Today's Markets: Fed channels Volcker spirit

The Fed increase the rhetoric around curving inflation, and the latest from world markets

April 6, 2022

Questions growing over how central banks will control inflation
Fracking review in the UK
Housebuilders signing up to cladding remediation pledge

In case you were in any doubt: Lael Brainard, a Fed governor and vice-chair in-waiting, notably the leading voice on the more dovish wing of the FOMC, began a speech yesterday with quotes from Paul Volcker.

“Forty years ago, Paul Volcker noted that the dual mandate isn't an either-or proposition and that runaway inflation ‘would be the greatest threat to the continuing growth of the economy… and ultimately, to employment'."

She then went on to quote another former Fed chair, Arthur Burns, who noted in the late 1960s that "there can be little doubt that poor people… are the chief sufferers of inflation”.

That’s now the two big beasts channelling Volcker. On 3 March, Senator Shelby asked Powell: “Volcker put the economy in a recession to get inflation under control. Are you prepared to do what it takes to get inflation under control?" Powell replied: "I hope history will record that the answer to your question is yes."

Hawkish credentials assured, 50bps of hikes in May and June are nailed on. We learn more tonight with the release of the FOMC minutes, but the latest commentary is what matters. Market pricing is already above the dot plot.

Brainard put forth where the Fed is today, saying “it is of paramount importance to get inflation down” and the Fed will “continue tightening monetary policy methodically through a series of interest rate increases and by starting to reduce the balance sheet at a rapid pace as soon as our May meeting”. Yields inverted further… DB: “We see the Fed's tightening beginning to materially slow growth in the second half of 2023. Our baseline forecast has negative quarters for growth in Q4 2023 and Q1 2024, consistent with a recession during that time.” It sounds as though the Fed is willing to trigger a recession to bring down inflation…

The bear market rally of the second half of March had already shown clear signs of breaking down before this, but the comments helped to nudge the market over: bonds blew out, stocks fell sharply. The US 10yr rose 0.16 per cent to 2.56 per cent and has sold off again overnight to 2.62 per cent. The S&P 500 fell 0.8 per cent, led by declines in tech as rates rose. NDX fell 2.24 per cent, whilst the Nasdaq Composite was lower by 1.81 per cent. The Dow was off just 0.45 per cent with Utilities and Healthcare catching some bid among the defensives. ARKK declined almost 6 per cent. Twitter shares added a further 2 per cent after Elon Musk was elevated to the company’s board after taking a 9.2 per cent stake in the company… so much for that passive investment, but hey, it’s Elon.

BofA: "We are in the late-stages of a short-cover-rally as the implied vol spike in heavily-shorted names has started to fade".

Companies

Fracking review boosts those left with assets

The government’s potential reboot of onshore shale oil and gas projects after the failed test wells done by Cuadrilla has sent Egdon Resources (EDR) shares up 11 per cent, thanks to the explorer’s East Midlands shale holdings.

“While shale gas extraction is not the solution to near-term price issues, it is right that all possible energy generation and production methods are kept on the table following the unprovoked invasion of Ukraine by President Putin’s regime,” a government statement said.

The British Geological Survey will look at whether there are “new techniques in use [in hydraulic fracturing, or fracking] which could reduce the risk and magnitude of seismic events”. The suspension for fracking came in 2019 after Cuadrilla’s Lancashire wells caused tremors during testing, including a quake that registered 2.9 on the Richter scale.

Michael Bradshaw, co-director of the UK Energy Research Centre, said research had showed it would be “difficult for the industry to meet” the safe, sustainable and of minimal disturbance threshold the government wants. “This is because the orientation of existing geological faults means they may be more likely to be reactivated during the hydraulic fracturing operations required to extract shale gas from the rocks,” he said. AH

Read the full story here

Housebuilders take the pledge

Is there an end in sight to the housebuilders’ standoff with ministers on the complicated matter of fire safety?

That’s one reading from the flurry of announcements from the sector over the past day. Taylor Wimpey (TW.), Redrow (RDW), MJ Glesson (GLE) and Persimmon (PSN), Berkeley (BKG) and Crest Nicholson (CRST) have all signed a government-initiated pledge to fund fire safety remediation works on all buildings above 11 metres in which they have been involved since 1992.

The request was sent by the Department for Levelling Up, Housing and Communities, which has identified 53 companies whose historic construction works it believes fall short of fire safety standards. Concerns about the inadequacy and dangers of the UK’s high-rise building stock were thrown into sharp relief five years ago, when the cladding used on the Grenfell Tower exacerbated a fire that killed 72 people.

Despite already setting aside hundreds of millions of pounds toward remedial works, several of the signatories said provisions would rise.

Taylor Wimpey upped its commitments by £80mn to £245mn, while Redrow raised its estimate from £36mn to £200mn following the pledge. Citing the “complex and judgemental” work involved in estimating its liabilities, Crest Nicholson was less specific, but expects to book a charge of between £80mn and £120mn in addition to the £47.8mn of net charges it has recorded since 2019.

By contrast – and in keeping with previous estimates from broker Jefferies – Persimmon believes its existing £75mn provision “remains appropriate”. MJ Gleeson says it is “not aware of any material fire safety issues in respect of the 15 buildings it was involved in”, though it aims to conclude a full assessment by June. Berkeley gave no update on the pledge’s potential financial impact.

Bellway (BWY), Barratt Developments (BDEV), Vistry (VTY) and Countryside Properties (CSP) are yet to comment, though all have incurred provisions for fire safety remediation work.

The pledge and associated provisions are in addition to the so-called Residential Property Developer Tax of 4 per cent of pre-tax profit, which came into effect this month. Shares in the housebuilding sector have fallen heavily in the past year, as investors have struggled to quantify the hit to balance sheets and future income from remediation work.

Shares in the sector were largely unmoved on the news. AN

Avon shares slump on earnings shortfall

Avon Protection (AVON) has revealed that full-year underlying earnings will fall short of previous expectations. Shares in the defence contractor slumped in response to the interim update, losing just under a fifth of their value in early trading.

The Wiltshire-based group blamed an unfavourable sales mix and additional manufacturing costs, partially a reflection of a faltering supply chain. It has forecast an adjusted cash profit margin of 10 per cent for the six months ending 31 March, half that of last year.

Sales did pick up through the second quarter, and they remain robust “following the events in Ukraine”, while the adverse margin mix is expected to unwind through the second half and benefits should accrue from the “operational gearing effect of higher revenues”. Management also pointed to a strong comparator in the first half in 2021, but the market wasn’t buying it. MR

Market action over the last few sessions has been essentially to drift. As noted over a week ago Monday: “Volatility has declined with the Vix down to the mid-20s, which indicates conditions for chopping sideways.” The Vix did move up yesterday but is not showing big signs of stress just yet... looking at an imminent bearish crossover on the MACD for SPX below.

The rise in US yields helped lift the dollar again. EURUSD trades under 1.09, the weakest in a month, whilst GBPUSD retreated to test the March 29th lows at 1.3050. USDJPY extended gains to 124.

Europe not looking great, hawks and doves still playing out a game in public. ECB policymaker Wunsch said “based on the current outlook… we will raise interest rates to 0 by the end of the year". German factory orders down 2.2 per cent month-on-month before the full extent of the Russian invasion, so likely to deepen. European stock markets have opened a little lower this morning but essentially flat.

China too struggling with lockdowns and the problem of getting goods to market: the China Caixin services PMI contracted to 42.0 from 50.2, the sharpest decline in two years. Chinese shares were mainly lower overnight as trading resumed following the long weekend.

With further sanctions for Russia incoming, oil prices are a bit higher but remain capped by the 20-day SMA resistance with the 50-day the main support. Generally rising market above the 20-day and falling when below. EIA inventories later today.