Mutual Daily Mutterings
Quote of the day…
“If nothing else works, a total pig-headed unwillingess to look facts in the face will see us through” – General Melchett, ‘Blackadder Goes Forth’
|“No Ragrets…Not Even a Single Vowel?”
“There’s A Bear In There….”
Overview…”Fed nailed it….for now”
- Moves: risk on… stocks ↑, bond yields ↑, curve ↓, credit spreads ↑, volatility ↓ and oil ↓….
- A strange session if ever I’ve seen one. The FOMC hiked the Fed Funds Rate by +75 bps (to 1.75% upper bound) and intimated they may go again at that magnitude at the next meeting (or +50 bps) if necessary to curb inflation. Nonetheless, Chair Powell stated hikes of such magnitude should not be considered common going forward, which looks to be the message that markets latched on to most. This was the largest hike since 1994, a period of significance in US monetary policy history – which I touched on yesterday. New Fed forecasts have interest rates reaching 3.4% by December, implying another +175 bps tightening this year (across just three meetings). The forecast for the end of 2023 is 3.8%.
- Fed Chair Powell expressed confidence in getting inflation back under control, and well, markets as a whole seemed to believe him. Stocks closed higher, halting a five-day losing streak (S&P 500: -10.0%), while bond yields plunged, in both the US. This indicates some confidence in what the Fed is doing. Consequently, the Fed should see a flatter yield curve as it raises rates, unless of course there’s fear that they’re not in control (of inflation) or they haven’t reached a critical point where they can do that. European bond yields rallied also as markets through some sun on the ECB’s work around stabilising interest rate markets.
- Markets have rallied on Powell’s assurances that hikes of this magnitude will be rare. Unfortunately, Powell has made similar assertions in the past, only to be forced to back track. For example, just over a month ago Powell pooh-pooed the notion that +75 bp hikes would be necessary to tackle inflation. On that day, Star Wars Day (May 4th), markets partied like it was 1999 and rallied +3.0%. Since May 5th, inflation has worsened and the S&P 500 is now down -11.9% and bond yields are up +31 bps (+54 bps before last night’s rally).
- Talking heads…”Any rally here is an opportunity to reduce risk. A hard landing is now the overwhelming likelihood. If the market is taking comfort in July potentially being 50 basis points when the Fed is telling us that the fed funds rate will likely approach 4.0% by early next year, I’d be inclined to take the other side of that.”
- Today’s bounce in risk sentiment aside…”while Powell may have succeeded in halting one of the most volatile stretches for equities in a decade, his warnings that growth will slow and unemployment climb as a bi-product of the quest to tame inflation did little to convince anyone Wednesday’s risk-asset rally is sustainable”….(Bloomberg)
The Long Story….
- Offshore Stocks – green, green and more green as the market laps up the Fed’s ‘we got this’ Kool-Aid. European markets rallied +1.2% – 1.6% on hopes the ECB can display similar self-confidence. The DOW gained +1.0%, the NASDAQ +2.5%, and the S&P 500 +1.5%. Almost 80% of stocks in the S&P 500 gained and only one sector, Energy (-2.1%) retreated. Discretionary (+3.0%), Telcos (+2.4%), and REITS (+2.3%) occupied the winner’s podium on the day. A bounce following the outcome of the FOMC, but I seriously doubt the rally has legs. Unlike broader markets, I don’t think the Fed has anything under control and they’re at risk of making some serious policy blunders, that increase the risk of the US slipping into a recession. Not an outlook to warrant adding risk to stocks at this juncture. Latest estimates (Bloomberg) have risk of US recession approaching 75% (by Q1 2024).
- Local Stocks – a down day for the ASX 200, dropping -1.3% with nary a green shoot to be seen. Just under 80% of stocks retreated and no sector was spared the rod. Best of the worst was Telcos (-0.2%), followed by Staples (-0.6%) and Utilities (-0.7%). At the shallow end of the gene-pool we had Tech (-3.1%), REITS (-3.0%) and Energy (-2.4%). Financials (-0.8%) and Material (-1.0%) had the most impact on the index, accounting for a third of daily losses. Relative strength indicators passed the ‘oversold’ threshold (chart), signalling a technical bounce is possible – and likely given positive offshore leads.
- ASX 200 relative strength indicators…
- Offshore credit – despite the better tone in stocks and bonds, secondary spreads (generic indices) drifted +3 – 6 bps wider. AU major bank US$ paper tightened -2 – 3 bps and on a swapped back basis is back around A$ levels is still +30 – 40 bps wide of local paper around the 5-year part of the curve. Around the 3-year part of the curve, we have parity around +89 / 84 bps. Primary was quiet on account of the FOMC meeting, but given the positive reception to the day’s events generally, i.e. bond yields lower, we could see issuance return tonight our time. At least six high-grade issuers are said to have stood down over the past couple of days, so the supply backlog continues to grow. In the synthetic space, CDS tightening on the better risk tone, with CDX -4 bps at 95 bps and MAIN -3.5 bps at 105 bps.
- Offshore cash spreads drifting wider on broader risk off tone …12-months
Source: Bloomberg, Mutual Limited
- Local Credit – traders reporting continued resilience in local spreads despite the fun and games across stocks and bonds. On the majors, traders reported…”closing the senior curve unchanged with an absence of any meaningful flow. Would not be surprised to see the long end steepen, yet time and again we have seen offshore buyers keep the 5-year point in check.” Five-year paper drifted a basis point to +102 bps, while the rest of the curve closed unchanged. In the tier 2 space, flows have diminished. Nonetheless, spreads have drifted wider as liquidity conditions remain poor and risk appetite cautious. CBA’s Apr-27 call is out +3 bps to +232 bps (vs +190 bps at issuance), while the rest of the tier 2 curve drifted +1 – 2 bps wider.
- Bonds & Rates – another tough day on the tools for duration managers yesterday. ACGB yields closed +25 bps higher across the board and market pricing for the terminal cash rate is at 4.4%, well north of the RBA’s recent guidance of 2.50%. Three-year yields closed at 3.70% (+24 bps) and ten-year yields at 4.21% (+24 bps), levels not seen in over ten-years (2011) for the three-years. The selling by all accounts was relentless. Again, yesterday’s price action will mean little today given overnight action in US treasuries. As per above, the Fed broke the glass because it was an emergency, hiking rates +75 bps. And as you would NOT expect, bonds rallied (yields fell) on the belief that the Fed’s ‘got this’…and ‘this’ being inflation under control. I must say, it’s somewhat heart-warming these days to see people, fully grown adults, believing in fairy tales still.
- US 2-year yields closed down -24 bps at 3.19% and 10-year yields tumbled -19 bps to 3.28%. From Friday last week, when US CPI figures surprised to the upside, through to last night, just before the FOMC announcement, US yields had risen +32 – 36 bps on the expectation the Fed had to get its skates on and go hard on monetary tightening. Expectations of a +75 bp rate hike entered the narrative and lo and behold, that’s what markets got, exactly what they expected….and yields rallied. Some commentary from on the ground in the US…”we need to stop confusing ‘dovish’ with what got priced because of leaks before the meeting. A bounce because things got priced is not dovish, just oversold conditions adjusting.”
- A significant announcement yesterday on wages with the minimum wages gaining a +4.6% boost, which will impact around a third of the work force and at its core will be inflationary – all other things being equal. Unfortunately, it’ll impact SME’s and will likely be a headwind for employment. Historically, wages have had a greater impact on interest rates than inflation measures. A simple fitted linear trend line between 3-year yields and the wages price index as a R-squared coefficient of 0.69, whereas the same for 3-year yields and CPI is just 0.27 (charted below). Implications? We’ll see a respite in the recent rise in yields for now, but risk is for yields to head higher at the front of the curve on rate hike risk remains, +75 bps any one? The back end should flatten on growth risks.
- With yesterday’s continued sell off in bonds, the Bloomberg AusBond ACGB Index lost another 130 bps of performance, taking month to date losses to -4.50%, now the worst month on record (per my data set back to 2000). Year to date losses have stretched to -12.71%, although we’ll see some relief today given offshore leads.
- ACGB 3-year yields…
Source: Bloomberg, Mutual Limited
- AU CPU & AU Wages vs ACGB 3-Year Yields…
Source: Bloomberg, Mutual Limited…
- A$ Fixed Income Markets…
- Fed Dot Plots…
- Macro – some commentary from NAB following the FOMC…” The updated dot plot profile of the FOMC members shows a significant re-think around where the Fed may need to take the funds rate to achieve the target of getting inflation sustainably back to 2%. The upward revision to the dots reflects a large upward revision to headline PCE forecast for the end of 2022, to 5.2% (vs previous forecast of 4.3%). The forecast for the core measure is little changed and so the assumption is that the Fed for now is fighting inflation expectations. There is a recognition that the faster pace of tightening will reign in growth with GDP forecast for 2022 lowered from 2.8% to 1.7%.”
- Labour data out locally today. Consensus is expecting +25K for May (vs +4K in April) and an unemployment rate drifting lowr to 3.8% (from 3.9%). Participation rate is expected to tick up from 66.3% to 66.4%
Source: Bloomberg, Mutual Limited
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Scott Rundell, Chief Investment Officer
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