Mutual Daily Mutterings
Quote of the day…
“Government is not a solution to our problem, government is the problem. … Government does not solve problems; it subsidizes them. Government’s view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. If it stops moving, subsidize it. … The problem is not that people are taxed too little, the problem is that government spends too much.…” – Ronald Reagan
Chart du jour: Tech pull-back…
Source: Westpac, Mutual Limited
“More Like Mongers than Mungers…”
Overview…”inflation bites …”
- US stocks copped a swift kick to the soft and delicate under-carriage overnight as inflation fears gained momentum with CPI data overshooting consensus estimates. US tech especially under the pump as the market cool kids are losing some of their lustre. European markets held their nerve and actually gained, but they’re less leveraged to tech, and more leveraged to old school miners and energy, supported by rising commodity prices.
- Monthly US CPI printed at four-times higher than median consensus, +0.8% MoM vs +0.2% MoM. Sharp rises were reported particularly for autos, transportation services, and hotel stays. Talking heads…”transitory pandemic influences clearly contributed to the surprise but there’s residual firmness in core inflation that’s hard to ignore.” Aside from the reopening effect, “there was still some residual firmness that suggests risks around inflation in the near term are still skewed to the upside.” More talking heads…”the markets have been hovering around all-time highs with a lot of the reopening trade already priced in…so it’s not out of the question that the outsized inflation read could bring us back down to earth a bit.”
- Treasury yields jumped with 10-year yields up +7 bps, and bond-market gauges of future inflation expectations jumping to multiyear highs after the report. Short-end interest rate pricing implied increased odds (80%) of a Fed hike as early as late-2022, which was quasi-endorsed officially, with Fed Vice Chair Clarida saying he was surprised by the rise in CPI and “we would not hesitate to act” to bring inflation down to its goals if needed.
- Is this an over-reaction? Time will tell. As the saying goes, one drink doesn’t make a summer…this is one month’s print. And, it includes a meaningful base effect from last year’s lockdowns. Also, the core number is not too far from the Fed’s target range. There is still a shed-load of liquidity in the system and it could easily settle down in a month or two.
- Interesting ‘fact’ I stumbled across via twitter yesterday, which is quite pertinent, “roughly 25% of all the debt accumulated by the United States of America since 1776 was incurred in the last 12 months.” So that’s up US$5 trillion to US$22 trillion since the beginning of 2020. Outstanding debt has doubled since the end of the GFC.
- Offshore Stocks – yeah, it was an old school rout, US stocks were taken behind the woodshed and given six of the best with a gnarly piece of lumber. Within the S&P 500 some 93% of stocks closed down. Tech was paid particular attention by market bullies, down -2.9% and accounting for a third of the index’s declines, which was two-times greater than he next closest negative driver – Discretionary (-3.3%, contributing 19% of the declines). Only Energy (+0.1%) gained on the day, and obviously only just. The S&P 500 is down -4.0% from its recent all-time highs, but still +81.6% up from pandemic lows, and up +20.0% from pre-pandemic peaks. A lot of upside is baked into these numbers, the occasional pull back is expected, given where valuations are sitting. Nevertheless, there remains a lot of liquidity support in the system…expect a bounce back to some degree, or at worse a stabilisation around current levels. European markets, which had a tougher session the day before, actually advanced on the day. Aided by the fact European markets are less tech heavy and more old-school weighted, with materials and energy benefiting from higher commodity prices.
- Local stocks – not a lot to be happy about in local markets yesterday, a fairly tough day in the trenches with the ASX 200 down -0.7%. Although, it could look like a two-day pass in Paris compared to what we might get today. Around three-quarters of the ASX 200 soiled the bed to some degree or another yesterday, with Materials (-0.7%) and Financials (-0.5%) the main culprits, accounting for just under half of the broader losses. For straight line speed, Utilities (-2.2%), Energy (-2.0%) and Industrials (-1.6%) were hard to beat in a downhill run. Only Tech (+0.8%) and Telcos (+0.2%) had any spring in their steps yesterday. We shouldn’t see a one-for-one rout today, i.e. to the same extreme as the US. Tech is a smaller component (3.7%) within the ASX 200 vs the S&P 500 where it represents 25.8%. The ASX 200 is more old-school, like the European markets, with around half the index comprising Materials (21.7%), which is 3x the next largest, and Financials (30.2%). Nevertheless, local futures are pointing to a soft open.
- Offshore Credit – despite the inflation bruhaha, credit markets remained active with primary still functioning and still somewhat constructive with the US IG daily primary deals 5x over-subscribed and strong spread compression (from launch to final) of 27 bps. US$6bn was priced, across six borrowers, taking weekly volumes to US$39bn. Despite the apparent strength in primary, some worrying signs of credit fatigue. Short interest in the one of the largest IG ETF’s in the US, the US$41b iShares iBoxx $ Investment Grade Corporate Bond ETF, is now 21.5% of shares outstanding, the highest on record (source: IHS Markit Ltd). Higher CPI and inflationary expectations are not only sending treasury yields higher, but also fixed rate corporate yields also. Ahead of this growing risk, the above fund has seen US$11.3bn in outflows so far this year, after absorbing nearly US$15bn in 2020. Higher yields put the fund in a particularly vulnerable position, given its duration (sensitivity to interest-rate changes), which is a relatively hefty 10 years. With Treasury yield curves poised to steepen, that should spell trouble for the fund and funds like it. Floating rate funds on the other hand….
- Local Credit – another meh day in local credit. The Federal Budget having zero impact. From the traders…”no material redeployment of redemption cash post yesterday’s NAB maturity. Two-way flow in sub 2-year tenors with better buying from cash type accounts. Spreads closing unchanged. CBA’s desk note on the prospect of a Sovereign downgrade provoked plenty of conjecture as to what this would mean for major bank senior spreads, given the ratings uplift they receive from the Sovereign AAA. Our desk view is that the impact on the domestic curve would be very limited indeed with most seeing any disproportionate widening as an opportunity to buy. Any fallout is likely to be contained to offshore curves and even that would be tame in our view”…I tend to agree.
- Bonds & Rates – yields are higher, curves are steeper. US treasuries (10-year) hit 1.69% overnight, up +7 bps and edging closer to end of March post pandemic highs (1.74%). Ten-year break evens hit 2.56%, up a couple of basis points and at levels not seen since the eve of the global financial crisis. From NAB’s morning note…”inflation is the driver in terms of when we will see the next surge in bond yields. For now the ‘transitory’ dialogue (Fed Clarida maintaining that dialogue overnight) may temper investor appetite to establish large short positions, but this could change very quickly on another strong CPI print”. May CPI will be a very closely watched print (10th of June), put it in your diary, it’ll be a hoot to watch! Yesterday in local markets, the spend heavy Federal Budget saw 10-year yields higher, +5 bps to 1.77%, and while we may not have the same inflationary pressures as the US, yields will likely be dragged higher today.
- Macro – all about US inflation data last night with US CPI increasing through April by the most since 2009 and clearing the top end of forecast ranges. CPI came in at +0.8% MoM (vs +0.2% consensus), or +0.9% MoM ex food and energy (vs +0.3% MoM consensus), aka core CPI. Annual data hit +4.2% YoY (vs +3.6% YoY consensus), or +3.0% YoY ex food and energy (vs +2.3% consensus). The gain in CPI was almost double the highest projection tracked by Bloomberg…economists hey, what are they good for? Caveat to the slightly derogatory comment about economists, my degree is in economics, although I’ve never worked as an ‘economist’ per se. As noted in the narrative, “similar to last week’s monthly jobs report, forecasters are struggling to get a handle on the rapidly reopening economy.” Back to the CPI, nearly every major category climbed, indicating “burgeoning demand is giving companies latitude to pass on higher costs.” Now, if wages growth follows, then I’d be more willing to nail my opinion to the ‘inflation will be a problem’ mast. Nevertheless, even if inflation expectations rise, and they are, then traditionally the real thing has followed…and US wages have shown signs of picking up.
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Scott Rundell, Chief Investment Officer
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