Mutual Daily Mutterings
Quote of the day…
“They’d say “if ya play the record backwards, you can hear evil tings like grrrr!” and I would think, “Jeez, I didn’t know the devil sounded like that. I thought he was coherent, like the rest of us” – Brian Johnson, AC/DC
“No Crying In Crypto…”
Overview…”Ok, that’s enough now…”
- Moves: risk on… stocks ↑, bond yields ↑, curve ↑, credit spreads ↓, volatility ↓ and oil ↑….
- With no apparent catalyst other than a post long-weekend feel-good buzz, markets have said enough is enough of this bearish crap, let’s par-tay! Stocks rallied, while bonds sold off touch, credit was mixed. Some have pointed the finger at comments from POTUS, Joe Biden, that a recession is not inevitable as rationale for the rally, but I’m not buying that. Or, there’s this view on why the rally…”options expiring in the money caused a gamma turbulent short squeeze after the open with major averages extending gains throughout the day. Still, it remains to be seen if these gains will hold into the overnight futures markets with some saying this was just a bear market phenomenon after the long holiday weekend.” (Bloomberg).
- I’m dubious on whether the rally in stocks has legs, in fact I’d suggest it doesn’t. Stay cautious. And I’m not the only one. Market pundits at the likes of Morgan Stanley and Goldman Sachs continue to warn that stocks may have further to fall to fully price in the risk of recession. SocGen has published its two-euros worth, stating a “typical” recession will see the S&P 500 falling to 3,200 points, which is about 15% below last night’s close. They also posed the though that a 1970’s style inflation shock could send the index crashing about 30%.
- On bonds, OATS, BUNDS and GILTS all drifted +2 – 5 bps higher out the back end of the curve (10Y), while in US treasuries, yields drifted higher also, with the curve bear steepening (long end yields rise faster than short end yields). Despite the buoyancy on the day in stocks, bond markets remain cautious, channelling Flavor Flav, “don’t, don’t, don’t believe the hype.” Oil was up a touch on technical factors.
- Talking heads…”we could likely skirt recession, almost touch it but not quite, because we think that the Federal Reserve has become much more sensitive to the effects of their actions on the economy, both in terms of employment and in terms of stability. We’re not out of the woods yet, but we think we’re walking in the right direction.”
- Fed speak…Richmond Fed President, Thomas Barkin, has thrown his support behind harder and faster rate hikes, of course preferably without causing undue harm to financial markets or the economy. “Inflation is high, it’s broad based, it’s persistent, and rates are still well below normal“. Easier said than done.
The Long Story….
- Offshore Stocks – modest gains in European stocks, while investors in the US stormed back onto the trading floors full of vigour, piling into stocks, sending the DOW up +2.2%, the S&P 500 up +2.4% and the NASDAQ up +2.5%. Volumes were more than double the daily average. It was a broad-based rally with just under 90% of the S&P 500 advancing and no sector left behind. Energy (+5.1%) received an elephant stamp and a gold star on their homework for best behaved, followed by Discretionary (+2.8%) and Staples (+2.7%). Under-achievers amidst a classroom of over-achievers was Materials (+1.5%), Telcos (+1.6%) and Industrials (+1.8%).
- Relative strength indicators…
- Local Stocks – the ASX 200 clawed back some lost ground yesterday, up +1.4% on the day. It wasn’t all one-way traffic though, with one in four stocks obstinately refusing to advance. Most sectors gained ground, but a handful still found the day challenging. Healthcare (-0.9%), Utilities (-0.8%) and REITS (-0.6%) all retreated. Energy (+2.8%) had a good day, followed by Financials (+2.7%) and Staples (+2.0%). Stocks seemed to ignore RBA Governor Lowe’s speech (covered below), with no discernible change in direction during or after his comments, despite talk of inflation likely peaking at 7.0% (admittedly already priced in), nor did there seem to be any reaction to his confidence that Australia should dodge a recession. Futures are signalling solid gains, up +0.7%.
- ASX 200 RSI’s…’oversold’ still…
- Offshore credit – US IG primary markets finally stirred with three deals pricing US$7.3bn in aggregate, breaking a run of seven consecutive donut sessions as concerns around global inflation – and central banks’ responses to it – triggered the longest high-grade primary deal hiatus since the Lehman collapse. Deal execution was orderly and investor demand was encouraging, suggesting that more near-term supply is likely to follow. Issuers paid 11 bps in new issue concessions, driven by order books that were 3.8x covered, which is well above YTD averages. Books held together at the pricing levels with investor attrition at a negligible 10% on average as dealers started IPTs 30-40 bps back of issuers’ credit curve. Secondary spreads drifted tighter, as did synthetics.
- Local Credit – no change to themes noted by traders, nor were there any flows of note. Nevertheless, traders have marked the 5-year part of the major bank senior curve a touch wider (+1 bps) to +105 bps. Three-year paper was left unchanged at +84 bps. I have the 5-year part of the curve at +109 bps and 3-year at +82 bps per my models. In tier 2, a modest uptick in spreads across certain lines. The CBA Apr-27 closed unchanged at +242 bps, while the 2026 callable paper closed +1 – 2 bps wider at +220 – 227 bps. Same in 2025 callable paper, +1 – 2 bps wider at +207 – 210 bps. Despite the reasonably constant drift wider, typically in increments of one or two basis points here and there, we remain constructive on A$ credit. While spreads have drifted wider, they remain well wide of long run averages and recent trading ranges.
- A$ credit continues to outperform offshore peers….
Source: Bloomberg, Mutual Limited
- Bonds & Rates – the main point of focus in early to mid-morning trading yesterday was the RBA’s July meeting minutes and Governor Lowe’s speech before the American Chamber of Commerce. The speech can be found on the RBA website, or here. The prepared speech didn’t really include much that wasn’t already out in the market ether, although there was a formal acknowledgement that CPI will likely hit +7.0% YoY, sometime around December this year (I think this was also mentioned in his 7:30 Report interview last week). The RBA remains confident and committed to managing CPI back within its targeted +2.00% – 3.00% cage and Lowe reminded listeners that CPI is the rate of change of prices, and it is not a measure of the level of prices. So, with the passage of time, if we have price stability, then the rate of change will moderate. Moderating supply chain blockages and the impact of tightening monetary policy should help in this regard.
- Governor Lowe expressed confidence that the Australian economy would avoid a recession, highlighting the resilience of households to rate increases because of large savings buffers. Which is a defendable stance. While risk of a US recession is elevated, historically the Australian economy hasn’t always headed into recession when the US has. Growth has slowed, no doubt, but not always into recession….”we’re different!”
- Key focus points going forward for the board in setting monetary policy, and forming their opinion around inflation beforehand include the global back-drop, labour market conditions (wage costs) and household spending. During Q&A time, Lowe acknowledged that if wage increases of +4.0% – 5.0% YoY became common (as per the recent minimum wage hike), it would be hard to bring down CPI. Lowe flagged steady state wage rises at around +3.5% YoY (vs +2.4% YoY at last print, Q1’2022). Another point of interest is Lowe’s concern around inflation expectations… “it is important that the higher rate of inflation this year does not feed through into ongoing inflation expectations. If it did, the period of higher inflation would persist and it would be more costly to reverse.” That is, it becomes a self-fulfilling prophecy.
- The governor also stated he felt the rate trajectory implied by the market was not very likely. Before his speech the market (option pricing) was pricing a terminal rate at 4.30% to be reached around Q1’23, which implies +350 bps or so of rate hikes in the next 9 months. Aggressive, very aggressive, and would mean we’d need to monthly rate hike of around +40 bps on average between now and then. Personally, I find that very hard to imagine. Instead, if we look at one-year ACGB yields at 2.73%, this is a more probable cash rate, give or take, within the next year, and is closer to consensus terminal rates (median of 2.35%).
- If I had to assign probabilities to the size of the next RBA rate hike, which will be categorically at the July meeting, I’d say there’s a 70% likelihood it’s a +50 bp hike and 30% it’s a +25 bp hike. This is subject to data between now and then (July 5th), although I note there is no meaningful price data out between now and then. Bloomberg consensus has the cash rate at 1.75% by the end of September (median), so +90 bps from current levels, indicating an average monthly hike of +30 bps. The range of calls recorded in the survey is 1.60% – 2.35%.
- While he was giving his speech, bond yields pushed higher (ACGB 3Y +3 – 4 bps), which was not surprising as he was warning listeners to prepare for higher interest rates. However, during Q&A, the prospects of a +75 bp hike was essentially taken off the table, with guidance that the board would be considering +25 bp or +50 bp hikes only at the next meeting. Three-year yields then rallied -11 bps during Q&A, but once Q&A ended, they drifted higher again (+7 bps). As the rest of the day played out, 3-year yields trended lower, as did the rest of the curve. One-year ACGB yields dropped 13.5 bps to 2.73% and two-year yields fell -12.5 bps to 3.20%. Three-year yields closed at 3.56% (-5 bps), and ten-year at 4.07% (unchanged).
- A$ Fixed Income Markets…
- Macro – some interesting tax developments in NSW around Stamp Duty. The NSW state government has announced that first home buyers will have the choice of making an upfront stamp duty payment when they buy a property or an annual tax. The concept was previously floated for the entire market, before I moved back home from Sydney. In its initial incarnation, once a property had switched from the upfront to annual payment, the change was permanent. The latest announcement is a softly-softly approach. The change will likely bring forward demand and will boost borrowing capacity for first home buyers, although it won’t do much for the other side of the equation, sellers – no change in dynamics there. Any action that on a net basis stokes demand, will provide a tailwind for house values. Timely given all the doom and gloom in the press around house prices…which is rubbish by the way. If house prices fall 15% – 20%, big-whoop, the market is up over 30% over the past two years. A correction of the magnitude quoted by most unqualified click-baiters, i.e. 15% – 30%, just brings the market back to trend.
Source: Bloomberg, Mutual Limited
Click here to find the full PDF from our Chief Investment Officer’s daily market update.
Scott Rundell, Chief Investment Officer
T: +61 3 8681 1907