Mutual Daily Mutterings
Quote of the day…
“Once when I was lost I asked a policeman to help me find my parents. I said to him, ‘Do you think we’ll ever find them?’ He answered, ‘I don’t know, kid. There are so many places they can hide.”…Rodney Dangerfield
Chart du jour…US inflation vs crude
Source: Bloomberg, Mutual Limited
Overview…”markets unfazed by FOMC minutes.”
- Stocks rose, bond yields fell, and credit trended sideways. If not for oil volatility and all the OPEC relationship troubles behind it (more on this below under special comments), it would have been a rather dull day. The main market focus overnight was the FOMC meeting minutes, and given the market’s muted response, everything that was said, or not said, wasn’t all that surprising. Another central bank fizzer with the Fed sticking to its soothing ‘inflation-is-transitory message.’ Consequently, bond traders are not really making a call one way or the other on what the market implications are from the minutes.
- Some outtakes from the minutes themselves…“the committee’s standard of ‘substantial further progress’ was generally seen as not having yet been met, though participants expected progress to continue….various participants mentioned that they expected the conditions for beginning to reduce the pace of asset purchases to be met somewhat earlier than they had anticipated at previous meetings.” So, a step closer to tapering, it’s being discussed, but nothing tangible yet.
- And this…“several participants highlighted, however, that low interest rates were contributing to elevated house prices and that valuation pressures in housing markets might pose financial stability risks.” The Fed is supporting the RMBS market through its QE program and post the meeting minutes there was a lot of commentary and speculation in the market on whether RMBS buying would be the first cab of the rank in any tapering decision, i.e. ahead of treasuries.
- A fun hobby for some in the market to do, when central bank minutes are release, is to count the number of times a key word is mentioned. This is then tracked against past meetings in order to ascertain whether said word is gaining more prominence or less. So, mentions of “inflation” in the June minutes jumped vs April, yet the Fed held steady with its “transitory” view. Inflation appears 83 times in the latest minutes, versus 55 in April, while “transitory” shows up eight times in both. So, the upshot is, no meaningful deviation, the Fed is sticking to their mantra. No change to the US monetary back drop for at least another month.
- Special comments (oil) – I pilfered this from a commodities strategist on Bloomberg, I thought it a succinct synopsis of the prevailing situation in oil….“crude prices are extending their previous session’s decline as traders continue to reinterpret the breakdown of talks between OPEC and its partners earlier in the week. Instead, traders are probably right in following a chain of logic which runs something like: (1) OPEC+ is a cartel, (2) the function of a cartel is to drive prices higher, and (3) thus, anything that undermines its unity should lead to lower prices. Now, obviously, this is a gross simplification, and there are many disagreements that may lead to OPEC+ pumping less, not more. But that a key player was willing to walk away rather than work with its current baseline, seems like a recipe for more future supply, not less.” Oil is important in the inflationary story, particularly in the US where ~70% transport of consumer goods along the value chain is via trucking, and ~70% of the US economy is consumption driven (give or take). Higher oil is inflationary, all other things being equal, it’s just a question of magnitude, and the impact of any other potentially counter-acting variables. WTI Crude, which is most relevant for US markets is sitting at around US$72/bl, or -4.3% below recent peaks, but has been rising consistently, up +100% since October last year. For some perspective, the five-year average has been US$53/bl, so yes, we’re well above recent averages. However, the prior 5-year average was materially higher at US$94/bl, and inflation (PCE Deflator) through this period ranged between 0.9% and 2.1%, well below the last print +3.4%. So, oil is a contributor to inflation, but not necessarily the whole show.
- Offshore Stocks – a modest rally offshore in US markets, while European stocks had a bit more of a spring in their step with the STOXX up +0.8%. The DOW (+0.3%) and S&P 500 (+0.3%) outperformed the flat NASDAQ. Within the S&P 500, two-thirds of stocks advanced, while only two sectors failed to make ground. Not surprising given moves in oil prices, Energy (-1.7%) was one of those, while Telcos (-0.1%) was the other, and only just down on the day. Relative strength indicators are still flashing ‘overbought’ at 71.1, but with the Fed still pushing its ‘transitory’ inflation barrow, and no apparent advancement with its eventual tapering agenda, the mini-bar remains stocked with the good stuff. E-mini’s are up across the board in after close trading.
- Local stocks – the ASX 200 shrugged off weak overnight leads from US and European markets to post solid gains yesterday. Three out of four stocks gained, and only one sector retreated, Energy (-1.9%), which was smacked across the chops with a wet fish following heightened oil price volatility – in turn the result of a break-down in relationships within OPEC+. Tech (+2.8%) was the best performing sector on the day, followed by Staples (+1.9%) and Healthcare (+1.7%).
- Offshore Credit – high yield is gonna need a new name….”as bond yields plummet to new lows, CCC yields, the junkiest of junk bonds, are hovering near 5.0%. Single B yields, and just tad less risky, have fallen below 4.0%.” To put these yields into perspective, the historical 5-year default probability of CCC rated credit is 46.2% (S&P data), or put differently, if you have a portfolio of CCC credits, after a 5-year holding period, almost half of your portfolio would have defaulted. Moody’s data is less eye-watering at 26% for Caa-Ca, and with this, and using some back of the envelope calculations, the required compensation for default risk on a portfolio of CCC rated credits is around 15% – 16%.
- Local Credit – from the traders…”the rally in rates, widening in swap spreads and news of an extension to NSW COVID lockdowns left credit to play second fiddle yesterday. We saw modest volumes trade in Regional and Offshore Banks, all else was fairly muted and spreads unchanged across the complex.” Major bank senior closed at +32 bps for the Jan-25’s, while the 2024’s are around +23 bps.
- Bonds & Rates – firstly, let’s have a gander at the local bonds – any recent hawkish tilt from the RBA has been well and truly ignored, forgotten, or just straight out kicked to the curb. A meaningful rally across the curve yesterday with a -2 bps bull flattener as 10’s fell -8 bps and 3’s fell -6 bps. Following the RBA’s June meeting, markets picked up on a slightly more hawkish tone, and was somewhat reiterated at the July meeting, which obviously came with some tapering announcements. Since the June meeting the yield on the 10-year bond has fallen -30 bps, while the yield on the 3-year bond has risen +12 bps. Markets are drinking the central bank Kool-Aid and buying the ‘inflation-is-transitory’ story for now, which I dig, it’s cool, it’s groovy. However, relative strength indicators, if you’re into that kind of thing, are on the cusp of flashing ‘overbought’ in the 10’s and consensus expectations are for yields to reach 1.90% – 2.00% by Q3/Q4. If this transpires, that’s a 5.5% – 6.0% capital downside to bonds (10’s). As for US treasuries, yields on 10-year Treasuries have fallen more than -10 bps in the past two days and post the FOMC minutes the yield dipped briefly below 1.30% (now 1.32%). They’re now drifting lackadaisically sideways, and break-evens haven’t budged. This may be a tip of the hat to the Fed’s communication skills, or it may reflect the fact that the tone of the minutes is tactically “maybe we will, but maybe we won’t, or both, or neither.” There’s something in there for almost everyone to confirm their prior positions or points of view…again, I dig it.
- Macro – pilfering from others again in the interests of time…this from NAB provides some thoughts and details of what to watch today. “in Australia today we have RBA Governor Lowe speaking on The Labour Market and Monetary Policy – at the Economic Society of Australia. Lowe is likely to recognise the recent strength in the labour market but given his comments on Tuesday he is also likely to emphasise the high level of uncertainty in the outlook and that the data is still a long way from levels required for the RBA to consider removing easy policy settings (and so pushing back on market pricing of rate hikes in late 2022/early 2023). Interesting for the market would be if he provided more detail/guidance on where the RBA sees NAIRU. Lowe could also elaborate on the impact of the international border closures on the current supply and demand dynamics in the labour market given that he noted in his speech on Tuesday that the Board is watching this carefully”
Click here to find the full PDF from our Chief Investment Officer’s daily market update.
Scott Rundell, Chief Investment Officer
T: +61 3 8681 1907