Mutual Daily Mutterings
Quote of the day…
“Discussing vaccination with a doctor is like discussing vegetarianism with a butcher”.…George Bernard Shaw
Chart du jour: implied change in overnight rates (from NAB)
Overview…”Risk of policy error building…”
- Mixed messages…US stocks were mixed with modest losses in the DOW, offset by modest gains in the S&P 500 and slightly more buoyant moves in the NASDAQ. European markets were a little more sombre, closing in the red. Treasury yields inched higher, and curves bear flattened as inflation fears rise, fuelling expectations central banks will be forced to tighten their monetary policy settings sooner than originally planned. GILTS were pummelled (2y +13 bps) as the BOE warned on the need to respond to price pressures. And, locally we saw the front of our curves taken to with a gnarly lump of timber, 3-year yields spiking +20 bps, with the theme likely to continue this morning. Countering some of the inflation pressure, in stocks at least, US reporting season have been solid, but…still only early days – less than 10% of the S&P 500 has reported.
- Oil was off a snifter last night, but that hasn’t discouraged the bulls. Texas Tea is on the cusp of reaching six-year highs, up 340% in a touch over a year and oil punters are calling for further gains. Aiding the cause is the news that Russia is keeping its gas supply to Europe limited next month. This means a greater reliance on oil for heating as a substitute will continue, boosting demand, while even the OPEC+ cartel struggled to pump enough oil to meet production targets.
- Talking heads…”rising commodity prices — particularly oil prices, which only appear to go in one direction at the moment — are boosting expectations of high inflation becoming more entrenched and a sooner move by the Fed to raise interest rates.” Policy error has been a risk for a while, with worries central banks won’t be nimble enough to respond to potential errors of judgement…”that’s where we could end up with recessionary risks down the line…that’s not going to be a risk for next year, but this could prove to be a shorter business cycle.”
- Offshore credit…”slower growth from supply disruptions reflects strong demand and is not a negative for spreads as the demand should be largely delayed rather than reduced… we acknowledge some risks, but it is hard to see credit markets bucking the trend given our positive equity and commodity market narrative… high-grade spreads don’t offer great value, but we see no sign of end-of-cycle excesses which might cause a credit shakeout” (JPMorgan)
- Offshore Stocks – a shaky start for the S&P 500 following weaker European leads, but after an hour or so of trading, the bulls (baby bulls, calves) found their mo-jo and the index drifted marginally into the green and stayed there. More sectors gained ground than lost ground, 7 to 4, but only a fraction over half of stocks closed higher on the day. Discretionary (+1.2%) led, followed by Tech (+0.9%) and Telcos (+0.7%). Down the shallow end of the pool we had Utilities (-1.0%), Healthcare (-0.7%) and Staples (-0.5%). Bank earnings-per-share beats this quarter are topping misses, while they account for a disproportionately large amount of the index’s EPS. Financials make up 11% of the SPX by weight, but ~20% of the index’s EPS… a significant chunk of bank earnings has come from reserve releases, aka clawing back loss provisions, which may be skewing sentiment about the broader market here and now. For some scale context, JPM’s Q3 earnings were boosted by US$1.5bn through reserve releases, and for Wells Fargo it was US$1.7bn. As a greater proportion of companies report we’ll have a fuller and more complete picture of underlying earnings fundamentals, but for now there is some doubt. Some talking heads…”we have used most of the superlatives we know to describe corporate America’s stunning performances over the past two earnings seasons. Despite lofty expectations, results exceeded estimates by the biggest margins we’ve ever seen….we expect solid earnings gains during the upcoming third-quarter earnings season, but upside surprises will be smaller…unfortunately, we won’t need as many superlatives.”
- Local stocks – it was a modest rally yesterday, but it wasn’t overly convincing, propped up by Materials (+1.0%) and Financials (+1.0%), which did all the heavy lifting – Energy (+0.8%) also up and about. The rout in bonds was felt in REITS (-1.0%), while Tech (-1.2%) and Healthcare (-1.0%) were also drags. Only about half of the ASX 200 gained ground and six sectors gained vs five retreating. Local futures are signalling a modest down day for local markets, -0.4%.
- Local Credit – traders EOD commentary…”rates undoubtedly the focus yesterday as the 3s10s curve bear flattened >10bps, pulling the timeline of expected hikes into question. A select few accounts capitalised on outrights but the majority were sidelined by the sheer severity of the moves.” Major banks did little, just the three-year part of the curve drifting a basis point wide…traders again…”bid side enquiry remains limited and any interest is met with strong offers from the street. Traded volume was thin on the day.” In the major bank tier 2 space, a bit of selling in one part of the market (real money), met by a bid in another part of the market (ETF). Net-net, most of the curve closed unchanged. The early-2026 calls drifted a basis point wider to +127-128 bps, as did the 2024 callable tier 2, out to +96 bps.
- Bonds & Rates – what a day in bonds! It started with New Zealand CPI punching through consensus expectations to the high side (details under ‘Local Macro’ below), which set the tone for local bond markets from the get-go. Within the first hour of trading 3-year yields were +16 bps higher and by days end they were effectively +20 bps higher, with three-year yields knocking on the door of 0.80%, up four-fold since mid-September. Ten-year yields weren’t spared the rod either, +9 bps to 1.75%, and within spitting distance of their YTD peaks set in March at the peak of the reflation trade hysteria. Where to from here? More to go this morning given offshore leads.
- Just over a month ago, on September 14, RBA Guvna, Dr Lowe, made the comment that he found it “difficult to understand why rate rises are being priced in next year or early 2023” and warned that “while policy rates might be increased in other countries over this timeframe, our wage and inflation experience is quite different.” I wonder what he’s thinking now. Assuming, he’s not under his desk in the foetal position, and is in fact standing resolute behind these comments, then perhaps we will have some dovish cooing from the bank in coming weeks to calm market nerves. US treasuries and UK GILTS continued to bear flatten overnight, which could see further pressure on local rates today.
- Local Macro – I’m appropriating some Kiwi data under the ‘Local Macro’ heading today, much the same way as we Australians claim Russell Crowe (when it suits) as one of our own, and similarly, Split Enz…and other notable or successful kiwi’s. And, I’m not even using my words, I’m borrowing from the old crew at CBA…”the NZ CPI itself was up 2.2% on the quarter to be up 4.9% on the year. It wasn’t so much a question of what rose in price (food, housing, transport) – but what didn’t rise. The “transitory” price pressures are morphing into something that looks a little more permanent. 72.2% of the CPI (by weight) rose in price in the quarter. Only 20.8% fell. That looks fairly widespread. Our NZ colleagues continue to expect a further two moves of 25 bps at the next two meetings, being November and February and more after that”. We saw what all that did to the front of our curve.
- As for comparisons between the Kiwi inflation experience and our own, per the following chart, Kiwi inflation has historically had higher peaks than Australia – I’m sure there’s a reason why, but I don’t explicitly know what it is…thankfully, CBA’s learned economists have a better handle on this…”NZ CPI has often been used as an omen for Australian CPI, though the linkages are not wonderful. There is a link in tradeable prices, historically, but with COVID related lockdowns playing havoc with supply chains and causing idiosyncratic factors both sides of the economy, the link may not be obvious in a mathematical way. But the lesson learned today (yesterday) was not about timing, it was about concepts: is very easy for supply shortages and localised transitory inflation to spread to the overall situation. That might not be at the print next week (27 October), but the risk is there.” For mine, the key is wage inflation, which is still somewhat sluggish. On the back of the NZ CPI print, I note ANZ upped their Q3 CPI forecast for next week, to +0.9% QoQ from +0.5% QoQ. RBA minutes out today, with interest likely on whether there is any mention of pricing action – keeping in mind, the meeting was held two weeks ago, when three-year yields were -43 bps lower. Not holding my breath.
- Offshore Macro – main event of note was China GDP data, which missed to the down side. The Chinese economy expanded by +0.2% QoQ, well down on consensus (+0.4% QoQ) and last reported (+1.3% QoQ). Over the year the economy grew by +4.9% YoY, just falling short of consensus estimates (+5.0% YoY) and a sizeable drop on the prior reading (+7.9%). Interestingly, in pre-pandemic China, the economy had never not grown more than 5.0% YoY (modern China). Retails sales beat (+4.4% YoY vs +3.5% YoY cons), while industrial production missed (+3.1% YoY vs +3.8%) and Fixed Asset Investment fell short also (+7.3% YoY vs +7.8% YoY). Property investment dipped against expectations, possible reflecting Evergrande issues (maybe?).
- Steak knives…commentary around offshore front end moves… “Inflation is one of those drivers that is a convenient scapegoat when overnight equity price action is poor, but in this case it looks like the culpability is actually true. The notable feature of Monday’s trading has been the evisceration of short-term interest rate contracts, with December 2022 futures down 6.5 bps in eurodollars, 5.5 in euribor, and a whopping 21 in short sterling.
- That’s not the stuff of happy clappy equity price action at the best of times, but particularly when it implies that central banks might have to hike because they have to, not because they want to (e.g., because of growth.) It remains to be seen if and when any of them hike, of course, but BOE governor Andrew Bailey’s weekend comments certainly suggest it could be soon.
- The Fed and particularly ECB need not follow suit mechanistically, of course, but it would still represent an important signal if the BOE were to go. You might well argue that the risks of Fed tightening are now amply priced into the eurodollar strip; September 2022 (the first contract expiring after the projected end of the taper that hasn’t even begun yet) projects Libor at 0.53%, some 40 bps above this morning’s setting.
- That’s a pretty aggressive timetable, particularly given the measured pace of Fed tightening cycles over the past 20 years. If that were to materialize, it would take a pretty healthy level of growth to encourage stocks to shrug off that kind of tightening, at least given current valuations. Of course, a year is a long time these days, so perhaps it will be the strip, not the stock market, that capitulates. Either way, though, the current backdrop seems like it is going to produce elevated levels of volatility for some time to come”.
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Scott Rundell, Chief Investment Officer
T: +61 3 8681 1907