop surging bond yields from disrupting the country’s surprisingly strong economic recovery.
After a sharp selloff last week, U.S. Treasuries have stabilized with bond market indicators and derivatives positioning pointing to near-term calm. But an improving economy could trigger another slide in their prices.
U.S. Federal Reserve Governor Lael Brainard said she was closely watching bond markets and would be concerned if a recent rise in yields continued and began to constrain economic activity.
“Some of those moves last week and the speed of the moves caught my eye,” Brainard said on Tuesday.
A Treasuries selloff last week pushed the 10-year yield to a one-year high of 1.614%. Benchmark 10-year notes last rose 11/32 in price to yield 1.4102%, from 1.446% late on Monday.
Gold prices rose, inching up from a more than eight-month low, as a retreat in the dollar and U.S. Treasury yields lifted demand for the safe-haven metal.
Spot gold added 0.8% to $1,736.02 an ounce. U.S. gold futures settled up 0.6% at $1,733.60.
The dollar index fell 0.318%, with the euro up 0.37% to $1.2092.
Earlier, the dollar was up for a fourth consecutive day after the spike in bond yields challenged the market consensus for dollar weakness in 2021. But riskier currencies rose as bond markets calmed and stocks recovered.
Bitcoin fell 2.19% to $47,808.00 after rising nearly 7% on Monday.
Shares in mainland China and Hong Kong fell overnight after a top regulatory official expressed concerns about the risk of bubbles bursting in foreign markets.
Oil prices largely shrugged off expectations that OPEC would agree to raise oil supplies at a meeting this week.
The global oil market is rebalancing after damage to demand wrought by the COVID-19 pandemic was met with curbs on output by OPEC producers, the group’s president said.
The industry is recovering from a collapse in demand triggered by the pandemic, but U.S. shale production will not recover to pre-pandemic levels, Occidental Petroleum Chief Executive Vicki Hollub said on Tuesday.
“The recovery is looking really good to us. If you look at what’s happening in India as well as the U.S., I think the oil industry is looking like things will be pretty good for us over next couple of years,” Hollub said.
U.S. crude futures settled down 89 cents at $59.75 a barrel, while Brent futures fell 99 cents to settle at $62.70 a barrel.
(Reporting by Suzanne Barlyn; Editing by Dan Grebler)
Robinhood now a go-to for young investors and short sellers
By John McCrank
NEW YORK (Reuters) – Robinhood, the online brokerage used by many retail traders to pile in to heavily shorted stocks like GameStop Corp, has made an ambitious push into loaning out its clients’ shares to short sellers as it expands its business.
The broker had $1.9 billion in shares loaned out as of Dec. 31, nearly three times the $674 million a year earlier, and it was permitted to lend out $4.6 billion worth of securities under margin agreements, around five times bigger than the prior year, according to an annual regulatory filing late on Monday.
The size of the jump highlights Robinhood’s rapid growth over the past year as the number of retail investors has soared in the work-from-home environment during the pandemic and as retail brokers have largely eliminated trading fees, a model Robinhood helped pioneer.
Menlo Park, California-based Robinhood is expected to go public this year with a valuation of more than $20 billion.
Securities lending is common among brokerages, which can earn income by lending shares to hedge funds and others, who then sell the shares back into the market, betting the share prices will drop so they can buy them back at a lower price when it is time to return them, pocketing the difference.
Shares that are in heavy demand from short sellers, like GameStop, which had 140% short interest in January https://www.reuters.com/article/us-retail-trading-shortselling-explainer/explainer-how-were-more-than-100-of-gamestops-shares-shorted-idUSKBN2AI2DD, command the biggest premium from the lender.
What makes Robinhood notable is that many of the stocks its users invest in are among the most sought-after by people who want to bet against them, said one senior financial executive involved with hedge funds.
It was unclear how great a benefit the securities lending was to Robinhood’s revenue and income, which it does not disclose.
Robinhood declined comment on the filing and did not immediately respond to a request for comment on the details of which stocks it loans out.
In January, retail investors coordinated through trading forums on social media in an attempt to punish hedge funds by buying up shares of GameStop and other heavily shorted names, like AMC Entertainment, driving up their prices and forcing short sellers to close out positions at big losses.
On Jan. 28, at the height of the retail trading mania, Robinhood, along with several other brokers, restricted the buying of GameStop and other so-called meme stocks due to a massive spike in collateral requirements needed to clear the trades, angering many of its customers.
The trading restrictions sparked congressional hearings, regulatory probes and have placed greater scrutiny on short selling.
In response, Vlad Tenev, Robinhood’s chief executive officer, called for shorter stock settlement times, which would reduce clearing collateral requirements.
He also said the idea that more shares of a stock can be shorted than there are available to trade, as was the case with GameStop, is a “pathology” that could destabilize the financial markets.
Robinhood positioned itself for growth in securities lending in October 2018 by launching its own clearing broker, which acts as a go-between with the clearinghouse that settles its trades, and allows it to hold its customers’ assets. The broker can then lend out securities its customers buy on margin.
At present, less than 3% of Robinhood’s funded accounts are margin-enabled, Tenev recently told Congress.
(Reporting by John McCrank in New York; Editing by Megan Davies and Matthew Lewis)
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