What if the Fed cuts rates?
STOXX 600 slides 1.8%
Banks lead fallers on contagion worries
Deutsche Bank, Commerzbank, UBS tumble
Wall Street futures lower
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WHAT IF THE FED CUTS RATES? (1131 GMT)
Only a few weeks ago markets were expecting the Fed to raise interest rates as high as 6% and keep them there for an extended period of time.
That feels a long time ago, with markets now viewing this week's 25 basis point hike as the likely last one of the tightening cycle.
Traders are also currently pricing in over 100 basis points of rate cuts from the Fed by the end of the year.
So, what if the Fed does cut rates?
"History shows us that equity markets only find their cycle trough after the Fed actually cut rates, not before," Barclays equity strategists, led by Emmanuel Cau, say in a note.
"What happens between the last hike and the first cut is unclear though. The record is indeed mixed, but on average equities were mostly up," Barclays says.
Mohit Kumar, chief financial economist Europe at Jefferies, says it's "difficult to short" risky assets despite the concerns over macro and U.S. regional banks.
"Equity investors tend to be optimistic and central banks pausing is a good enough excuse for them to buy," Kumar says.
"If we move towards more regulatory support for US depositors, it could provide short term support to risky assets," Kumar adds, although he retains a cautious view over the medium term.
After the first rate cut and the picture is a different story.
Barclays' Cau finds that equity markets mostly fell in the short term as recession takes hold, before troughing and beginning a new cycle.
"So if history is any indication, investors should not rush to buy the pivot, as when the Fed cuts rates, it is too late to prevent a recession," Barclays says.
BANKING TURMOIL AND STRONG PMIS COMPLICATE RATE OUTLOOK (1112 GMT)
Bank contagion fears are in focus in Europe, but markets are also assessing the implications of a raft of strong PMI readings that hit screens this morning.
Business activity across the euro zone unexpectedly jumped this month as consumers splashed out on services, but weakening demand for manufactured goods deepened the downturn in the factory sector, a survey showed.
The S&P Global's flash Composite Purchasing Managers' Index (PMI) for the euro zone bounced to a 10-month high of 54.1 in March from February's 52.0.
"Underlying developments in the fourth quarter were particularly weak, but surveys have recently suggested that the first quarter of this year is already showing some improvements," ING senior economist Bert Colijn wrote in a note.
"Today’s PMI perfectly fits that view as the jump from 52 to 54.1 suggests a fairly strong rebound in activity."
As for the recent banking turmoil, Colijn says any impact on the eurozone economy is not yet clear to see.
"...but if problems remain contained we still expect a mild downward effect on economic activity for the coming quarters. That adds to a picture of weak economic growth for the quarters ahead as high inflation and monetary tightening weigh on economic prospects," he wrote.
Overall, though, the inflation picture is improving.
"For the ECB, this will be a key argument to continue hiking – albeit at a slower pace – at the coming two meetings. If financial conditions allow, that is," concludes ING's Colijn.
On Friday, data showed German business activity expanding for a second month, French business activity strengthening by more than forecast and UK PMIs also coming out above the threshold for growth.
Writing about the latest UK PMIs, Ruth Gregory, deputy chief UK economist at Capital Economics said there were few signs that a fall in sentiment due to the turmoil in the banking sector crept into the survey.
"Overall, March’s flash composite PMI doesn’t change our view that the economy will slip into recession as the drag from higher interest rates intensifies and it provides further signs that yesterday’s hike in Bank Rate from 4.00% to 4.25% could well prove to be the last of the tightening cycle," wrote Gregory.
MORE FINANCIAL "ACCIDENTS" COULD BE IN THE OFFING (1050 GMT)
European companies may face more financial "accidents" over the coming months due to rising interest rates, coupled with reduction in credit availability, Morgan Stanley says.
With recent market events following the failure of two mid-sized U.S. banks and the takeover of Swiss bank Credit Suisse by peer UBS UBSG.S, investors are now trying to assess eventual consequences and implications.
As central banks try to tighten the noose around inflation, analysts at Morgan Stanley led by Graham Secker, expect issues to arise around liquidity for companies in the auto financing and commercial real estate sectors. They flag likely renewed weakness in some economic indicators as well as earnings.
"These issues may not manifest themselves in the mainstream European banking sector; however, European asset markets will still be vulnerable if risks emerge from other areas," Secker said.
The Wall Street bank believes that investors should reduce cyclical exposure and switch towards more defensive stocks, which includes stocks with "more of a quality and/or growth bias".
Morgan Stanley highlights 25 stocks with compelling features like low valuation and low earnings risk during economic slowdown, which includes, Lufthansa LHAG.DE, British American Tobacco BATS.L, Volvo VOLVb.ST, and Associated British Foods ABF.L.
BANKS LEAD SEA OF RED IN EUROPE (0902 GMT)
Europe's banking shares are leading the way lower for the broader European market on Friday, with markets on the lookout for strains in the financial sector.
Shares in Deutsche Bank are down as much as 8% after a sharp jump in the bank's credit default swaps a day before, fuelling more concerns about the overall stability of Europe's banks.
Meanwhile, UBS and Credit Suisse are dropping after Bloomberg reported the company's are facing a probe by the U.S. Department of Justice into whether financial professionals helped Russian oligarchs evade sanctions.
Europe's banking index .SX7P is last down 3%, leading a 0.9% drop for the broader STOXX 600 .STOXX.
Britain's FTSE 100 .FTSE, France's CAC 40 .FCHI and Germany's DAX .GDAXI are all down around 1.2%.
The one bright spot in Europe is British budget pub chain JD Wetherspoon, whose shares are up 7% after the company returned to profit in the first half of the year.
Here's your opening snapshot:
EUROPEAN FUTURES POINTING LOWER (0736 GMT)
European equity futures are modestly lower on Friday, with financial stability concerns still lingering after central banks in Europe pushed on with further interest rate hikes, although the end of the tightening cycle appears to be getting closer.
Credit Suisse and UBS are again likely to be on watch after Bloomberg News reported the two banks are under scrutiny in a probe by the U.S. Department of Justice into whether financial professionals helped Russian oligarchs evade sanctions.
Meanwhile, U.S. Treasury Secretary Janet Yellen tried to soothe contagion fears in the U.S., saying she was prepared to take further action to ensure that Americans' bank deposits stay safe amid banking system turmoil.
"The immediate concern for market remains the US regional banks and their impact on the broader economy," says Mohit Kumar, chief financial economist Europe at Jefferies.
Euro STOXX 50 futures STXEc1 are down 0.4%, while futures on the DAX FDXc1, CAC 40 FCEc1 and FTSE FFIc1 are lower between 0.3%-0.5%.
Looking forward, flash PMIs from the euro area and UK are likely to be in focus.
BANKS QUEUE ROUND THE BLOCK AT FED DISCOUNT WINDOW(0653 GMT)
It's been a slow day in Asian markets, no doubt with everyone tired and emotional after another rough week.
Japan's flash PMI edged up to a still-contractionary 48.6, while services fared a bit better at 54.2. Analysts suspect a recession is still likely, but that's hardly a novelty for Japan.
Presumably, European and U.S. PMIs will have more bearing for monetary policy and markets.
Japanese CPI growth slowed to 3.3% y/y as expected thanks to government subsidies on energy, but inflation ex-food and energy climbed to its highest since 1982 at 3.5%.
Normally that might add to pressure for the BOJ to water down its yield curve control, but it's also less of a burning issue given the recent plunge in global bond yields.
It was notable that U.S. two-year Treasuries kept almost all of their massive gains with yields at 3.82%, having fallen an astonishing 126 basis points in 11 sessions and crushed a host of short positions in the process.
The whole yield curve from one month to 30 years is now below the overnight Fed rate, which is something you see only once in a very blue moon. While the 2-10 curve has dis-inverted markedly, that's not a sign recession is less likely. Rather, history shows the curve steepens like this just before recession arrives, as short-term yields dive in anticipation of rate cuts.
Fed futures are currently 65% for no hike in May and 85% for a rate cut in July, a U-turn that the Fed is surely hoping to avoid. And it would be extremely unlikely were it just down to inflation and the economy. But there's the banks.
Treasury Secretary Janet Yellen on Thursday tried to reassure markets that they would backstop depositors in a crisis, and it looks like there are bidders for some chunks of Silicon Valley Bank.
Yet the strains are showing in the Fed books as borrowing at its discount window as of Wednesday was a hefty $110.2 billion. Lending from the Fed's new Bank Term Funding Program ballooned to $53.7 billion, suggesting some institutions simply can't borrow anywhere else.
Even loans to foreign central banks surged to $60 billion, implying the supply of dollars through the interbank system is too expensive or just not available for some offshore banks. The Fed really is the lender of last resort.
The ECB is expected to reassure European Union leaders on Friday that euro zone banks are safe, while also pushing them to adopt a full EU deposit insurance scheme.
Key developments that could influence markets on Friday:
- Global PMIs, UK retail sales
- ECB President Lagarde is at the European Council meeting
- Bundesbank President Nagel speaks on inflation and the labour market, so expect fire and brimstone
- Federal Reserve Bank of St. Louis President Bullard gives a cosy fireside chat on the U.S. economy and monetary policy
Global business activity strengthened in Marchhttps://tmsnrt.rs/3ZleRa8
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