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Mutual Daily Mutterings

Quote of the day…

 

“I stopped believing in Santa Claus when I was six.  Mother took me to see him in a department store, and he asked for my autograph” – Shirley Temple.

 

 

 

 

 

Chart du jour… US vs AU Ten-Year Bonds

 

 

 

“Are We There Yet?…


Source: www.heraldsun.com.au

 

 

Overview…”holding our breath…”

  • Day one of the FOMC meeting saw no headlines of note, with the real action expected tomorrow.  US producer price data came out, overshooting consensus at a meaningful clip, signalling that broader inflation is still running hot.  Concern that the jump in both producer and consumer prices will put pressure on the Fed to be more aggressive sent stocks lower on the day, and bond yields higher.  Anytime there’s a risk of easy money being taken away, that will result in some of these very expensive areas of the market to pull back.  In this regard, a recent Bloomberg survey of fund managers identified that policy error as the biggest downside risk for stocks over the year ahead.  While not invited to participate in said survey, I’d echo that concern.  Rising omicron cases also weighed on sentiment as businesses and governments roll out some restrictions.
  • Talking heads…”the pressure on the Fed to pick up the pace of tightening is only mounting. With higher prices permeating the marketplace, we could see a snowball effect when it comes to inflation challenges as more suppliers justify higher prices and more consumers begin to close their wallets.”  And…”the inflation trajectory remains worrisome. While we believe that price pressures will abate next year, the Fed is doing the prudent thing by tapering faster, so that it is well-positioned to hike rates if needed.
  • COVID corner….”trading during the European session was dominated by headlines from a South African study of the Covid-19 Omicron variant.  Protection against any disease by the Pfizer vaccine was found to be markedly reduced relative to the Delta variant, but the protection against hospitalisation (70%) is still robust, even if much lower than against the Delta variant (93%).  The ‘faster-transmission-but-milder-disease’ hypothesis remains intact.” (NAB).   Pfizer also reported that its experimental COVID pill was highly effective in keeping patients out of hospital, but less adept at erasing milder symptoms often associated with breakthrough infections.
  • As we wind down to the end of the year, and the time for gift giving, keep in mind the gift of knowledge and wisdom.  Please feel free to share my daily mutterings to friends, family, and enemies alike.

 

The Long Story….

  • Offshore Stocks – European markets started their session in the green, but then the day slowly went to custard with stocks flipping over into the red, which set the tone for US markets.  Higher then expected PPI data highlighted continued inflation risk and the need for the Fed to act = higher rates = headwind for stocks (all other things being equal).  At its intra-day worst, the S&P 500 was down -1.3%, but by day’s end the index had clawed back some lost ground to close -0.8% down.  Tech stocks come under some additional love and attention (i.e. selling), with the NASDAQ down over -2.0% at one stage.  As with the S&P 500, the NASDAQ won back some lost ground by day’s end, down -1.1%.  Despite the modest rally off the lows, it was all pretty much one way trading with ten of eleven sectors in the red, and almost 70% of stocks down on the day.  As evidenced by the falls in the NASDAQ, Tech (-1.6%) was the lead underperformer within the S&P 500, followed by REITS (-1.3%) and Industrials (-1.0%).  Only Financials (+0.6%) was able to land a blow for the bulls.
  • Local Stocks – the ASX 200 closed largely unchanged yesterday (-0.01%), although the index spent much of the session in the red, down as much as -0.5% in early trading.  After briefly sticking its nose ahead in later trading (+0.2%), the index closed on or about its opening level.  Staples (-4.0%) was the biggest mover on the day, driven south by Woolworths (-7.8%), Endeavour (-3.4%) and Coles (-2.7%).  The catalyst for the moves was Woolworths downgrading its Food earnings guidance and highlighting “significant COVID-related costs, even more so than last year, due to the combination of both direct COVID-related costs and indirect impacts from disruption caused by COVID.” (NAB).  Discretionary (-1.5%) also failed to find Christmas cheer.  REITS (+1.1%) was the top performer, followed by Materials (+0.7%) and Telcos (+0.7%).  Futures are pointing to a down day, -0.5%.

 

 

 

 

  • Local Credit – the non-denominational festive season lull looks to have set in with another day of light flows and muted spread movement.  Nonetheless, the flows that were noted, were constructive…from the traders “seasonal trading condition reign, with few looking to transact material risk positions in secondary markets.”  On the local banks…”recent primary issuance and amassing street inventories in the very front end has precluded any bull steepening with the only respite likely to come by way of forthcoming maturities.”  The only movement of note in major bank senior paper was a -1 bp drop in the Aug-26’s, to +63 bps.  Unchanged elsewhere along the senior curve.  Tier 2 also stable.
  • Bonds & Rates – FOMC meeting today and tomorrow…”we expect the FOMC to signal a faster end to the Fed’s bond purchases in April 2022 rather than June 2022, which is roughly in line with consensus. The updated median Fed funds rate projections (dot plot) will also likely be revised higher to imply an earlier and more aggressive normalisation path. Fed funds futures have virtually fully priced in a 25 bps hike for June 2022.” (CBA).  Still with CBA…”more than half of US economists expect the FOMC to taper their asset purchases by $US25bn – $US30/mth, according to a Bloomberg survey.  At this pace, the FOMC will finish tapering in March.  We expect the FOMC to taper by $US25bn/mth and finish in April.
  • Local market yesterday marched to the US treasury’s tune again, yields lower on offshore leads, which is somewhat counter intuitive, to me, given tapering and rate hike expectations.  Gut feel, we’ll see flatter curves over the next year or so.  Rate hikes next year by the Fed are almost a given, they have to be in the face of inflationary pressures.  So, the front end moves to reflect hike probabilities, but with the scale of debt outstanding and COVID overhangs, I suspect we’ll have a short sharp hiking cycle, with rising rates to curtail growth somewhat – which will be reflected in lower-highs in the back end.  Locally, the pace of tapering is scheduled to be reviewed in February, and despite the RBA’s continued assurances that it’s not on the 2022 working agenda, markets are pricing a full 25 bps hike by August next year.

 

 

 

 

 

  • Offshore Macro – US PPI inflation in November was much stronger than expected, rising +0.8% MoM to +9.6% YoY (consensus +9.2% YoY) – a record high, with core at +7.7% YoY (consensus +7.2% YoY).  Strength was skewed toward goods prices, which rose +1.2%, versus services, which rose +0.7%.

 

 

 

 

  • Elsewhere…“economic activity in China probably slowed in November due to the real estate downturn and subdued consumption. Consensus is for fixed-asset investment growth to ease on reduced property investment. New home prices may have dropped for a third month. Retail sales gains are also expected to decelerate as Covid outbreaks depressed in-person shopping. The bright spot: Industrial output likely picked up on strong external demand and the easing of production curbs. The jobless rate may hold at 4.9%.” (Bloomberg)
  • Local Macro – nothing of any real substance, or market moving.

Steak Knives….”Can the Fed be Hawkish If Everyone Expects It to Be? (Cameron Crise)

  • Let the game theory begin. If the market at large expects a hawkish outcome from Wednesday’s FOMC announcement and the associated forecasts (most notably the dot plot), how much does the Fed’s messaging actually need to move to fulfill, let alone exceed, expectations? It can be tough to know, especially if you consider market pricing to be not a single or a modal expected outcome, but rather a probability-weighted summary of a much wider distribution.
  • At the same time, of course, market expectation — or at least pricing– is still heavily skewed toward a dovish outcome in terms of the full extent of the coming cycle. As discussed in recent weeks, the real issue for markets is not whether the Fed does five hikes or six through the end of 2023, but what happens after rates hit 1.5%. It’s there that a potential surprise — and an associated tantrum — could lurk.
  • If we consider the state of the world today versus how it looked the day before the September dot plot was published, there’s a pretty incontrovertible argument for an acceleration of the expected policy trajectory. Headline CPI inflation has risen from 5.3% to 6.8%, while core has advanced from 4.0% to 4.9%. The equivalent shifts in PCE inflation haven’t been as dramatic, but then again that data is published with a longer lag. The unemployment rate has fallen from 5.2% to 4.2% and wage growth is surging. We may not be in the throes of a wage/price spiral quite yet, but we’re heading in that direction — at least judging by small business expectations.
  • The market has noticed all of this, of course. December 2022 eurodollars are trading 55 ticks lower than their closing price the day before the September Fed meeting. Dec 2023s are lower by 59, which implies that almost all of the shift in expectations has been to add rate hikes to next year’s pricing. The degree of expected tightening in 2023 has barely budged, and that in later years has fallen. More tightening now equals less tightening later
  • As discussed virtually ad nauseum in recent weeks, one of the reasons that equity markets, and indeed bond markets, have remained so well-behaved amid all of this repricing is the implicit belief that the Fed is going to remain in control. They’ll hike just enough over the next couple of years to knock inflation on its head, then go back to business as usual, keeping real rates negative to support both the labour market and financial assets.
  • But inflation has a funny way of fouling up the best-laid plans of central bankers, because it can force them to hike rates because they HAVE to, not because they WANT to. We’ve spent more than a decade of the Fed claiming to be data-dependent, but ultimately deciding what they want to do first, and then reverse-engineering a justification for that action. That’s difficult to do when inflation is problematic, which is why the delta of Fed policy shifts has moved so quickly recently.
  • And that, of course, is why the market’s apparent conviction that there’s little chance of tightening beyond 2023 — or beyond 1.5%, if you prefer — is so odd. Granted, pricing for 2024 has risen about 5 bps since we discussed this “irrational conviction” last week, but it is quite remarkable to think that 10-year yields have only risen 10 bps since the day before the September meeting, despite the guidance, the subsequent shift in market pricing, and of course the data.
  • It’s like the bond market is a sort of Gandalf character standing on the bridge labelled “5% Fed funds,” slamming its staff down and intoning “you shall not pass!” One can also imagine it having a look at the equity market and saying “run, you fools!” should rates threaten to exceed that threshold. That’s going to be one of the big stories of next year, if not tomorrow — what happens if the Fed forcefully communicates a high probability that rates will need to exceed the levels currently priced by financial markets?
  • A friend reached out yesterday to express surprise that the equity weighting in household balance sheets — comprising just under 19% of total assets — was so low, even if it is near record highs. Part of this is because the comparison is to gross assets — naturally for most people, the gross value of their home exceeds the total of their stock market holdings. On a net basis, however, things are different – direct holdings of stocks now exceed home equity for the first time since the peak of the dot-com bubble.
  • That certainly seems more in tune with the recent market zeitgeist. It also probably raises the risk of some sort of tantrum if the market’s view on terminal rate pricing comes under threat because of inflation. The stock market throwing its toys out of the pram in the face of a potential monetary squeeze would be nothing new — the key question is how much of it the Fed would be willing to withstand.
  • The answer is “probably more than if they were hiking purely pre-emptively or in response to growth.” And this is ultimately what it’s going to come down to. Thus far in the cycle, market expectations have simply represented a shifting of rate hikes from one calendar year to another, with the embedded assumption that moving earlier means moving less. The real hawkish surprise would be an effective shift in the market’s view of the ultimate extent of the cycle. Will an increase in the 2024 dot plot do the trick? Probably not by itself if the terminal (e.g., long-run) projection doesn’t move.
  • Frankly, it might be a little early for that to happen. Jerome Powell could of course partially influence expectations with his comments — especially if he talks up the medium-term trajectory of nominal GDP and emphasizes upside risks. Hopefully one of the journos will ask him if market pricing seems appropriate given the current state of play and, presumably, their projections. If he answers forcefully in the negative, then things could get pretty interesting.

 

 

Click here to find the full PDF from our Chief Investment Officer’s daily market update.

 

 

Contact:

Scott Rundell, Chief Investment Officer

T: +61 3 8681 1907

E: Scott.Rundell@mutualltd.com.au

W: www.mutualltd.com.au

Mutual Limited Daily Update

Mutual Funds

MCTDF – Mutual Cash Fund
Gross running yield: 0.30%
MIF – Mutual Income Fund
Gross running yield: 1.39%
Yield to maturity: 0.98%
MCF – Mutual Credit Fund
Gross running yield: 2.66%
Yield to maturity: 1.88%
MHYF – Mutual High Yield Fund
Gross running yield: 5.24%
Yield to maturity: 4.34%