Mutual Daily Mutterings
Quote of the day…
“Is it possible to get a cup of coffee-flavored coffee anymore in this country? What happened with coffee? Did I miss a meeting? They have every other flavor but coffee-flavored coffee. They have mochaccino, frappaccino, cappuccino, al pacino…Coffee doesn’t need a menu, it needs a cup”– Dennis Leary…
Chart du jour…Fed dot plots …
Source: Bloomberg, Mutual Limited
Overview…”taper talk-talk is off and running…”
- The Fed last night signalled that the pace of the US economic recovery from the pandemic is bringing forward their expectations for how quickly they’ll flick the lights on and take the punch bowl away, aka reducing monetary policy stimulus. Some meaningful moves in markets overnight, at least in the context of recent trading ranges, but generally the Fed’s move was in line with consensus expectations, so no ‘major’ change to overall investment themes. Expect bond yields to march higher, and stocks and credit to range trade over the near term.
- Stocks eased off a touch on the prospect of sooner rate hikes, but moves were modest in the grand scheme of things. Bond yields (treasuries) on the other hand gapped higher with US 2-year yields jumped +4 bps to 0.20%, levels not seen since June last year, but only +1 bps off consensus expectations for the end of Q2’21 (0.19%). At the back end (10-year), yields jumped +8 bps higher at 1.57%, and we were at these levels just last month. A decent bear steepener in the 2s10s curve, which remains steeper than average at +136 bps vs +62 bps 5-year average, but off its recent peak of +158 bps.
- Fed Chair Powell told a press conference overnight that officials had begun discussing scaling back bond purchases…“You can think of this meeting as the talking-about-talking-about meeting, if you like.” While the official cash rate was left unchanged, the Fed did move the dot-plots higher, now showing two expected interest-rate hikes by the end of 2023, projecting a faster-than-currently priced in pace of tightening.
- More from Powell….“As the reopening continues, shifts in demand can be large and rapid, and bottlenecks, hiring difficulties and other constraints could continue to limit how quickly supply can adjust — raising the possibility that inflation could turn out to be higher and more persistent than we expect.” While inflation is running hotter than expected, by the Fed, labour markets are lagging, or disappointing relative to forecasters’ expectations with total employment still millions of jobs below pre-pandemic levels.
- Offshore Stocks – growth outperformed value overnight despite the rise in bond yields – reflecting more the Fed’s higher near-term growth expectations, I would suggest. The old-school, value dominated, DOW fell -0.8%, while the growth-value hybrid S&P 500 fell -0.5% and the growth dominated NASDAQ fell just -0.2%. A modest pull back with key indices still within spitting distance of recently set historical highs. In the S&P 500, 80% if stocks lost ground and only one sector gained, Discretionary (+0.2%). Leading the pack down the garden path to market purgatory was Utilities (-1.5%), followed by Staples (-1.2%) and Materials (-1.2%). Volumes were marginally below average. A couple of charts below to show the precarious link between flow of capital into stocks, valuations, debt linked to stock purchases and interest rates. Margin debt in the US has risen +56% in the past 12 months (data to the end of May), or just under US$310bn. In April it was up +72% over the prior 12 months, the fastest annual rate of increase since at least 2013 (extent of data).
(Source: www.finra.org, Bloomberg, Mutual Limited)
- Local stocks – marginal gains on the day locally yesterday, with the ASX 200 closing off its intra-day highs, but still setting a new record high. Looking under the hood, and for the most meaningful impact on the day’s performance, we see that Financials (+0.8%) duked it out with Materials (-1.6%) for dominance. On the downside, it was a lonely day for Materials, joined only by Tech (-0.4%). The grass was greener everywhere else, with Energy (+1.5%) up and about, as was Utilities (+0.7%). Relative strength indicators are still flashing ‘overbought’, but with the weaker leads from offshore overnight, we expect some pressure to be released and markets to ease off today.
- Offshore Credit – a bit happening in the high yield space, M&A related, but generally a modest day in investment grade space – normal for Fed meeting days. The Fed meeting had minimal impact on CDS markets, with just marginal moves. Cash spreads in secondary were generally tighter. Some trader commentary on the recent Macquarie and ANZ deal in US$….”Aust banks understandably busy with the new issues – MQGAU the busiest with the 27’s (+84/82) and 32’s (+119/118) both trading a touch inside reoffer (+85 and +120 respectively – both 20 bps tighter than IPG) with US$60m trading so far as we saw some decent topping up in the 32’s. ANZNZ not as busy but also performing – last +48/46 after pricing at +50 bps”
- Local Credit – an active day yesterday as investors kicked the tyres on a range of primary deals. In secondary, traders are reporting light flows, although they are fielding offshore buy interest in major bank fixed lines. Yours! Nevertheless, major bank senior lines closed unchanged. It has now been 524 days, give or take, since one of the major banks priced a senior deal in A$ markets. That’s a record…I made that up, but it’s probably true. Traders are reporting the cupboard is looking particularly bare, so some tightening of already tight spreads is plausible. I wouldn’t be counting on it though, there is very little upside in going overweight in major bank paper here. The TFF expires in two weeks, and then shortly thereafter there is a raft of major bank maturities, around A$4.5bln or so, within a couple of weeks. Dare we dream of a new primary deal? In the tier 2 space, spreads largely unchanged, showing signs of consolidation. Traders again signalling that “flows skewed towards better selling but what we have seen so far has been readily absorbed”. All about the carry here.
- Bonds & Rates – local bond yields marched higher yesterday, possibly in anticipation of the Fed moves overnight. The new Fed dot plot profile now shows 13 members (out of 18) are expecting at least one rate hike in 2023 (up from seven at the last meeting). There are 11 members looking for two rate hikes by the end of 2023, while seven expect a rate hike in 2022 (up from four). Reflecting these changes, US 2s10s curve steepened +4 bps, with 2-year yields +4 bps to 0.20%, just a basis point above quarter end forecasts, but at 12-month highs. If consensus is to be followed, a further +5 bps rise in yields is expected over Q3’21 to 0.25%, where it is expected to stay – on average – for the remainder of the year. Out the curve, 10-year yields have more room for movement factored into forecasts. At 1.58%, up +8 bps over night, there is still +11 – 15 bps of yield increases baked into forecast by the end of Q3’21, or +25 – 30 bps by7 year end. Regardless of where you play along the curve, there is very little upside to holding bonds (from the long side) over the remainder of the year…if consensus is to be believed, and I’m a believer.
- Macro – the Fed jacked up their inflation forecasts through to the end of 2023, up from +2.4% (March) to +3.2% by the end of 2021, +80 bps. Despite the increase in expectations, the transitory inflation theme persists with the 2022 forecast only marginally increased, up from +2.0% to +2.1% (+10 bps), and the 2023 estimate was raised from +2.1% to 2.2% (+10 bps). Per the chart below, while inflation is well ahead of the Fed’s stated goal, labour markets are lagging, which should moderate the pace of any forth coming tapering or hiking, all other things being equal. Despite labour markets lagging, the Fed median projection for unemployment in Q4’21 was left unchanged at 4.5%, and the median estimate for the same quarter a year later was marked down to 3.8% from 3.9% (-10 bps). The 2023 forecast was left unchanged at 3.5%. Lastly, the Fed raised its GDP forecasts, which is the bank now expects to grow at +7.0% over 2021 vs prior projections of +6.5%. The Fed left their 2022 GDP forecast at +3.3% and tweaked the 2023 estimate to +2.4% vs +2.2% from the March meeting. All other things being equal, these are solid forecasts – under normal circumstances, you’d be happy with them…if they’re accurate. The main anguish for some in the market is the inflation data, specifically will it follow the expected path – a constructive path, or will it get out of hand and require much more aggressive and hawkish policy intervention. The problem with this is, there is a lot more debt in the world today than there was 2 – 3 years again, so the marginal effect of say a +10 bps move in yields is materially more profound, and potentially debilitating now vs then.
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Scott Rundell, Chief Investment Officer
T: +61 3 8681 1907