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Investors look to U.S. inflation measures, eye bond gyrations as taper looms

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November 2, 2021

By Saqib Iqbal Ahmed

NEW YORK (Reuters) – Investors are watching everything from bond volatility to inflation measures as they try to gauge how an expected unwind of the U.S. Federal Reserve’s easy money policies will reverberate throughout markets.

Most market participants believe the Fed will announce the timing of the tapering of its $120 billion per month U.S. government-backed bond buying program at the conclusion of its November meeting on Wednesday.

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(GRAPHIC: Fed’s balance sheet – https://fingfx.thomsonreuters.com/gfx/mkt/zdvxorlyrpx/Pasted%20image%201635797906162.png)

The central bank has gone out of its way to prepare investors for the start of a taper and so far avoided the sort of gyrations that hit markets in 2013, after then-Fed chief Ben Bernanke alluded to the policymaker’s thinking on plans for pulling back its monetary support in an appearance before lawmakers. Bond yields rocketed higher and stock prices dropped during the so-called “taper tantrum” that year. Yields drifted lower while stocks rose, however, as the Fed gradually unwound its $85 billion in government bond buying in 2014.

Shifting expectations of how aggressively the Fed will need to move this time around in order to tamp down surging inflation have already caused ructions in the rates on shorter-dated Treasury securities, even as stocks have marched to fresh highs.

“You can’t anticipate what it means when a central bank is suddenly no longer buying a $120 billion in securities each month,” said Bryce Doty, senior portfolio manager at Sit Investment Associates. “But once it actually stops, there is an impact.”

Here are various metrics investors are watching.

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(GRAPHIC: Breakeven inflation rates – https://fingfx.thomsonreuters.com/gfx/mkt/znpnezydkvl/Pasted%20image%201635798624668.png)

INFLATION

The 10-year breakeven rate – which shows inflation expectations by measuring the yield spread between 10-year Treasury Inflation Protected Securities, or TIPS, and 10-year Treasury notes – stands near multi-year highs, suggesting investors increasingly believe the current bout of inflation may last longer than previously anticipated.

Signs that the central bank is backpedaling on its view of inflation as transitory could ramp up expectations for how quickly policymakers raise rates.

“We are concerned that the central bank could make a policy error and raise rates sooner than they should,” said Tom Martin, senior portfolio manager at Globalt Investments.

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The Fed’s most recent “dot plot” depicting policymakers’ rate-hike expectations show about half seeing the Fed lifting rates by the end of next year, with the other half expecting liftoff by the end of 2023.

(GRAPHIC: S&P dividend yield vs 10-year U.S. Treasuries – https://fingfx.thomsonreuters.com/gfx/mkt/myvmngdmmpr/Pasted%20image%201635796129587.png)

DIVIDEND YIELD

The gap between yields offered by the benchmark 10-year Treasury note and the dividend yield on the S&P 500 recently opened to its widest since May 2019, potentially dimming the allure of some stocks to income-seeking investors.

The yield on 10-year Treasury bonds is already up about 67 basis points from this year’s low and may rise further as investors factor in interest rate increases from the Fed.

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“It really means that interest rates are going to be teed up in the future for increases and that is going to have an effect on stock prices,” Stephen Tally, chief operating officer at Leo Wealth said.

(GRAPHIC: Bonds on the move – https://fingfx.thomsonreuters.com/gfx/mkt/gkvlgxrmgpb/Pasted%20image%201635796495338.png)

VOLATILITY

Near-zero interest rates and massive monthly bond buying helped soothe nerves and dampen volatility as global markets grappled with the pandemic.

Some of that volatility is now creeping back in as investors adjust their positioning for a Fed taper and eventual rate increases. In bond markets, investors’ expectations for Treasury market gyrations as measured by the ICE BofAML U.S. Bond Market Option Volatility Estimate Index stand near post pandemic highs.

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Ebbing central bank support and the prospect of policy tightening “puts more importance on effectively every major economic data point that comes out,” said Chuck Tomes, associate portfolio manager at Manulife Asset Management in Boston.

(GRAPHIC: Rising reverse repo – https://graphics.reuters.com/USA-FED/znpnezrrmvl/chart.png)

REPO FACILITY

Some investors will be watching the usage of the Fed’s overnight reverse repurchase agreement facility as a proxy for how less accommodative monetary policy is affecting liquidity in the market.

The facility lets counterparties like money-market funds place cash with the central bank. The volume of the Fed’s overnight reverse repurchase agreement facility recently hit a record $1.6 trillion.

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The robust volume suggests markets are flush with cash and less vulnerable to dislocations. Signs that liquidity is on a downtrend as the Fed withdraws support could bode ill for riskier assets, analysts said.

“I consider the repo facility the canary in the coalmine,” said Bryce Doty of Sit Investment Associates.

(Reporting by Saqib Iqbal Ahmed; Editing by Ira Iosebashvili and Marguerita Choy)

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Exclusive-KNDS readies 650 million euro binding bid for Leonardo units – sources

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December 2, 2021

By Angelo Amante, Francesca Landini and Elisa Anzolin

ROME (Reuters) – KMW+Nexter Defence Systems (KNDS) is close to making a 650 million euro ($736 million) binding bid for Leonardo’s OTO Melara and Wass units, three sources said on Thursday, in a move that could strengthen its position in the land defence sector.

The Franco-German consortium is conducting due diligence on the two units that Italian defence group Leonardo has put on the block and could submit its offer by the end of the year or early 2022, the sources familiar with the matter said.

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KNDS is pitted against Italian shipbuilder Fincantieri, which expressed an interest in the units but has not started formal due diligence and has put forward a less generous proposal so far, the sources said.

The Italian government, which controls both Leonardo and Fincantieri, is determined to have the final say on the deal.

As Europe pushes for closer cooperation on defence, Rome wants to keep open the door for cooperation between domestic and foreign groups, political sources have said, but also wants to protect jobs and growth at home.

As part of its proposal, KNDS has offered to include Italy in the Main Ground Combat System (MGCS) tank project, an option that would give Leonardo the possibility of offering its sensors and electronics for the new tank.

OTO Melara, which makes naval and terrestrial cannons, would also fit into KNDS’s portfolio and strengthen its hand in a 2.2 billion euro contract that the Italian army is due to launch in the near future.

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OTO Melara is currently a tank supplier to the Italian army together with Iveco Defence Vehicles, while Wass produces torpedoes.

Fincantieri, which started informal talks with Leonardo over OTO Melara and Wass before KNDS’ approach, could decide to join forces with other groups, the sources said.

($1 = 0.8836 euros)

(Additional reporting by Christina Amann in Berlin Writing by Francesca Landini; Editing by Mark Potter)

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Fed’s Quarles says regulatory overkill could stifle stablecoin innovation

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December 2, 2021

By Pete Schroeder

WASHINGTON (Reuters) -Randal Quarles, the former regulatory chief of the Federal Reserve, said on Thursday that U.S. regulators may “unnecessarily” hamper innovation around so-called stablecoins if they pursue recent recommendations put forward by a Biden administration working group.

Quarles, who will leave the Fed’s Board of Governors at the end of the month, said regulators must show “reasoned constraint” on monitoring stablecoins, which are digital currencies whose value are pegged to traditional assets like the dollar. He added that banks should be allowed to engage with them once certain concerns around transparency, stability and consumer protection are met.

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“It is clear that there is a strong demand for these assets among bank customers, and well-regulated banks should be allowed to engage in activities regarding these assets,” he said in a virtual appearance at an American Enterprise Institute event in Washington.

Quarles specifically cited a recommendation that any stablecoin issuers or “wallet providers” have limited access to other commercial entities, calling it needlessly stricter than rules for nondigital assets.

The President’s Working Group on Financial Markets published a report in November calling on Congress to pass a new law to apply bank-like scrutiny to stablecoin providers.

In his final speech at the Fed, Quarles laid out a series of recommendations for the central bank following his exit. President Joe Biden has yet to nominate his replacement.

For example, Quarles also said the Fed should consider easing its “globally systemic” capital surcharge for the nation’s largest banks, particularly as regulators move to finalize added global capital restrictions known as “Basel III.”

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He said the Fed’s plan to finalize those new rules would come after his exit from the U.S. central bank, and said there will be “little justification” for keeping the G-SIB surcharge at its current high level once it’s done.

He also argued the Fed should consider averaging the results of its annual stress test of bank finances over several years to result in a more consistent capital level, and that the central bank needs to address “perverse implications” of current leverage requirements that could discourage banks from holding safe assets in times of stress.

(Reporting by Pete SchroederEditing by Paul Simao)

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S&P 500, Dow climb on boost from financials, Boeing

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December 2, 2021

By Devik Jain and Anisha Sircar

(Reuters) – The Dow and the S&P 500 rebounded on Thursday, boosted by financials shares and Boeing as rising cases of the new Omicron variant globally continued to drive volatility across markets.

Boeing Co jumped 3.5% after China’s aviation authority issued an airworthiness directive on the 737 MAX jets that will help pave the way for the model’s return to service in China.

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Kroger Co surged 9.9% to top the S&P 500 after the retailer raised full-year sales and profit forecasts, boosted by sustained demand for groceries.

Travel and leisure stocks bounced back, with S&P 1500 Airlines and the S&P 1500 Hotels, Restaurant and Leisure indexes rising 4.5% and 2.8%, respectively.

All of the 11 major S&P sectors advanced in early trading, with eight of them surging more than 1% each. Financials led the pack, up 2.3%.

Wall Street’s main indexes closed below key technical levels on Wednesday, with the Dow breaching its 200-day moving average for the first time since July 2020 on growing angst about the latest coronavirus variant and the Federal Reserve’s hawkish comments.

“It is a bit of a ‘buy the dip’ environment … uncertainty will persist over the next week or so as scientists do more studies over the new variant,” said Sam Stovall, chief investment strategist at CFRA Research in New York.

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“I still think investors want to focus on equities, they just need to be given a reason to do so.”

Wall Street whipsawed this week as investors scrambled for bargains after every drawdown. Still, the three indexes are tracking sharp weekly losses, with the Dow on pace for its fourth straight fall.

The United States and Germany joined countries around the globe planning stricter COVID-19 restrictions as the Omicron variant rattled markets, fearful it could choke a tentative economic recovery from the pandemic.

The CBOE volatility index, also known as Wall Street’s fear gauge, was last trading at 28.6 points, a day after hitting its highest level since February.

At 10:27 a.m. ET, the Dow Jones Industrial Average was up 462.69 points, or 1.36%, at 34,484.73 and the S&P 500 was up 43.36 points, or 0.96%, at 4,556.40.

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The Nasdaq Composite was up 31.90 points, or 0.21%, at 15,285.96, supported by shares of Amazon.com, Tesla Inc, Microsoft Corp and Nvidia Corp.

Apple Inc fell 2.7% after Bloomberg reported about slowing demand for Apple’s iPhone 13.

Meanwhile, lawmakers reached an agreement to fund the U.S. government until Feb. 18 as they scramble to avoid a partial government shutdown this weekend.

Stellar earnings reports and strong economic growth have powered U.S. stocks to a series of record highs in November, with the S&P 500 climbing 20.1% so far this year.

A Reuters poll of equity analysts said a correction was likely in the next six months, with the benchmark expected to gain 7.5% between now and end-2022 to finish at 4,910.

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Advancing issues outnumbered decliners by a 2.63-to-1 ratio on the NYSE and a 1.43-to-1 ratio on the Nasdaq.

The S&P index recorded three new 52-week highs and nine new lows, while the Nasdaq recorded seven new highs and 393 new lows.

(Reporting by Devik Jain and Anisha Sircar in Bengaluru; Editing by Maju Samuel)

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