Mutual Daily Mutterings
Quote of the day…
“I have a photographic memory; I just haven’t developed it yet”…Jonathan Winters
Chart du jour…treasuries vs S&P 500
Source: Bloomberg, Mutual Limited
“The End is [Nowhere] Near…”
Overview…”risk aversion is the new risk, not inflation”
- One drink doesn’t make a summer, but a noticeable change in risk-tone overnight in stocks – probably a few weeks, months even, behind bond markets, which have seen yields falling since the end of March. There is growing anxiety within markets that the spread of COVID variants will upend growth expectations, and undo popular reflation trades – I suspect the latter has already happened. Perhaps markets were spooked by the global COVID death toll passing 4 million. US jobless claims data overnight also underwhelmed, coming out above expectations and up on the prior print, which wouldn’t have helped the tone.
- Again, if the narrative is correct, the heavy selling in US markets (stocks) last night was triggered by an algo, a sell program, one of the largest in the US market. Perhaps, but I’d point out European stocks were belted before the US came on line, so maybe it was a contributor to the momentum, but not necessarily an instigator. Also, US RSI’s were signalling overbought, and valuations are on the frothy side, so a pullback was inevitable at some stage.
- European stocks puked, likely as a result of the largely ineffectual ECB meeting. The main focus of the meeting was the change to inflation targeting, which the bank had signalled in advance. The target is now “0% over the medium-term” vs the previously ambiguous “below, but close to 2.0%”. For some context, since the European crisis (2011 – 2013), EU CPI has averaged just 0.8%, with a peak of 2.0% (briefly) and most recent readings of 1.9%. While the target is clearer, the ECB unfortunately didn’t provide any insights on how or when that target might be achieved.
- US treasury yields dropped a few more basis points, which was accompanied by a broad fall in bond-market inflation expectations. The 10-year yield fell below 1.25% briefly intra-day before climbing over the second half of the trading session. 10-year yields have now fallen -45 bps from the peak of the reflation trade mania through Feb-Mar. Is 1.0% a possibility? It has been floated as an idea by some of the braver strategists.
- Talking heads…”it feels like we have moved from thinking inflation will be transitory, to fearing growth will be transitory”
- Offshore Stocks – within the S&P 500, almost 90% of stocks closed in the red, and no sector fired a shot in anger, all down. Volumes were modest, a touch below recent averages. The best performers on the day were REITS (-0.1%), Discretionary (-0.1%) and Utilities (-0.2%), while wallowing in their own self-pity we saw Financials (-2.0%), Industrials (-1.4%) and Materials (-1.4%) crying into their beers. E-mini’s have carried the pain torch in after-market trading, down -0.6% to -0.8%. I’ve been touching on valuations recently, the fact they’re frothy and priced to perfection, and that markets were wound tight as a drum. At a tactical level, in this kind of environment, it doesn’t take much to trigger a pull-back. Is this the start of something grander and more painful? I doubt it, but at the same time stocks can’t just keep rising. Vaccination rates are still rising with herd immunity estimated to be reached later this year, monetary policy remains super-accommodative despite recent hawkish tilts from central banks, and fiscal stimulus continues to grow. But, earnings can only grow so much, so pull backs are inevitable.
- Local stocks – a modest and narrow rally yesterday in the ASX 200 after US markets largely ignored the contents of the FOMC minutes, and provided modestly supportive leads…but that’s old news. Within the index, winners and losers were evenly spaced, and the same at the sector level. Sectors performing best were Tech (+1.3%), Staples (+1.1%), and Materials (+0.7%), while sectors hanging their heads in shame included Utilities (-0.5%), Energy (-0.4%) and Healthcare (-0.3%). Given weak leads from offshore, it’ll be a tough day on the tools in stocks, futures are down -0.66% as I type.
- Offshore Credit – this snippet caught my eye as a potential, albeit very modest headwind for credit spreads – in its own right, all other things being equal. The Fed took a baby step toward paring back its extreme policy accommodation. The NY Fed announced the Secondary Market Corporate Credit Facility (SMCCF) will begin gradual sales of its corporate bond holdings from next week, which is consistent with plans announced by the Board to begin winding down the SMCCF portfolio. Holdings within this facility total US$13.7bn, so equivalent to a modest week of primary issuance. Under normal circumstances this wouldn’t touch the sides in a technical sense. With the broad risk off tone, secondary spreads drifted wider, between +1 bps and +3 bps across US and EU IG markets, while High Yield spreads were +12 bps higher in US markets and +4 bps wider in EU markets. CDS spreads were +1 bps wider across the CDX and MAIN.
- Local Credit – trader talk….”a reasonably busy day as local set near term highs. Local risk appetite remains intact, credit spreads mostly unchanged despite some offshore weakness apparent. Techicals likely to keep local credit spreads underpinned in the near term.” I doubt last night’s risk off tone will have any meaningful impact on local risk appetite (credit), the sell-off would need to be more sustained and entrenched.
- Bonds & Rates – overnight, the yield on 10-year treasuries sank briefly below 1.25%, the lowest since February, but ended the session higher at 1.29%. Apart from jobless claims there was no major economic news of note to accompany the move lower. On the back of a number of steep daily declines from 1.52% just 13 days ago, markets have been left guessing as to why rates have moved so quickly, given a robust US economy and still potent near-term inflationary pressures. It’s fair to say, the pandemic has come back on the radar as a risk and has perhaps precipitated yields falling so much.
- Recent moves in the Treasury bond market may also suggest that bond market vigilantes, those who had agitating to force the Fed’s hand on interest rates, have thrown in the town, spat the dummy, thrown their toys from the cot, and straight out capitulated. After flirting with post-vaccine +80 bps 2s10s steepening, the US yield curve has flattened -40 bps since March, which suggests the market is anticipating lower rates for much longer (vs previous expectations). This flattening of the yield curve amidst some of the best economic numbers the US has seen and conversely some of the worst inflation numbers seen in a generation is telling. It indicates those who were expecting higher inflation to force the Fed’s hand toward tightening have now taken their bat and gone home.
- Macro – US initial jobless claims unexpectedly increased to 373K last week from an upwardly revised 371K. Even so, new weekly filings for jobless benefits have more than halved since the beginning of the year. Continuing claims declined to 3.34 million from 3.47 million. Locally, RBA Governor Lowe gave a speech titled “The Labour Market and Monetary Policy” to the Economic Society of Australia (QLD). I’ve pilfered (below) NAB’s summary of the speech to save ink and time…some editing from me.
- Governor Lowe reiterated the RBA’s baseline is for conditions for a rate hike not being met until 2024, namely it will take until 2024 for inflation to be sustainably within the 2% – 3% target. In a speech Dr Lowe noted “it is likely that the unemployment rate will need to be sustained in the low 4s for the Australian economy to be considered to be operating at full employment. Underemployment will also need to decline further ”. Even when full employment is reached, it will take time for a lift in wages growth to emerge. Dr Lowe continues to see that wages growth needs to exceed 3% for inflation to be sustainably within 2-3%.
- While the closed international border has clearly impacted the supply of labour, Dr Lowe notes “the spillover effects to the broader labour market have been limited to date” and “most firms retain their strong focus on cost control, with many preferring to wait things out until the borders open, and ration output in the meantime”. Should borders remain closed for longer (current government guidance is a gradual re-opening from mid-2022), then “aggregate wages growth would pick up more quickly than currently expected, but production and investment would…be constrained”.
Have a good weekend…
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Scott Rundell, Chief Investment Officer
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