Mutual Daily Mutterings
Quote of the day…
“War, huh, yeah. What is it good for, uhh. Absolutely nothing,
uhh”…you know the rest…Edwin Starr
Diplomacy at thirty paces……
Overview…” DefCon 2 anyone…?”
- The West continues to point the finger at the Ruskies, accusing them of planning to invade Ukraine (Biden: probability is “very high”). Not surprising, the Ruskies continue to deny it…as you would. The Art of War certainly doesn’t suggest telling your neighbour well in advance that you’re going to invade. While no expert, I’d say Sunday or Monday are likely days, once the Beijing Winter Olympics are done, then it’s game on. Stocks down, bonds up, credit wider, commodities down.
- Fed speak…James Bullard (St Louis Fed) said bringing down inflation may require the Fed to overshoot a neutral target interest-rate, which he sees as about 2.0%. He repeated his preference for a +100 bp hike by July 1, and start a balance-sheet run-off in Q2. Nothing new and should already be baked into prices. The overshoot comment is new, however, I think. Nevertheless, geopolitics trumped macro matters and bonds rallied.
- One of the ongoing themes around inflation is persistent and historically tight labour markets and what this means for the trajectory of inflation. Low unemployment and rising wage inflation is putting pressure on company profit margins, which has forced analysts to cut their profit-margin expectations for 75% of industries and about half of companies in the S&P 500 for the Q1 and Q2 this financial year.
- Talking heads…“as we enter the back end of earnings season, stock market fluctuations continue to be driven by two key themes: inflation and Russia…and as the headlines continue to roll in, investors will have to carefully gauge both the inflation and security risk already priced in, as well as the reliability of any political messaging, to prevent any unnecessary knee-jerk trading.”
- Some strong words from Credit Suisse…”the Fed needs to deliver a Volcker-style shock to drive down asset prices if it wants to slow inflation without causing a recession….policy makers should stoke volatility to set off corrections in assets including stocks, houses and Bitcoin, deterring early retirement and driving people into the workforce.” For reference, the then Fed Chair, Paul Volker “broke the back” of inflation in the 1980’s with massive rate hikes, i.e. Fed Funds Rate at 20.0% and averaging just shy of 10.0% over the subsequent decade. Unthinkable levels today given the scale of global debt outstanding.
The Long Story….
- Offshore Stocks – it was a downhill day from start to finish with geopolitical risks driving the sentiment bus. European losses were modest, but as is their way, the US came in and just had to go bigger. I’m pretty sure it’s in their constitution, “Ite magna, vel vade in domum tuam,” that’s Latin for “go big, or go home”…according to Google Translator. The S&P 500 closed -2.1% lower, and the NASDAQ down -2.9%, while the DOW fared a touch better (-1.8%). Almost nine in every ten stocks retreated in the S&P 500, with only Staples (+0.9%) putting up any real fight. Tech (-2.9%) took it in the jugular with a bayonetted Kalashnikov, with Telco’s (-2.7%) and Financials (-2.6%) sporting similar wounds. One of the ongoing themes around inflation is persistent and historically tight labour markets and what this means for the trajectory of inflation. Consequently, low unemployment and rising wage inflation is putting pressure on profit margins. Accordingly, analysts have cut their profit-margin expectations for 75% of industries and about half of companies in the S&P 500 for the first and second quarters this financial year.
- Local Stocks – very modest gains yesterday, not a lot to really bother with. Uppers and downers were almost equal, while at the sector level, it was a bit of a barbell. Discretionary (-3.4%), Telcos (-3.0%) and Tech (-2.9%) all soiled the bed, while Health (+3.0%) had to do most of the cleaning up. The rest of the index rose between +0.3% and +0.9%. Volumes were elevated relative to earlier trading sessions in the week. Regardless, these modest gains will be cleaned from the slate today. With weak offshore leads, futures are down -1.0%.
- Offshore credit – no primary issuance of note overnight, which is somewhat understandable – risk off tone and some heavy issuance earlier in the week. Spreads are still drifting. US IG Corporates are +7 bps on the week, while Financials are +4 bps. YTD to the two indices are +27 bps and +20 bps wider respectively. European IG corporates are +6 bps wider on the week, and +30 bps YTD, while Financials are +5 bps on the week and +22 bps YTD. Sizeable moves optically, but nothing more than an adjustment process as markets price in expected monetary policy normalisation. Prevailing spreads are half a standard deviation in from their three-year averages, or around one standard deviation inside their five-year averages, suggesting there is more room to widen (on a statistical basis).
|EU Cash vs CDS…
Source: Bloomberg, Mutual Limited
|USD Cash vs CDS…
Source: Bloomberg, Mutual Limited
- Local Credit – traders…”very much a primary story with accounts looking at deals from UOB Sydney Branch, BNP Paribas, Kfw and The Council of Europe. Secondary flows were light and limited mostly to switches for the new prints. Organic secondary interest remains light and we expect this remains the case whilst markets are characterised by headline driven volatility.” And …”no reason to change to the curve as yesterday’s jumbo NAB print was digested by the market – we have the 5yr FRN settling at +70 bps mid, the 3yr FRN at +45 bps mid and note a modest outperformance in the FXD lines, each of which close -3 bps tight of reoffer levels. Little in the way of secondary flow.” If we’re to see any more senior from the majors any time soon, it’ll likely be ANZ. Major bank 5-year senior paper is in the middle of historical (2016 – now) primary ranges. Over the past six years or so the peak in primary pricing for 5-year primary deals was +120 bps (since matured) and the tight was +41 bps (NAB August last year). The average is around +85 – 90 bps, which is where I think we’ll eventually trend toward (vs prevailing level of +70 bps). Major bank tier 2 still drifting, +1 bps across the curve with the 2026’s at +142 – 148 bps.
AU Cash vs CDS…
Source: Bloomberg, Mutual Limited
- While US and EU credit spreads are within a few basis points of their recent historical averages, A$ spreads are still very tight historically. The AusBond Credit FRN index is hovering around +46 bps (+2 bps YTD), which is six standard deviations inside the pre-pandemic average of +77 bps (+53 bps to +102 bps range). The main cause of this tightening was the almost two-year absence of any meaningful ADI wholesale funding, which saw the index shrink by $38bn (~20%) between December 2019 and January 2022. The AusBond Credit Fixed index is looking less skewed, averaging +64 bps or around two-standard deviations inside pre-pandemic averages of +93 bps (+75 bps to +127 bps range). At its worse, the fixed index fell just $7bn, or -5.6%. Recent interest in fixed rate deals has been interesting given inflationary risks and expectation of monetary tightening. Investors appear to have decided that markets have perhaps overshot and priced in too much inflation risk. Time will tell. Geopolitical risks are also helping here.
- Bonds & Rates – local bonds rallied a touch yesterday, reflecting the growing caution (and flight to haven assets) stemming from the situation in Eastern Europe. That trend persisted again overnight and gained some additional legs. European bonds rallied with yields (10Y) falling 5-8 bps, while US treasuries closed 7 bps lower. Ever the loyal puppy, local bonds will follow suit today.
- More on the above CS’ Volcker strategy…the strategy would need to target services inflation – which is driven by housing costs and reduced labour supply – with higher mortgages, and harnessing volatility to set off strong corrections in risk assets. It was noted earlier this week that the interest rate on the average 30-year fixed rate mortgage in the US rose from 3.0% at the end of September last year to 4.2% now, so a +120 bp hike. Still on US housing, talking to a father from my son’s water polo team, he’s a housing developer in California (but lives here) and he said earlier this week that on average there are 1.2 – 1.4 million new house listings across the country each week. Volumes are down to 200K, a headwind for the broader economy.
- Macro – Australian labour data out yesterday. Pilfering some NAB commentary…”January labour market data was stronger than expected even with the disruptions caused from the Omicron variant. Employment rose +13k, unemployment was unchanged at 4.2%, and the participation rate rose a tenth to 66.2% (from 66.1%). Instead, the impact from the Omicron variant was concentrated in hours worked, which fell 8.8% MoM. Data on the reasons for working fewer hours are consistent with people withdrawing labour due to sickness or other reasons more so than because of a fall in the opportunities to work and suggests labour market activity will bounce back strongly in February as virus disruptions receded.”
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Scott Rundell, Chief Investment Officer
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