News of the week summary - 12/24/2023

Monetary policy around the world:

• Yen weakens after BoJ maintains negative rates

The Japanese yen weakened after the Bank of Japan (BoJ) opted to maintain its negative interest rates, causing the currency to decline. BoJ Governor Kazuo Ueda stated that there was no urgency to alter the policy before the US Federal Reserve decides on potential rate cuts next year. The decision follows the Fed's recent indication that it plans to reduce interest rates in the coming year.

Governor Ueda acknowledged an improved outlook for achieving the BoJ's inflation target but emphasized that the central bank was not yet prepared to outline an exit strategy from its ultra-loose monetary policy. The BoJ, committed to ending decades of deflation in Japan, is unique among leading central banks in maintaining interest rates below zero.
The BoJ retained overnight interest rates at minus 0.1 percent and made no alterations to its yield curve controls, maintaining its dovish stance. While some investors anticipated a change in the BoJ's forward guidance or an indication of an imminent policy shift, the central bank chose to stick to its easing measures, committing to maintaining them "as long as necessary."
The yen weakened by 1.3 percent against the dollar, reaching ¥144.67. The potential unwinding of the BoJ's ultra-loose monetary policy could have significant implications for international bond and currency markets, particularly following recent volatility in the yen.
Governor Ueda highlighted the difficulty in specifying exit measures with high certainty and pledged to communicate the BoJ's stance to investors once there is more clarity. The yen, which has experienced a 9.5 percent decline against the dollar this year, rebounded from a historic low of around ¥151 in the past month amid expectations of policy tightening.

Despite the short-term reversal in the yen, economists believe it is not the beginning of a trend. Some anticipate a boost for the Japanese currency in the first half of the next year when the BoJ is expected to end its yield curve controls, possibly in March or April. Most economists expected the BoJ to maintain its policy stance this week, awaiting further evidence of a persistent trend of wage increases. Although Japan's core inflation has surpassed the BoJ's 2 percent target since April 2022, prices are expected to decrease in the coming year.

• ECB warns rates cuts are unlikely for March

Belgium's central bank governor, Pierre Wunsch (member of the European Central Bank's governing council), has stated that the likelihood of an interest rate hike has diminished, altough he considers investors' optimism about an early cut in March to be overdone. Wunsch indicated that sustained high wage increases without clear signs of slowdown could lead to a reassessment of borrowing costs. He acknowledged a shift in companies' response to rising wages, observing some absorbing costs within profit margins rather than passing them on to consumers through higher prices. Eurozone wage growth reached its highest point in over a decade in the third quarter, rising 5.3% year-on-year. 

Wunsch cautioned against overemphasizing the positive impact of November's significant drop in eurozone inflation. The ECB's inflation forecast, predicting a decline from 5.4% this year to 1.9% in 2026, factors in assumptions of higher borrowing costs, which may not align with current market conditions. Looser financial conditions, resulting from falling bond yields, could contribute to sustained inflation by boosting economic activity.

Despite market speculation, Wunsch deemed a rate cut in March highly unlikely, citing the need for more data and potential shocks. He acknowledged the transatlantic divergence in central banks' views on rate cuts, with the Federal Reserve considering the possibility while the ECB and Bank of England remain cautious. ECB President Christine Lagarde emphasized the need to remain vigilant against inflation and highlighted upcoming wage negotiations as data-rich insights into employment dynamics.  

• FED's increasingly dovish stance to favor Biden

The Federal Reserve's recent signal of potential interest rate cuts next year has validated President Joe Biden's optimistic outlook for the US economy. The Fed's shift towards a more dovish stance, indicating a likely end to its monetary tightening cycle, is seen as a step towards achieving a "soft landing" for the economy. This scenario envisions a decrease in inflation without a significant rise in unemployment or a recession, a narrative crucial for Biden's economic record heading into the 2024 presidential election.

The prospect of the Fed lowering interest rates has already led to lower mortgage rates, easing housing affordability concerns. This shift is expected to benefit potential homeowners and the housing market while potentially reducing costs across the broader economy, including for business investments. US government bond yields have touched multi-month lows since the Fed's meeting, with the 10-year Treasury note trading below 4 percent for the first time since August. The positive market response aligns with the Biden administration's goal of portraying a favorable economic trajectory, crucial in the lead-up to the election year.
Federal Reserve Chair Jay Powell emphasized that political considerations would not influence the central bank's decisions. The Fed's shift towards considering rate cuts primarily stems from a changed outlook on inflation. Projections now suggest a majority of officials expect inflationary pressures to ease more rapidly in 2024 and 2025, aligning with the central bank's 2 percent target in subsequent years.

While forecasting continued economic growth in 2024 and 2025, with a minimal rise in the unemployment rate, Powell underscored the importance of safeguarding the soft landing. The Fed remains focused on avoiding the risk of prolonging monetary measures, emphasizing a commitment to making decisions in the best interest of the economy. 

Bankruptcies on the rise after the pandemic

Corporate bankruptcies are on the rise in most advanced economies, experiencing double-digit growth as borrowing costs increase and governments phase out pandemic-era support measures for businesses. In the United States, after a decade of decline, the number of corporate bankruptcies surged by 30% in the 12 months ending September compared to the previous year.

Germany, the largest economy in the European Union, reported a 25% increase in bankruptcies from January to September compared to the same period the previous year. The country's statistical office, Destatis, noted consistent monthly double-digit growth rates since June compared to the previous year.

Across the European Union, corporate insolvencies rose by 13% year-on-year in the first nine months of the year, reaching their highest level in eight years, according to Eurostat. This trend can be attributed to higher interest rates, the collapse of zombie companies surviving on Covid-era government support, and increased energy bills. Government support schemes during the pandemic, totaling more than $10 trillion according to IMF estimates for 2020 and early 2021, have been largely withdrawn. The withdrawal, along with the increased cost of debt servicing, has impacted industries such as transportation and hospitality the most.

The trend is likely to persist as many businesses will need to refinance debt at higher rates in the coming months, even if central banks have reached their peak in rate hikes. Analysts have identified transportation and hospitality as the industries suffering the most from the surge in insolvency rates.

Moody's rating agency anticipates a continued increase in the global speculative-grade default rate in 2024, having reached 4.5% in the 12 months ending October, above the historical average of 4.1%. In October, France, the Netherlands, and Japan recorded bankruptcies up by more than 30% year-on-year, according to their respective national statistics offices.

 

Major companies halt oil shipments through the Red Sea amid security concerns

In a significant move, BP has become the first major oil company to halt all shipments through the Red Sea due to a "deteriorating security situation." The decision is a response to escalating attacks by Yemeni rebels on ships using this route, which handles approximately one-tenth of global trade.

The announcement resulted in a 2.8% increase in Brent crude, the international benchmark, reaching $78.66 per barrel. West Texas Intermediate, the US equivalent, rose 2.7% to $73.42 per barrel. Additionally, the UK's benchmark gas price surged by up to 14%, while its European counterpart increased by almost 13%, reflecting concerns about the shipment of liquefied natural gas (LNG).

The Iran-backed Houthi rebels intensified their campaign following the Israel-Hamas conflict, prompting BP's precautionary pause. The situation has led other major shipping companies, such as AP Møller-Maersk and Hapag-Lloyd, to temporarily halt transit through the Red Sea. This disruption in shipping has triggered a positive response in the stock market, with shares of leading shipping companies rising, as investors anticipate increased freight rates and earnings.

Analysts suggest that if all shipments from the Middle East to Europe avoid the Red Sea, opting for longer routes around Africa, the price of Brent crude could surge by at least $10-$15. Similarly, Europe's main gas trading benchmark, TTF, might see a rise of 25-30%.

LNG flows through the Red Sea account for about 8% of global trade, according to the US Energy Information Administration. BP's decision comes as the UK's maritime authority reported "incidents" in the Red Sea, advising vessels to proceed with caution.

The situation has prompted concerns about the security of sea routes, leading to calls for protection from ship owners and expectations that the US will announce the formation of a task force for safe passage. The potential disruption could impact global supply chains, as the Red Sea and the Suez Canal together account for 30% of all container ship traffic and play a crucial role in crude oil shipments.

 

Copper shines amidst supply struggles

In the midst of a challenging year for metals, copper is set to emerge as the top-performing industrial mineral in 2023. Recent disruptions in production, particularly in Latin America, have led to a surge in copper prices, currently standing at $8,600 per tonne, up 2.5% for the year.

Key factors contributing to copper's success include the closure of a giant mine in Panama and a significant downward revision in Anglo American's copper production forecast. Combined, these events have resulted in the removal of 750,000 tonnes or 3% of global supply estimates for the next year.

Vale and Rio Tinto also provided production forecasts below analysts' expectations, causing traders to reassess the copper market. Previously, expectations for 2024 were pessimistic, but recent developments have transformed the outlook, with the market now seen as tightly balanced.

Despite a challenging backdrop marked by aggressive interest rate hikes and a less-than-robust Chinese economy, copper's resilience can be attributed to supply disruptions and signs of improvement in China. The metal's broad applications in construction, manufacturing, and the growing green energy sector have contributed to its strong performance.

The rebound in copper prices contrasts with the struggles faced by other base metals such as aluminum, lead, and zinc, making base metals the worst-performing commodity sector for a second consecutive year. Tin, another major industrial metal, experienced a rise due to mining suspensions in Myanmar, the world's third-largest producer.

Nickel, however, faced challenges with surging supply from Indonesia and the conversion of low-grade nickel products into high-quality metal. The key ingredient for steelmaking and electric car batteries saw a 45% decline in prices to $16,750 per tonne.

Copper has seen increased demand from green energy sectors, including renewable power, grid upgrades, and electric cars. The Chinese production surge in electric vehicles, plug-in hybrids, and solar panels has helped support copper demand.

Supply issues for copper entering the next year reflect broader concerns about the mining industry's ability to meet the rising demand for green energy. Challenges include declining deposit quality, making extraction more difficult, and supply cuts announced by major producers.

Looking ahead to 2024, analysts anticipate that industrial metals will remain caught between China's economic performance and the rest of the world. The interplay between global economic growth and China's ability to sustain or re-accelerate its growth will likely determine the future performance of industrial metals.