Mutual Daily Mutterings
Quote of the day…
“Truth is incontrovertible. Panic may resent it. Ignorance may deride it. Malice may distort it. But there it is” – Winston Churchill
“Crashed Test Dummies…”
Chart du jour …two cartoons, whaaaat!…
Overview…”to infinity and beyond…”
- US inflation came out higher than expected last night, with core CPI at +7.5% YoY vs +7.2% consensus, or +0.6% MoM vs +0.5% MoM consensus, which sent bonds into a tail spin. Ten-year yields surged +9 – 13 bps across US and European markets, while at the front of the curve, US two-year yields spiked +20 bps. Aussie bond futures (yields) are up double digits. After a couple of positive sessions, “CPI can’t be that bad, right?” Stocks were smacked over the nose with the rolled-up morning newspaper…with the cling wrap still intact for extra sturdiness.
- Fed speak….ooh, and it’s a doozy…Fed President James Bullard called for lifting rates by a full 100 bps by the start of July — including the first half-point hike since 2000 in March. “I’d like to see 100 basis points in the bag by July 1…I was already more hawkish but I have pulled up dramatically what I think the committee should do.” If that’s not a sign that the Fed has lost control, well I just don’t know anymore. Trading volumes in February Fed Funds futures went ballistic in the aftermath of Bullard’s rate hike comments, with markets pricing an 85% probability of a 50 bps rate hike in March, up from 30%.
- Talking heads… “there is a difference between what any one FOMC participant says and what the committee does …but the odds of a 50bp hike in March or May are higher if the market expects it. Bullard is well aware of this and likely intended to push the fed funds futures market to reprice in support of the urgency he feels after this morning’s CPI report. If he can make us think it, the Fed is much more likely to do it.” All other things being equal, I’m now on board with the double barrel rate hike at the next meeting.
- More talking heads…”high energy prices and supply issues are stoking inflation but these issues should eventually fade. Of greater concern is that wage pressures are building and the central bank will not want to risk a wage price spiral. Looking ahead though, real consumer spending on discretionary goods and services is likely to cool naturally, as higher energy costs begin to bite.”
- While inflation has spiked, there are signs of supply chain improvements and the like, so while inflation may not have peaked yet, there is some light at the end of the tunnel
The Long Story….
- Offshore Stocks – nowhere to hide, nowhere to run…all sectors sporting an array of cuts, bruises and abrasions overnight. REITS (-2.9%) and Tech (-2.8%) copped it right between the eyes, which is du rigor for sessions were yields spike. Utilities (-2.5%), Discretionary (-1.9%), and Healthcare (-1.6%) rounded out the five top underperformers. Materials (-0.6%), Financials (-0.9%) and Energy (-1.0%) were the best of the worst. Despite the sell-off and hurdles ahead, not everyone is making slip knots…talking heads “Overall, we remain constructive on equities over bonds with a preference for cyclical and value stocks, commodities and commodity-linked equities. One theme that ticks all those boxes is dividend-paying European and UK equities which have lagged their U.S. peers and offer the potential for catch-up gains on a total return basis.”
- Company profit margins are set to take a hit and fall because of recent increases in producer and consumer prices. With no other fundamental supports and a Fed in tightening mode, downside risks to earnings and valuations remain…”ultimately, tight labour markets are bad news for companies’ profit margins. The current low unemployment rate in the U.S. augurs a squeeze on the profitability of US firms in the coming months and years. P/E expansion won’t be able to retake the baton for stock returns while we are in an inflationary environment. P/E ratios – which use nominal not real earnings – typically decline in inflationary environments, as earnings rise with inflation. The Prices Paid component of the ISM manufacturing report has generally shown a good inverse relationship with P/E ratios. Revenues, too, will be unable to pick up the slack while headline economic growth slows. The New Orders to Inventory ratio in the ISM manufacturing survey gives a lead on economic growth and points to declining revenues for large-cap stocks this year.” (Bloomberg).
- Local Stocks – modest gains in local stocks, but that’s history after last night’s weak leads. Nevertheless, for completeness…while the index gains, it was a shallow and superficial day for the bulls. Just 55% of stocks gains, and only three sectors closed higher, led by Financials (+0.9%), follow on good mo-jo from CBA’s recent results and markets happy with AMP’s results also. Materials (+0.5%) also gained, so the two largest sectors pulling their weight. Tech had line honours with +2.6% gains, but that was it…red everywhere else. Health (-0.8%) was leader of the red-riders, followed very closely by7 Industrials (-0.8%) and Staples (-0.8%). Futures are comfortably in the red at the moment (-0.7%), nowhere near as crimson as the experience offshore, but give it time to warm up.
- Offshore credit – no issuance of note, which is normal for a CPI print day, especially one so closely watched where it’s expected to be a big one. Spreads generally wider on the risk off tone, by +2 – 4 bps.
|EU Cash vs CDS…
Source: Bloomberg, Mutual Limited
|US Cash vs CDS…
Source: Bloomberg, Mutual Limited
- Local Credit – traders…”a reasonably busy day with some solid two way flow across all asset classes. The relative tranquillity in rates markets over the past 48 hours is likely to be unseated by tonight’s US CPI data with the likelihood that A$ primary issuance will resume early next week.” Major bank senior paper didn’t do much, unchanged. In tier 2, traders were giddy with excitement as recent drifting wider in spreads spurred some buying action, and a very modest basis point of tightening across the curve. The 2026 callables are now +138 – 144 bps. A technical dynamic to consider for the local market, there is no 2022 callable paper.
- Some comments from Citigroup this morning on likely tier 2 (majors) supply…”we estimate there is A$11-11.5bn (or US$8bn) of tier 2 supply to come from major banks in FY’22 (note the major bank FY’22 ends in Sept, with the exception of CBAAU whose FY ends in June). On average the majors are about 38% through their FY’22 tier 2 issuance targets. As usual we think most of the issuance will hit the USD market, given the depth and size advantages of that market. We include a chart showing the current progress that the majors have made getting to the Jan 2024 and Jan 2026 tier 2 targets of 5.0% and 6.5% respectively. The majors are currently tracking ahead of the required run rate to get to these targets. Note that the chart does not incorporate any potential changes to RWAs following the finalisation of B3 by APRA.” If Citi are correct in their assumptions, ANZ has the most to do ($4.0bn) followed by WBC ($3.0bn), CBA ($2.6bn) and then NAB ($1.6bn).
AU Cash vs CDS…
Source: Bloomberg, Mutual Limited
- Bonds & Rates – local bond markets were dull yesterday, not too much of a surprise ahead of last night’s US CPI, so ‘nuff said about ACGB’s. Now, how did bond markets take the higher-than-expected US CPI print? Not well. Market pricing is now for the Fed to move swiftly to nip this inflation thing in the bud with 6.3 rate hikes now priced for 2022 (vs 5.5). Broader consensus amongst street talking heads is for a +50 bps move in March, with markets pricing in an 85% probability of that eventuality, up from 30% yesterday. Understandably, bonds were smoked, both in treasuries and across European markets. The US 2-year rate jumped +24 bps to 1.60% while the 10-year rate surged +11 bps higher and has broken through 2.00% since the onset of the pandemic sit at 2.05% as I type. Real yields rose +7 bps to -0.45% with the implied 10yr breakeven little changed at 2.46% from 2.44% yesterday. Terminal Fed Funds pricing is sitting around 1.89%, up from 1.83% yesterday. Locally, oh the bloodshed we will see…the yield on the Australian 10-year bond future is +13 bps overnight.
- Macro – some cherry-picked snippets from NAB’s morning commentary…”US CPI came in hot with both core and headline one-tenth more than expected. More importantly price pressures were very broad based. Core inflation was +0.6% MoM and +6.0% YoY (consensus +0.5% MoM and +5.9% YoY) and Headline was +0.6% MoM and +7.5% YoY (consensus +0.4% MoM and +7.3% YoY), and highest since 1982. Price increases were very broad-based. As for the main contributors, rents were up +0.5% MoM, with notable increases in household furnishings (+1.6% MoM), used cars (+1.5% MoM), prescription drugs (+1.3% MoM), apparel (+1.1% MoM), personal care (+1.0% MoM) and recreation (+0.9% MoM).”
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Scott Rundell, Chief Investment Officer
T: +61 3 8681 1907