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Australian shares have dropped to their lowest level in two months, ahead of a US Federal Reserve meeting which is likely to result in another large interest rate hike.
Key points:
- Australian dollar fell as low as 66.77 US cents overnight, near a two-year low
- Europe's Stoxx 600 index has dropped to an 11-week low
- Markets are betting the Fed will lift US rates by at least 0.75pc tomorrow
The ASX 200 was down 1.5 per cent to 6,706 points, by 2:10pm AEST.
The Australian dollar was trading at 66.7 US cents, after a 0.8 per cent slide.
Nine out of every 10 stocks fell on the benchmark stock index, with materials, real estate, and industrials being the hardest hit ASX sectors.
Shares of Viva Energy jumped 4.9 per cent, after the fuel retailer said it will buy Coles' fuel and convenience store network (Coles Express) for $300 million.
Meanwhile, share registry firm Link Administration saw its stock fall by 3.8 per cent, in relation to an investigation being carried out by the UK's Financial Conduct Authority (FCA).
Link said its British subsidiary (Link Fund Solutions) may be fined 50 million pounds ($85m), and pay 306 million pounds ($520m) in redress to customers — over the collapse of a fund it managed in June 2019.
This may be a roadblock for Link to get bought out by Canadian software firm Dye & Durham — which has already slashed its offer by a fifth from an agreed price to $1.95 billion.
RBA facing big losses from emergency stimulus program
The Reserve Bank has revealed that its $300 billion pandemic-era bond buying program (BPP) had benefits to the economy but will also cause large losses for the bank, potentially putting it into negative equity.
In a review of the program, the RBA estimated the financial costs of the program to the bank could range anywhere from $35 billion to $58 billion, depending on how high it lifts official interest rates.
As a result, the RBA said it would likely be unable to pay a dividend to the government for several years.
The central bank will also take a large mark to market valuation loss on the bonds in its 2021/22 accounts, although this will be offset as the bonds mature over the coming decade.
The RBA's board concluded the program was successful in lowering both government bond yields and the Australian dollar, but its costs meant it should only be used in emergencies.
The BPP was part of a range of emergency stimulus packages enacted during the pandemic and lasted from November 2020 to February 2022.
The total purchase price of the bonds was around $300 billion, while the RBA will receive $281 billion when they mature.
However, the market value of the bonds has fallen sharply as the economy recovered and yields rose, while the RBA has also raised its cash rate by 2.25 percentage points since May.
The RBA is unusual among central banks in marking its assets to market value, and will therefore take a large loss in the year to June 2022, which could wipe out its equity.
"A number of central banks in other countries have operated for extended periods with negative equity," the RBA noted.
"Several other central banks are, or are likely to be, in a similar position over coming years."
It was not clear from the review whether this might require the government to inject cash into the bank, as in 2013 when the RBA suffered large losses on its foreign currency reserves.
Any injection of taxpayer money could be a political headache for Treasurer Jim Chalmers given the RBA has already faced criticism for raising interest rates sharply in recent months.
"Unlike a normal business, there are no going concern issues with a central bank in a country like Australia," said Michele Bullock, the RBA's deputy governor.
"Under the Reserve Bank Act, the government provides a guarantee against the liabilities of the Reserve Bank
"Furthermore, since it has the ability to create money, the Bank can continue to meet its obligations as they become due and so it is not insolvent.
"The negative equity position will, therefore, not affect the ability of the Reserve Bank to do its job."
Big US rate hike anticipated
Stocks on Wall Street have been sinking this year as investors fear aggressive rate hikes by the Fed could tip the US economy into a recession.
The S&P 500 lost 1.1 per cent, to end at 3,856 points. It was the third straight day that the benchmark stock index closed below 3,900 points, a level considered by technical analysts as a strong support for the index
The Nasdaq Composite lost 0.9 per cent, to 11,427, while the Dow Jones index fell 1 per cent, to 30,713.
The Fed is widely expected to lift rates by 0.75 percentage points for its third straight month, at the end of its policy meeting on Thursday morning (AEST).
There is also a 17 per cent chance of the US central bank increasing rates by a super-sized 100 basis points (or 1 percentage point), according to market pricing.
Markets are also betting the Fed will lift rates as high as 4.5 per cent by March 2023.
"There are a lot of headwinds to prevent sustained rallies," said Greg Boutle, head of US equity and derivative strategy at BNP Paribas.
"It's hard to have [price-to-earnings] expansion while the Fed is tightening."
Investor sentiment on Wall Street was also hit by a dire outlook from automaker Ford Motor Co.
Ford's share price sank 12.3 per cent after it it flagged a bigger-than-expected $US1 billion hit from inflation and pushed delivery of some vehicles to the fourth quarter due to parts shortages.
Recession signals
On bond markets, the US 10-year Treasury yield shot as high as 3.6 per cent, its highest level since April 2011.
But the yield on the US two-year bond (which is highly sensitive to shifts in monetary policy expectations) jumped as high as 3.99 per cent overnight — its highest level in 15 years.
Basically, the closely-watched yield curve between two-year and 10-year bonds in America has inverted even further.
An inversion of the yield curve — where investors get a higher return from short-term bonds, compared to long-term bonds — is seen as a reliable indicator that a recession will follow in one to two years.
On oil markets, Brent crude futures slipped 1. per cent, to $US90.87 a barrel.
Spot gold fell 0.7 per cent, to $US1,664 an ounce.
'Little room for optimism'
Elsewhere, European stock markets dropped for a sixth straight day, closing at a fresh 11-week low.
The STOXX 600 index had risen as much as 1 per cent earlier in the session. However, it took a U-turn and ultimately finished 1.1 per cent lower.
It comes as Sweden's central bank, the Riksbank, raised interest rates by a larger-than-expected 1 percentage point (which takes its benchmark rate to 1.75 per cent) and warned of more to come over the next six months.
Investors will also be watching the Bank of England's policy decision, split on whether it will hike by 0.5 or 0.75 percentage points on Thursday evening (AEST).
"The prospect of hefty rate hikes and hawkish rhetoric from the FOMC [US Federal Open Markets Committee] and Bank of England gives little room for optimism," said Joshua Mahony, senior market analyst at IG.
He also cited geopolitical tensions between the United States and China over Taiwan as another factor weighing on sentiment.
ABC/Reuters