Mutual Daily Mutterings
Quote of the day…
“Anyone who believes exponential growth can go on forever is either a madman or an economist”– Kenneth Boulding
Chart du jour… US public debt vs S&P 500
“Congratulations, America! (You’re $30,000,000,000,000 in debt…”
Overview…”what comes after trillion? Gazillion?…”
- It was Groundhog Day in the US last night and given markets continued to claw back some of January’s losses, perhaps Punxsutawney Phil didn’t see a shadow, indicating the Northern Hemisphere winter will end early…or something like that. US stocks rose, shrugging off weak jobs data and capping off their biggest four-day rally since November 2020. Earnings season helped the cause, as did soothing Fedspeak around the path of rate hikes, which seems to be providing some comfort that perhaps aggressive policy tightening won’t derail the post pandemic recovery. This also suggests the Fed didn’t read the room too well previous communications. Markets are like a cat in a room full of rocking chairs…nervous.
- Treasuries advanced (and flattened) on materially weaker than expect jobs data, pushing 10-year yields down to 1.77% (-2 bps). European markets were neither here nor there, some up, some down, moves very modest. Bunds underperformed (yields ↑) as rate hike expectations were brought forward following last night’s CPI print (core +2.3% YoY vs +1.9% YoY consensus).
- Diverging central banks at ten paces…the BOE is poised to leave the ECB in the dust by lifting rates and signalling more increases on the way. ECB boss, Christine Lagarde, on the other hand, is expected to resist suggestions she should tighten this year — even after January’s record euro-area inflation fuelled bets of an earlier than expected hike. UK currency and bond markets are testing levels last breached during the 2016 Brexit vote in anticipation of a 25-bp move (Bloomberg, with some editing from me for literary flair).
- Oil retreated from a fresh seven-year highs overnight as OPEC+ agreed to another modest increase in output and Iran signalled that it’s ready to turn the taps back on quickly if sanctions are removed. The cartel will lift production by 400K barrels a day in March (vs 5.1 mb/d currently), a widely expected move. Having said that, there’s still concern that some members will be unable to meet their supply targets.
- US Q1’21 reporting season is approaching the half-way mark (S&P 500 companies reported) with aggregate sales up +18.0% on the pcp and aggregate earnings up +32.5% pcp. No sector left behind. Results also well ahead of consensus estimates, with sales beating by +3.3% and earnings by +5.4%.
The Long Story….
- Offshore Stocks – another positive session to help ease the pain of January’s woes, which saw US and Europe markets smacked down as much as -10.0% lower. Before you get all hot and bothered that perhaps it’s all sunshine and lollipops for the remainder of the year, or the near term at the very least, there is evidence to suggest the recent pull-back from the abyss is just short-covering, and on muted volumes at that. Investors shouldn’t get to aggressive on risk, if at all, until volumes improve and open interest increases. “Robust volumes and increases in the number of outstanding positions taken together would mean investors are committing to the market and its direction. While stocks have rallied however, liquidity has evaporated and resembles what we saw during the start of the pandemic in March 2020. Volume figures in E-mini S&P 500 futures last night are the lowest of the year.” (Bloomberg)
- A a titbit of insight from the high yield market…”junk bonds are highly correlated to stocks, so looking at the selloff in high-yield during the past month can help us identify drivers of the stock rout. As it turns out, better-rated bonds did worse than the junkiest junk. That’s symptomatic of a market more concerned about yields and rate hikes than it is with slowing growth and corporate profits.” While I haven’t done the analysis, this could be a case of the ‘chicken or the egg’ who leads who, or is it whom? Either way, take it for what it is, free intel.
- Local Stocks – a decent +1.2% rally in the ASX 200 yesterday, quite broad-based too, with 84% of the index advancing Materials (+2.0%) and Financials (+1.1%), the two largest sub-sectors of the index drove the bulk of gains. Only Utilities (-0.4%) really failed to launch, while Tech had a flattish day (-0.03%). Futures are pointing to very modest gains in the ASX 200 this morning.
- Local Credit – trader’s rhetoric…”rates markets once again the focus with Governor Lowe underscoring the RBA’s dovish stance. Credit markets stable throughout, though we did see better buying immediately following the Q&A session. With this seminal RBA meeting behind us we may see some tranquillity in local rates markets, though this may also herald the resumption of A$ primary supply.” As for spreads on the day, nothing to see here, move along. The major bank senior curve closed unchanged, and the same for tier 2. On the latter, traders are indicating that the street “remains flush with inventory.” So, two things. If we have a period of stability, then anyone wanting add risk in the space should be able to get supply – to some degree. That’s the glass half full scenario. Alternatively, we have a mini-shock of some sort and it’s risk off again. With the street full as a goog on liquidity, there’s limited liquidity, and absent any counter-balancing influence, spreads could gap wider. Post the RBA and Fed meetings, we should have some clean air for a while, which could tempt buyers to dip their toes into some risk. But, overall it’s likely range trading from here until we see some new supply, with reasonable probability that we drift wider as financial accommodation eases.
- Offshore Credit – a snippet from Citigroup yesterday that I thought was interesting…”we have previously argued that US IG credit investors, hedged for rate risk, needn’t topple out of the raft on account of the choppy wake of a pivoting Fed. Improving credit fundamentals and positive technical factors for domestic and global demand should help to steady the course. Yet even those more bullish than we are on the prospects for IG credit spreads may be looking askance at the stickiness of some traditional measures of risk premia in US credit. A variety of relative value relationships that typically tilt with prevailing risk sentiment remain eerily stable, indicating a nonchalance that flies in the face of a VIX at two-sigma highs. For now, the repricing of IG credit has yet to unleash a full-blown risk-off environment. Pessimists among us now have a window to trim risk tactically at lower cost, and even the cautious optimists may determine, after reviewing three RV relationships below, that some measures of risk premia are simply too low within crossover risk, capital structure risk, and liquidity risk.”
- Some additional outlook comments on offshore spreads that I picked up, Bloomberg is reporting that January was the worst month for its US Corporate Bond Index since the GFC, losing -3.37%. Still-hot inflation and monetary-policy tightening pose nearer-term challenges that may exacerbate losses, though coupons could help offset those declines over the course of the year. More spread widening is still on the table for investment-grade corporates. Fair value for the Bloomberg US Corporate Bond Index option-adjusted spread is forecast at +125 bps for end-2022, given our assumptions for further Treasury-curve flattening, reduced volatility and moderating — yet still expansionary — manufacturing new orders. A less-supportive Federal Reserve may extract more of the estimated +10-15 bp monetary-policy premium that we calculate in the market, resulting in an overall year-end base case scenario for +120 bps, plus or minus 10 bps. Tail risks, either deeper risk-off sentiment or a Fed far behind the inflation curve, could see spreads test as wide as +155 bps, while moderating inflation and GDP growth of about 3.5% could compress spread back to the mid-90 bps level from 106 bps at month-end.
- A$ spread are 70% – 85% correlated to US spread moments. If we run a regression across the two, and take Bloomberg’s US Corporate spread forecasts, there is risk of a +16 – 23 bps widening from current levels (Bloomberg Credit FRN Index), or +29 – 36 bps under the worse case scenario. Slightly worse for fixed spreads, but much worse in a performance sense.
- Bonds & Rates – a somewhat volatile session yesterday. A$ bond yields rose 3 – 5 bps through the day, but as markets digested Guvna Lowe’s annual National Press Club speech, and probably more because of Q&A, yields pulled back to close largely unchanged. Here and now, the RBA is content to be patient on hiking rates, although Lowe did conceive that a rate-hike this year was ‘plausible’, but was then quick to point out that many other scenarios were plausible also. From CBA’s commentary… Governor Lowe “continued to remind financial market participants that the cash rate will not be raised until the Board is confident inflation is sustainably within the target band which will require wages growth to be materially higher than it currently is.” The point of conjecture is ‘what length of time proves or supports sustainability?’ Despite Lowe’s assurances, to a man, women, child and your neighbour’s dog, most strategists are calling rate hikes to kick off around August or September. And, of course there are some outliers at dates either side of this period. Markets are a tad more aggressive, calling BS on Lowe’s patience rhetoric, which is evidenced by the cash futures pricing pre and post the RBA meeting (and Lowe’s subsequent speech).
- Offshore Macro – US companies lost 301K jobs in January, the ADP report showed, completely missing forecasts for a 180K gain…’completely missing’…that’s an understatement. The hiring drop may be temporary due to last month’s omicron surge but reinforces expectations that Friday’s employment data will underwhelm. Tonight – Jobless claims will probably post a second straight decline, falling to 245K from 260K, suggesting that the variant wave is passing. US Non-Farm Payrolls (January) tomorrow night will be the big one to watch, with +150K the consensus forecast (vs +199K in December). The unemployment rate is forecast to remain steady at 3.9%, while average earnings are expected to show growth of +0.5% MoM (vs +0.6% MoM last) or +5.2% YoY (vs +4.7% YoY last).
- Local Macro – as per above, RBA Guvna Lowe’s speech was the main event here…from a macro perspective, the following comments from NAB provide a good summary….”overall, the speech and Q&A is consistent with the RBA waiting a while longer until it is confident of a sustainable lift in inflation, alongside evidence of higher wages growth. NAB recently changed its RBA rate view to the first rise occurring in November 2022 and we see today’s speech as consistent with that view. By November, the RBA will have had three more WPI prints, and three more CPIs, which should enable the Bank to judge actual inflation is sustainably within the target. NAB sees a relatively fast pace of policy normalisation once rate rises begin, given the RBA will be operating with unemployment at historical lows, inflation higher than the mid-point of the 2-3% target, and interest rates well below neutral when it starts to raise rates. NAB has pencilled in a 15bps hike in November 2022, followed by 25bps rises in December and February, taking the RBA cash rate to 0.75% early in 2023. By the end of 2024 we see the RBA cash rate at 2.50%”….I have empathy for these views and timelines.
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Scott Rundell, Chief Investment Officer
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