Will something break? What are the prospects for global financial markets after the UK crash.

Tensions in global financial markets are building up, but the hustle and bustle that forced the Bank of England to make an extraordinary intervention on the UK bond market Wednesday will not change the game for US stock market investors looking for a dead market. .

A working idea among investors and traders has been that the Federal Reserve will continue to aggressively raise interest rates “until something breaks,” forcing policy makers to ease and potentially allowing a failing stock market to touch the bottom.

While a chaotic day in UK markets adds to a list of global financial worries, it’s not likely to give Fed policymakers a reason to slow down, much less stop, investors and analysts said.

“I don’t think you can read the Bank of England’s stock in the gilt market and draw conclusions about the Federal Reserve and the US bond market,” Baird’s market strategist Michael Antonelli said in a telephone interview.

“Whatever ladder is needed”

In a stunning turnaround, the Bank of England announced Wednesday that it would buy long-maturity British government bonds, or gilts, at “whatever scale it takes” to halt a rise in yields that followed the announcement of the British government last week of a deficit- increase the amount of tax cuts and energy aid.

Laws: Here are two reasons why the Bank of England had to step in and buy bonds

The BOE had planned to sell the bonds it had accumulated on its balance sheet as part of its quantitative easing program. The surge in bond yields was accompanied by a sharp sell off of the British pound GBPUSD,
+ 0.87%,
which on Monday traded at an all-time low against the US dollar. The moves were alarming, as rising yields typically support developed market currencies, sparking fears of a financial crisis that could have collateral damage on global markets and the economy.

Keyword: UK Could Trigger Global Crisis As Pound Tumbles As Bond Yields Rise, Says Larry Summers

The BOE’s turnaround, meanwhile, meant the central bank had to effectively ease monetary policy, putting its responsibility to maintain financial stability at odds with its inflation-fighting mandate.

It bounces

The moves resulted in a pullback for US Treasury yields, which have soared in recent weeks, as the rate market has shown that traders have slightly scaled back expectations about how aggressive the Fed will be in raising rates. Yields and debt prices move opposite each other. Treasury yields fell sharply on Wednesday, in a move that analysts attributed to traders who made profits on short bets.

A rise in short-term rates in anticipation of the Fed’s aggressive tightening contributed to a sell-off in equities. Higher yields make Treasuries more attractive to investors than equities and other perceived risky assets.

See: Because 2-year Treasury yields are “the basic problem” for the struggling stock market

US equities rebounded sharply as yields fell Wednesday. The Dow Jones Industrial Average DJIA,
closed with a gain of almost 550 points, or 1.9%, while the S&P 500 SPX,
increased by 2%. The Dow and the S&P 500 closed on Tuesday at their lowest since November 2020, extending a losing streak to six straight sessions.

Treasury yields rallied again on Thursday, while equity index futures headed lower.

Hidden vulnerabilities

Expectations that something will break are rooted in financial history. Past cycles of rate hikes have often led to tensions in the financial system, giving way to the crisis.

“Usually during tightening cycles something explodes,” Christopher Smart, chief global strategist at Barings and head of the Barings Investment Institute, told MarketWatch.

“Sometimes it’s Orange County and sometimes its Mexico and sometimes its Lehman Brothers. It’s hard to know what might be more vulnerable, “she said.

The loss of investments forced Orange County, California, into bankruptcy in 1994, rocking the bond market, the same year the Fed’s aggressive interest rate hikes contributed to the Mexican peso crisis. The collapse of Lehman Brothers in 2008 pushed the global financial system to the brink of collapse.

Read also: The first thing the Fed breaks with higher rates will be the financial markets, says BMO

No major setbacks have emerged so far.

“Are we waiting for ‘something nobody knows what it is’ to break or are we already there? What’s broken already? ”Said Thomas Martin, senior portfolio manager at Globalt Investments in Atlanta, in a telephone interview.

Shares of the stock market, such as growth stocks, already look “broken,” he said, noting that the shares of some former highfliers have fallen 60% or more from their 52-week highs.

“But the system broke? Did cash take hold to the point where it snowballed? No, we haven’t seen it, “said Martin.” But we’re seeing liquidity struggles, yes. “

Dollar wrecking ball

The rise in the US dollar remains a major cause for concern. The collapse of the pound earlier this week contributed to a further increase in the closely following ICE US Dollar Index DXY,
+ 0.13%,
a measure of the currency against a basket of six main rivals, to a maximum of 20 years.

The scale and speed of the dollar rally has sparked fears of market dislocations and tensions in emerging and developing economies which hold a high percentage of dollar-denominated debt. The dollar gains are also seen as negative for large-cap American multinationals that rely on international sales.

See also: Because an epic US dollar rally could be a “wrecking ball” for the financial markets

The currency market, meanwhile, is likely to remain an important “statement” for equities, said Jeff Kleintop, Charles Schwab’s chief global investment strategist.

“Equities completed the round trip to June lows last week and European equities entered a bear market. As stocks rose from mid-June to mid-August this year, the currency market was skeptical as the dollar strength continued, ”Kleintop told MarketWatch in an email.

“It’s hard to imagine a sustained rebound in global equities without at least stabilizing the dollar,” he said. “This may require a weakening of the labor market to lower rents that are driving inflation.”

Watch: A rising dollar is creating an “unsustainable situation” for the stock market, warns Wilson of Morgan Stanley

Antonelli di Baird said the US housing market was the most likely candidate for the kind of slump that could ultimately pause the Fed. A hike in mortgage rates above 7% is shaking the housing market, a further hike that sees Rates above 8% or 9% could create economic disruptions that policy makers would be hard pressed to ignore, he said.

“This would show up on their radar very brightly if they started hearing from the Fed’s regional polls that the housing market is completely at a standstill,” he said, given the crucial role of the sector in the US economy.


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