Mutual Daily Mutterings
Quote of the day…
” Kids are great. You can teach them to hate what you hate and, with the Internet and all, they practically raise themselves.” – Homer Simpson
“Prepare To Get Shocked…”
Overview…”FOMC: All good things must come to an end…”
- Moves: risk off … stocks ↓, bond yields ↔, curve ↑, credit spreads ↑, volatility ↑ and oil ↓….
- Fed speak again doing the damage to risk assets. Tech stocks especially under pressure as the FOMC minutes revealed the Fed’s thinking on quantitative tightening. Yields drifted higher out the back end in response, while the front end rallied a few points (bear steepener). Nothing too surprising in comments, much of it already signalled through the various Fed talking heads in recent weeks. The minutes did suggest if not for the bruhaha in Eastern Europe, the Fed would have fired both barrels last month, +50 bps, not just +25 bps.
- FOMC minutes revealed the central bank is locked, cocked and ready to rock the rate hike cycle. Sharply is the word, assertive is the action. The Fed will also reduce its balance sheet to cool the economy, with reductions flagged at US$95bn a month (consensus was at US$100bn), split US$35bn MBS and US$60bn treasuries – potentially kicking off post the May meeting.
- Interest rate markets are pricing in another +225 bps of rate hikes between now and the end of the year in the US. The Fed hasn’t tightened this much in a given year since 1994, which if you’re old and crusty enough, you’ll know that year was many trader’s annus horribilis. The last time the Fed Funds Rate was 2.5%, 10-year yields were around 4.0%.
- Fed speak…”ahead of the minutes, several Fed members reinforced the message that rates are going up. Harker expects “a series of deliberate, methodical hikes as the year continues and the data evolve.” Barkin said the Fed could move faster on tightening if need be. “We have moved at a 50-basis-point clip in the past and we could certainly do that again.” Both tempered their remarks by noting the risk of pushing too hard on the brakes and tipping the economy into recession.” (Bloomberg)
- Talking heads…”there’s clearly some negative momentum in markets. They’re very nervous; volatility is high. Markets probably have an inclination to sell off further, but you have to look at what’s already priced in and how much things have moved and start thinking that, at some stage, there’s going to be the tactical opportunity to actually dip a toe into this market.”…you go first!
The Long Story….
- Offshore Stocks – two days of softness now in stocks as investors continue to adjust their thinking around financial conditions going forward, which will be less accommodative versus the recent past. European stocks were comfortably in the red, down over -2.0% in most instances, while US markets fared a little better. The DOW dropped -0.4%, the S&P 500 -1.0%, while the tech heavy NASDAQ dusted -2.2%. Just over half of the S&P 500 lost ground, while across sectors it was similarly split – five gained, six retreated. Top of the pops was Utlities (+2.0%), followed by REITS (+1.6%), and Healthcare (+1.6%). Discretionary (-2.6%) threw most toys from the cot, followed by Tech (-2.5%) and Telcos (-2.1%).
- US Financial Conditions Index – a positive measure implies financial conditions are constructive, negative implies they’re constrictive…
- Local Stocks – a modest -0.5% dip in the ASX 200 yesterday as tightening financial conditions (rising interest rates) and geopolitical uncertainties weigh on sentiment. While it was modest in its overall change on the day, the dip was widespread with two-thirds of the index retreating. Only two sectors held their heads high, Financials (+0.7%) and Staples (+0.1%). If not for the banks, the pain yesterday would have been more acute. By virtue of its weight in the index, Materials (-1.5%) did most of the damage, ably assisted by Tech (-2.9%) and Discretionary (-0.9%). All other things being equal, we can expect another soft session today, with futures down -0.3%.
- ASX 200 Relative Strength Indicators…
- Offshore credit – a couple of softer sessions across stocks and credit started to look sluggish with a modest push wider in generic spreads (+1 – 4 bps), across US IG and EU IG. In primary, another quiet day with just two deals for US$1bn priced, taking weekly issuance to US$15bn (vs US$25bn forecasts). I’m increasingly of the opinion there is absolutely no science to these forecasts, it is pure dart board stuff. A little more active in EU primary markets with a handful of mandates announced.
- Offshore Credit Spreads…daily & YTD changes
Source: Bloomberg, Mutual Limited
- Local Credit – traders…”sentiment remains brittle with generic spread product challenged. Some late buying, but the skew of client enquiry remains towards better selling.” Minimal change in major bank senior paper, 5-year still stuck in neutral at +84 bps, while 3-year is at +66 bps. Only movement seen was a +1 bps drift wider at the front of the curve, +34 bps for 1-year risk.
- In T2 it was all attention on CBA’s surprise 10-NC-5 deal, which came with guidance of +200 bps, bang on our expectations. The last update I saw before books closed had a book of around $1.7bn with pricing tightened into +190 -195 bps range. In the end, $1.1bn priced across $700m FRN and the balance fixed at +190 bps, also ball-park our expectations and around our fair value thoughts, although an additional +5 bps would have put more of a spring in our step. I note the FRN is half the size of CBA’s last T2 deal, which priced Aug-21….and the one before that also.
- Trader’s view…”a solid recovery for this asset class which will likely herald a similar transaction from one of the other Majors once we emerge from earnings blackout. To this point we remain some wary of secondary spreads, with the likelihood that spreads gravitate to meet freshly minted primary levels.” An undertone of wariness is noted within trader’s commentary across the board, which will keep spreads elevated. The new CBA deal repriced secondary markets +2 – 3 bps wider. The 2026 callable cohort are now quoted +170 – 175 bps and the 2025s at +155 – 156 bps. The new CBA is quoted at +189 bps (mid) per Bloomberg.
- A$ spreads resilient in the face of offshore volatility...
Source: Bloomberg, Mutual Limited
- Bonds & Rates – another meaningful sell-off in local bonds yesterday with the front of the curve smashed as markets adjust for rate hike expectations. One-year year rose +14.5 bps and two-year yields rose +15 bps to 1.38% and 2.14% respectively. Across the rest of the curve, it was very much a +7 – 8 bps parallel move higher. Markets have very much pegged the first rate from the RBA in June. Historically ten-year yields have averaged a spread to the cash rate of +89 bps (median of +79 bps) – chart below. Because of QE and other monetary black magic that spread is out to +285 bps. So, while we expect rate hikes etc, the scope for further increases in long end yields ‘should’ be limited. Especially if we expect that rising interest rates will curtail growth, which is a key driver of the long end. If cash rates hit the terminal rate of 1.25% – 1.50%, which seems to be the popular view amongst street strategist, that would imply ten-year yields of say 2.15% – 2.20%. Obviously, we’re nowhere near that, so we could say the market has well and truly overshot the runway, or the plumbing of the system has changed and historical averages are no longer relevant, be it cyclically or structurally.
- ACGB 10-Year yield vs RBA Cash Rate…
- Overnight, we witnessed a modest bear steepener in US treasuries following clarity around quantitative easing plans and the like. Despite my view that the long-end sell-off in ACGB’s is overdone, I suspect we might see more widening today in response to offshore moves. I’m not game enough to suggest going long the long end, but I do struggle to justify yields close to 3.0% given prevailing growth headwinds. Having said that, historically inflation in the vicinity of 3.0% has typically been accompanied by 10-year yields closer to 4.0% – 6.0%. Different times my friend, different times.
- 1994, annus horribilis, my second year out of university. In that year the US Fed raised rates aggressively, from 3.0% in January to 5.5% by year’s end (and then went on to 6.0% in 1995). Inflation wasn’t that onerous compared to now, slightly above the then 2.3% target. The economy was growing well ahead of previous levels, at or around c.4.0%. Nevertheless, the Fed was pre-occupied with the risk of an overheating economy. Aggressive monetary tightening was deemed the necessary tonic. The RBA too was on a hiking path, starting in September 1993 at 4.75%, rising to 7.50% by December 1994. The flow on effect in Australia was 10-year yields rising from 6.4% in January to 10.7% in November, +430 bps in ten months, a tough year by any measure.
- Macro – “On the Australian economic calendar for today is the trade balance report. On the offshore calendar is German industrial production and Eurozone retail sales. The ECB releases its March Monetary Policy meeting minutes while Fed Bullard ad Bostic are speaking.” (NAB)
Source: Bloomberg, Mutual Limited
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Scott Rundell, Chief Investment Officer
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