News of the week summary - 06/30/2024
US inflation expected to slow down
The Federal Reserve's preferred inflation gauge, the Personal Consumption Expenditures (PCE) index, is expected to show a slight decrease in May. The core PCE index, which excludes the volatile food and energy sectors and is closely monitored by the Fed, is anticipated to drop to 2.6% from 2.8% in April.This follows encouraging consumer price data released earlier this month, indicating that inflation fell to 3.3% in May. As a result, investors are now predicting multiple interest rate cuts this year, despite the Fed’s own forecast suggesting only one cut by December.
Another measure, the Producer Price Index (PPI), also indicates a slowdown in inflation. The annualized PPI rate fell to 2.2% in May, below the expected 2.5% and April's revised figure of 2.3%.
A guide to inflation and its measures here
Euronext leader asks for calm among business leaders
Stéphane Boujnah, the CEO of Euronext, Europe’s largest stock exchange group, has called for calm among business leaders as France approaches elections. He pointed out that even if Marine Le Pen’s RN or the NFP coalition were to win, their ability to execute their plans would be limited. Factors such as pressure from rating agencies, workers unions, the European Union, and presidential power would mitigate the impact of their policies.
Both parties propose significant departures from President Emmanuel Macron’s pro-business stance. The RN aims to cut value-added tax on energy and lower the retirement age, which would add to France’s public debt. The NFP proposes a radical tax-and-spend agenda, including increased taxes on wealth and high incomes, to fund public services and climate initiatives.
The looming election has already caused market jitters, with France’s Cac 40 index falling by about 5% and the yield spread between French and German bonds widening.
Boujnah emphasized the importance of waiting for the final election results on the 7th of July before drawing conclusions, noting that both parties would likely need to adjust their ambitious programs once confronted with governing complexities. He also reassured that the euro would prevent a crisis similar to the UK's 2022 mini-budget turmoil under Liz Truss.
American banks passed the FED's tests on recession scenarios
All 31 of the largest US banks have passed the Federal Reserve's annual stress tests, demonstrating their ability to withstand a hypothetical severe recession scenario. These stress tests are conducted to ensure that banks hold enough capital to absorb potential losses in case of major unexpected events. The scenario tested today included a 10% unemployment rate, a 40% drop in commercial real estate prices, a significant rise in office vacancies, and a 36% fall in house prices. Despite these harsh conditions, banks like JPMorgan Chase, Goldman Sachs, and Bank of America would still meet regulatory minimum capital standards, even though they would collectively lose nearly $685 billion.
Results from the stress tests are used by banks to update investors on potential shareholder payouts. Indeed, some such as Goldman Sachs and Bank of America, may see higher capital requirements than anticipated, possibly reducing available capital for dividends and buybacks. For that reason, JPMorgan expressed concerns that the Fed's predictions overstated unrealized gains on its securities portfolio.
The annual stress tests were introduced following the 2008 financial crisis to restore confidence in the banking sector. However, the consistent passing of these tests by large banks in recent years has raised questions about their current relevance. While banks survive these theoretical stress event lasting nine quarters, the recent failures of Silicon Valley Bank, First Republic, and Signature Bank show the possible gaps in the stress tests' realism.
Investment to India expected to increase after joining JPMorgan Index
India is set to attract billions in foreign investment as its sovereign debt joins JPMorgan's emerging markets index. This move places Indian debt on the radar of global investors who previously avoided it due to capital controls. It is the first inclusion of the world's fastest-growing large economy's bonds in a major benchmark, reflecting efforts to open up India's previously restrictive market.
India's inclusion involves 28 government bonds worth over $400 billion, granting it a 10% share of the index. Goldman Sachs estimates that $11 billion has already flowed into Indian bonds ahead of the formal inclusion, with an additional $30 billion expected over the next 10 months. This increase in foreign ownership from around 2% to 5% follows years of negotiations and the easing of administrative controls.
Despite initial challenges, such as bureaucratic hurdles for market entry, the inclusion is seen as a positive step. Prime Minister Narendra Modi, known for market-friendly reforms, now relies on coalition partners after his party lost its parliamentary majority. This initially caused market jitters, but the impact was short-lived.
S&P Global, a very influential credit rating agency, recently indicated potential economic continuity and a possible upgrade of India’s credit rating. Modi's focus on fiscal targets aims to improve India’s standing further. With Russia’s removal from JPMorgan's index and China’s economic slowdown, India might also join other major fixed income benchmarks.
Yen continues to drop against the dollar
The Japanese yen has dropped to its weakest level against the US dollar since 1986, sparking concerns that Japanese officials may need to intervene again to stabilize the currency. The currency fell by 0.6% against the dollar, reaching almost ¥161, surpassing its previous low in April. This drop occurred despite Japan’s finance ministry spending a record $62 billion to support the currency earlier this year.
Japan's top currency official, Masato Kanda, expressed serious concern and indicated the government might respond to any excessive movements. If the yen suddenly spikes to ¥162, it could prompt another intervention. The government aims to prevent further declines as a weak yen increases living costs, which is politically sensitive ahead of the ruling party’s leadership election in September.
This year, the yen has depreciated by 12% against the dollar due to reduced expectations for US Federal Reserve interest rate cuts, which have strengthened the dollar. Although the Bank of Japan ended its eight-year policy of negative interest rates in March, it remains cautious about further rate hikes.
Despite an initial rebound to ¥152 per dollar in early May after Japan’s previous intervention, the yen continued to weaken due to the significant interest rate gap between the US and Japan. Analysts caution that another intervention may be unlikely, given the brief impact of past efforts.
Some analysts suggest that Japanese officials might delay further interventions until after the upcoming elections in France, which could prompt the selling of euros and the buying of yens, and the release of US economic data, which could potentially strengthen the yen if the US economy shows signs of slowing.