Hardcore

Drama and volatility continued to grip UK bond markets this week, eventually forcing the Bank of England to intervene not once, but twice. And just when you think that Britain has enough on its plate, new data out this week showed the UK economy unexpectedly contracted in August from the month before. Over in the US, the CPI report came in worse than expected with core inflation reaching its highest level since 1982. That’s hardcore. In other news, UK large caps are buying back their own shares at record pace. Finally, speaking of records, hackers are on track to steal a record amount of crypto this year. Find out more in this week’s review.

Macro

Volatility has gripped British markets ever since the country’s government announced a series of debt-funded tax cuts last month only to embarrassingly reverse course ten days later (see our last week’s review). The episode led to a major rout in the country’s bonds and currency, and forced the Bank of England (BoE) to intervene last month to avert a catastrophe for the UK’s pension funds (which own truckloads of bonds). It did this by pledging to buy up to £5 billion worth of government bonds a day until the 14th of October.

While those measures helped restore order to the bond market, selling picked up strongly again on Monday as investors worried about the program’s looming end this week. That caused the BoE to intervene again, announcing that it’s doubling the upper limit of its daily bond purchases to £10 billion. It also created a new lending facility that allows banks to offer up a wider variety of instruments as collateral in exchange for short-term funding, with the hope that this would trickle down to their pension fund clients, buying them more time. But the moves failed to reassure the market and did little to reverse the selling. Inflation-linked debt was the worst hit, with the yield on 10-year inflation-linked bonds surging 64 basis points to 1.24% – the biggest single-day rise on record, which can be seen in the graph below.

That huge selloff in inflation-linked debt – a market dominated by UK pension funds – prompted the BoE to intervene again on Tuesday. It kept the upper limit of its daily bond purchases intact at £10 billion, but said it would buy as much as £5 billion a day in conventional bonds and £5 billion in inflation-linked ones until the program expires on Friday. While that might help stem losses at the country’s pension funds, the policy of repeated interventions in response to selloffs without a long-term plan in place is unnerving investors and it’s denting the BoE’s credibility. Time will tell how this entire episode plays out, with things potentially getting uglier after the temporary bond-buying measures expire on Friday.

Finally, just when you think that Britain has enough on its plate, new data out on Wednesday showed the UK economy unexpectedly contracted in August from the month before. GDP fell 0.3% between July and August on the back of a sharp slump in manufacturing and as the cost of living crisis hit household budgets and business activity. Economists had expected no month-on-month change in GDP. The decline now means the economy is likely to contract in the third quarter, marking the start of a recession (two consecutive quarters of shrinking economic output).

Over in the US, all eyes were on September’s inflation report, which came out on Thursday and led to further market volatility. Consumer prices increased 8.2% last month compared to the same time last year. While that was a slight slowdown from August’s 8.3%, it was higher than the 8.1% economists were expecting and is still near a four-decade high. Consumer prices increased 0.4% on a month-on-month basis – double the 0.2% gain economists were expecting. But here’s where things got ugly: core consumer prices (which strip out volatile energy and food components) advanced 6.6% from a year ago. That’s a marked acceleration from August’s 6.3% and is the highest rate of core inflation since 1982. On a month-on-month basis, core consumer prices increased by 0.6%, which also topped forecasts for a 0.4% gain.

The rise in core inflation to a 40-year high confirms the very sticky nature of the US inflation problem, and will keep up the pressure on the Fed to continue aggressively hiking interest rates – especially considering that this is the last major data release before the Fed’s next meeting. That’s even more true considering that the latest labor report showed the US economy added more jobs than expected in September and the unemployment rate unexpectedly fell to a new 50-year low of 3.5%. Put differently, the labor market is still going strong and can withstand more aggressive rate hikes aimed at cooling down inflation. So all in all, the CPI report likely cements an additional 75-basis point interest rate hike at the Fed’s November meeting, which would be its fourth “jumbo” rate hike in a row.

Stocks

Companies in the FTSE 100 Index are set to repurchase a record £51 billion of their own shares this year, according to financial services firm AJ Bell. That’s significantly above previous peaks and means corporates are the main buyers of UK shares in the first half of the year, according to Goldman Sachs, as households, pension funds, foreign investors, and mutual funds all turned to net sellers.

For companies, share buyback programs are an attractive method of returning cash to shareholders as they can be easily reduced or canceled if, for example, the economy nosedives and firms need to hoard cash. There are a few factors driving the record buybacks. First, this year’s drop in stock prices makes buybacks a more efficient use of capital than investing in growth at a time when the economic outlook is pretty dire. Second, with FTSE 100 firms generating three-quarters of their revenue outside the UK, the weak pound makes it cheaper for them to buy back shares in their own currency. Third, the FTSE 100’s forward P/E sits below 9 – a record 40% discount to global peers that’s encouraging member firms to purchase their shares in a bid to narrow the valuation gap.

What do share buybacks indicate about the future? On one hand, many executives claim that buybacks are a vote of confidence, indicating that the firm’s future prospects are solid and/or its shares are going for a bargain. There’s some empirical evidence suggesting that firms with share buyback programs see their stocks outperform. For example, the Solactive European Buyback Index, a benchmark tracking companies announcing repurchase programs, has outperformed the Stoxx Europe 600 by about three percentage points this year. But on the other hand, cynics argue that buybacks are a last resort, and could mean that a firm’s management has failed to find any growth-fuelling opportunities – a negative long-term earnings signal.

Crypto

It might be a bear market for crypto investors, but it’s most definitely a bull market for crypto hackers. According to blockchain analysis firm Chainalysis, at least $718 million worth of crypto has been stolen in hacks so far in October. That brings the year-to-date total to past $3 billion, putting 2022 on course for a record-breaking year in terms of total value hacked. Most of the targets have been DeFi (decentralized finance) protocols – algorithmically run platforms that allow crypto investors to deposit, borrow, lend, and exchange tokens without any financial intermediaries like brokerages, exchanges, or banks. While that sounds great on paper, hackers have become adept at exploiting weaknesses in the security, coding, and structure of DeFi protocols. That, in turn, has been undermining confidence in crypto-based financial services.

Next week

The third-quarter earnings season continues next week with financial heavyweights Bank of America, Goldman Sachs, Blackstone, and American Express all providing updates. They’ll be joined by household names Procter & Gamble and Johnson & Johnson as well as tech firms Netflix, IBM, and Snap. Tesla also reports its earnings but considering that the firm has already disclosed its third-quarter vehicle deliveries, there’s less of a surprise with its earnings release. On the macro front, we have Chinese Q3 GDP data on Tuesday, UK September CPI data on Wednesday, and Japanese September CPI and UK September retail sales data on Friday.