- Major U.S. indexes red; Nasdaq down ~1.7%; banks outperform
- Tech weakest S&P sector; financials biggest gainer
- Euro STOXX 600 index down ~0.8%
- Dollar edges up; gold, crude fall; bitcoin gains
- U.S. 10-Year Treasury yield rises to ~1.44%
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FUND DEMAND DROP POSES RISK FOR U.S. TREASURIES (1112 EST/1612 GMT)
A record more than $500 billion net decline in U.S. Treasuries held by investment funds in the third quarter raises the risk of higher rates and volatility in 2022, particularly as the Federal Reserve shrinks its purchases of the government’s debt, according to John Canavan, lead analyst at Oxford Economics.
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The decline, which was concentrated in Treasury bills held by money market funds, came as outstanding bill supply was slashed, investment funds’ U.S. bond and note holdings were about flat, and the Fed remained a big purchaser of Treasuries, Canavan wrote in a report on Monday.
He added that “the market will need to find other sources of support going forward, as the Fed has already begun to taper (quantitative easing), and we expect purchases will end by March 2022.”
Foreign investors own the biggest share of Treasuries. However, foreign allotments in Treasury auctions, while strong, have not compensated for a sharp drop in allotments to investment funds over the past few months, which helped fuel a volatility rise since mid-September, Canavan noted.
“As markets contend with sticky inflation and investors position themselves for increased Fed policy rates, we expect the fall in investment fund demand and the additional decline in demand from the Federal Reserve will sustain the increased volatility through early 2022,” the report said, adding that should pressure rates higher with the benchmark 10-year yield rising to around 1.75% in 2022’s first quarter.
ROASTING ON AN OPEN FIRE: PRODUCERS, SMALL BUSINESS, FED FEEL INFLATION HEAT (1045 EST/1545 GMT)
Welcome to Fed Tuesday, where inflation is hot and the Federal Reserve is feeling the heat.
And with the polar icecaps melting, the mercury is also on the rise at Santa’s Workshop in the North Pole, according to November’s PPI print.
The Labor Department’s producer prices report (PPI) (USPPFD=ECI), a gauge of the prices U.S. goods-producers get for their wares at the factory door, came in significantly hotter than analysts expected, unexpectedly accelerating to 0.8% from 0.6% and well above the 0.5% consensus. read more
Year-over-year, the headline print jumped to a sweltering 9.8%, while the core number (which strips out food, energy and trade services) gained 0.6 percentage points to 6.9%.
“Price metrics have been running well above target for much longer than anticipated,” says Rubeela Farooqi, chief U.S. economist at High Frequency Economics. These data support the Fed’s switch to a faster taper that will likely precede a quicker tightening of policy next year.
As seen in the graphic below, core PPI, along with other major indicators, has been launched into orbit, sailing well above the Federal Reserve’s average annual 2% inflation target.
The picture it paints provides a rather clear rationale for the Fed to stop batting the word “transitory” around like a shuttlecock in its monetary policy game of badminton.
And, increasingly, U.S. businesses are planning on passing those prices along to the consumer.
While the National Federation of Independent Business’ (NFIB) Optimism index (USOPIN=ECI) inched up 0.2 points to a reading of 98.4 last month, you’d never know it from accompanying NFIB press release.
“The outlook for business conditions is not encouraging to small business owners as lawmakers propose additional mandates and tax increases,” writes Bill Dunkelberg, NFIB’s chief economist. “Owners are also pessimistic as many continue managing challenges like rampant inflation and supply chain disruptions that are impacting their businesses right now.”
And the typical respondent is putting their money where their mouth is, namely on the consumer’s plate.
As Lydia Boussour, lead U.S. economist at Oxford Economics points out:
“Small firms continue to pass along higher prices onto consumers,” Boussour says. “The share of firms raising prices – a leading indicator of core inflation – jumped 6 points to a new record 59%. And in a sign that high inflation is not going away any time soon, the share of firms planning to raise prices climbed to a new record.”
The uptick in the Optimism index was attributable to a slight easing in the inability to find qualified workers and an increase in inventories.
It should be noted that the NFIB is a politically active membership organization.
Wall Street fluctuated in morning trading, with the market-leading tech associated stocks weighing on all three major U.S. stock indexes.
The Dow flipped nominally into negative territory, its losses mitigated by financials.
AND THEN IT WAS TUESDAY: S&P 500 EXTENDS ITS SELL-OFF (1001 EST/1501 GMT)
U.S. stocks wobbled in early trading on Tuesday, as the latest in a string of hot inflation reports appeared to raise concerns over just how soon the Fed will whisk the punch bowl away.
That said, all three major stock indexes are off initial lows, with the blue-chip Dow flipping green as producer prices came in well above consensus read more , just as the Federal Reserve is convening its two-day monetary policy meeting, during which inflationary concerns were likely to take center stage.
Apple Inc (AAPL.O) is the exception, resuming its trudge toward reaching the $3 trillion market cap milestone.
Meanwhile, in Washington, lawmakers were expected to vote on raising the federal government’s debt limit, ending a months-long stalemate. read more
Here’s your opening snapshot:
MIGHT MICRO-CAP MELTDOWN LEAD TO S&P 500 MISHAP? (0900 EST/1400 GMT)
Despite a stellar-start to the 2021, micro-caps have struggled to keep pace for much of the year.
Of note, on a weekly basis, the IWC/SPY ratio peaked in mid-March just shy of a 15-year resistance line:
Perhaps not surprisingly, it was also around this time, that the retail-driven meme-stock mania was its most intense. Highly speculative stocks, like micro-caps, tend to have greater volatility and are thus inherently riskier than larger-cap shares. They can, therefore, be especially sensitive to the key drivers of liquidity and psychology.
Recently, the performance disparity between the IWC and SPY has been particularly acute. Since November 8, the IWC has lost more than 13%, while the SPY is off just 0.6%, having just recorded a fresh record close last Friday.
With this, the IWC/SPY ratio has plunged to its lowest level since November 2020.
Meanwhile, the severity of the ratio’s decline from its peak has been especially sharp. In fact, in the time since the IWC topped in relative strength vs the SPY, the ratio’s 40-week rate-of-change has collapsed to an all-time low.
It now remains to be seen if the micro-cap ship can be righted in the midst of tax-loss season and building fear-of-the-Fed.
However, of concern for the S&P 500, from 2007 to 2020, the five biggest SPY declines from record-high territory were all preceded by protracted IWC/SPY ratio divergence.
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Terence Gabriel is a Reuters market analyst. The views expressed are his own
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