Mutual Daily Mutterings
Quote of the day…
“When I was born … the doctor came out to the waiting room and said to my father … I’m very sorry. We did everything we could … but he pulled through.” – Rodney Dangerfield
Chart du jour…Fed rate hike pricing.
Overview: ”Status quo…”
- Biden went early on his Fed Chair nomination (wasn’t expected until later in the week), tapping incumbent, Jerome Powell, to back up again for a second four-year term. Somewhat strangely, bond yields were belted in response, as the market interpreted the announcement as meaning a greater likelihood policy might tighten at a more rapid pace than if Lael Brainard was anointed. Despite Powell being odds-on favourite, markets moved to price a full quarter-point rate hike into the June Fed meeting and brought forward the anticipated pace of subsequent increases. Two-year treasuries hit 0.59%, +9 bps, YTD highs.
- Talking heads…”this decision removes uncertainty with Powell’s current term ending in February. Had there been any delay in appointing a new chair, due to a lack of political support, this could have caused significant financial market nervousness. In consequence there is a theme of continuity for markets that should result in minimal material impact.” And…” “I don’t think there was a ton of Brainard probability priced, but on the margin this does remove what some saw as a dovish risk.” In post announcement comments, there was a particular emphasis on employment.
- Stocks were mixed, with the NASDAQ under pressure on the back of rising yields. The old school DOW led all comers, followed by the S&P 500 for much of the day, but then fell out of bed in the last hour of trading. Despite the late minute sell-off, “US stocks are trading at record levels, outpacing the rest of the world, as investors see few alternatives amid rising inflation and a persistent pandemic that undermines global recovery. Concerns about high valuations and the potential for the economy to run too hot on the back of loose monetary and fiscal policies have interrupted, but not stopped the rally.”
- Some headlines around on oil, which clawed back some lost ground. There is speculation “that OPEC and its allies may adjust plans to raise production if the U.S. releases crude reserves in coordination with other nations. Delegates said that even the modest output increase they have pencilled in may now be re-evaluated when the group meets next week.”
- COVID risk continues to grow in Europe with rising infection rates, which have leaders worried and agitating for tighter restrictions.
- Offshore Stocks – mixed across Europe as rising COVID infection rates continue to weigh on investor sentiment. In US markets it was the Fed Chair nomination and resulting bond market reaction dictating movements across stocks. For the S&P 500 it was a fairly broad rally…is what I wrote when I first arrived this morning, with 71% of stocks advancing and only one sector in the doghouse, Telcos (-0.5%). I stepped out to grab a coffee and came back to find the S&P 500 had dropped -0.8% in half an hour, down -0.3% on the day. Only 56% of stocks gained ground in the end, and at least four more sectors joined Telcos in the dog house. Energy (+1.8%) led all comers, but eased back from intra-day highs (+3.0%). Financials (+1.4%) were firm, as were Staples (+0.8%). In addition to Telcos, the doghouse was crowded with Tech (-1.1%), Discretionary (-0.5%) and REITS (-0.5%). Rising COVID infection rates in Europe have yet to weigh on US sentiment, but it has to be a consideration, especially if infection rates begin to rise in the US also – although, that might stall policy tightening, which markets will appreciate.
- Local stocks – the ASX 200 is really struggling for direction at the moment, although arguably side-ways is a direction. The index closed moderately lower yesterday, with around two-thirds of individual stocks retreating and only three sectors able to make any advances. Materials (+0.4%), Utilities (+0.3%) and Staples (+0.2%) were those three. At the back of the bus, controlling the tone of the day, was Tech (-2.1%), Energy (-1.6%) and Financials (-1.4%), with the latter doing the bulk of the damage. Major banks came under selling pressure with CBA and WBC the worst inflicted, both down -2.1%, with ANZ a close third, down -2.0%, while NAB outperformed all, down only -1.2%. Futures are pointing to modest losses this morning.
- Local Credit – trader EOD commentary…”solid transacted volumes, with similar themes repeating from recent weeks – front end (2-3yr) bonds in demand, and belly/long end cash struggling for momentum with Swap EFPs continuing to leak. Cash Spreads optically unchanged for the most part.” No meaningful changes in spreads, or themes…I’ll leave it at that.
- Bonds & Rates – yesterday’s price action was very much as expected, a non-event given offshore leads. Today will be a different story with some meaningful moves in yields offshore, in both European markets (+4 – 9 bps) and especially treasuries (+7 – 8 bps) given Powell’s re-appointment as Fed Chair (Lael Brainard as Vice Chair, a new role for her). On team Powell-Brainard as the 1-2, this replaces team Powell-Clarida, with the latter coming under some heat in the press for the timing of his stock trading activity (no wrong doing proven). He has also been on the hawkish side of the policy divide of late. Powell and Brainard on the other hand are definitely team-dovish. Some NAB commentary…”around 40% of the rise in 10-year treasuries overnight was recorded prior to Biden’s announcement that he was nominating Powell to a second term as Fed chair and Brainard as Vice Chair. Yields spiked higher as the headlines hit the screens with stronger than expected US data supporting the sell-off later in the session. Note that in announcing the Fed Chair and Vice chair Biden said “It’s the Fed’s job to balance two key The first is to achieve maximum employment to get as many American worker America’s working as possible. The second is to keep inflation low and stable. To meet these goals is going to require patience, skill and independence.” I’d expect local bonds to sell-off on the back of the lead in treasuries.
- Offshore Macro – it’s a quiet week on the data front, but there were some nuggets in the press-conference to announce that Jerome Powell would be continuing in his role as Chair. Powell spoke after Biden made the announcement and he stressed the “need for monetary policy to be felt far and wide across the US economy, even before hitting on inflation. He said many who were left behind after the Great Financial Crisis were just getting onto the wage gain ladder before the pandemic snuffed out the recovery. That tells you that maximum employment remains the priority mandate at the Fed”. But, that’s not to say inflation is an afterthought, Powell recognised that inflation was eroding real wages and impacting household spending power. “Overall then, the takeaway is that the Fed continues under the same guiding principles as before, with Brainard’s voice now elevated, putting employment, therefore, into a more prominent role”.
- Local Macro – CBA recently downgraded their house price growth forecasts for 2023, expecting a -12% fall in prices (after rising another 6% – 9% in 2022), mainly because of their view that the RBA will begin hiking rates a year from now – a view that is supported by market pricing. Let’s assume CBA is right, what does it mean for bank bonds and RMBS? History would suggest not much. A very simply charting of house price growth with RMBS arrears data indicates that there is very little correlation between house price growth, or otherwise, and arrears – charted below. There is, however, a meaningful correlation between BBSW and arrears, especially non-conforming RMBS – also charted below. If markets are correct and rates do begin to rise next year, historically the arrears (non-conforming) range has been on or around current levels up to cash rates of around 2.0%. Accordingly, we remain constructive on RMBS fundamental strength despite expectations of rising interest rates.
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Scott Rundell, Chief Investment Officer
T: +61 3 8681 1907