Mutual Daily Mutterings
Quote of the day…
“Never fight until you have to. But when it’s time to fight, you fight like you’re the third monkey on the ramp to Noah’s Ark…and brother, it’s startin’ to rain.” – unknown
Overview…”swings and round-abouts”
- Moves: risk on… stocks ↑, bond yields ↑, curve ↑, credit spreads ↓, volatility ↓ and oil ↑….
- Risk on brothers and sisters, risk on. For now. Solid gains across both European and US markets overnight, while bonds retreated (yields higher). US President Biden has signalled that he’d reconsider Trump administration tariffs on China (removal thereof), which has been pegged as the basis for improved sentiment – suggesting thawing of US-China relationships. I’m not convinced to be honest, looks a long bow to draw. Biden also said the US would back Taiwan militarily if required, which would counter any positive mojo stemming from the tariff comments I would have thought – the White House subsequently walked back from these comments (i.e. “the soon to be octogenarian got his wires crossed”). Reports of short-covering after markets reached bear market territory late last week have also been tabled as a driver of the rally. Sure, why not.
- Talking heads…“the markets have been due for a rally for quite some time. It is not likely to mean the end of the decline that began at the start of the year, but a respite from the persistent selling of the past two months.” And…”the macro backdrop remains challenging, but a lot of bad news has been absorbed. We are probably approaching a near-term bottom in risk assets.” I have some empathy for this view, but I’m not inclined to jump into risk assets with gay abandon just yet. Stocks continue to be volatile. Investors still need to digest ongoing uncertainty around the impact of China’s zero COVID policy and the growth impact of tightening monetary policies globally. And, of course there is still the fracas in Ukraine.
- Beijing has reported a record number of COVID cases, which has added fuel to concerns that a lockdown is on the cards. In a bid to offset economic headwinds here, the Chinese government has announced plans to offer tax relief to businesses and consumers in the order of 140bn yuan (US$21bn). Lenders will also double the quote of loans set aside for smaller firms.
- Fed speak…”Atlanta Fed President Raphael Bostic said, “My motto is observe and adapt. I have got a baseline view where for me I think a pause in September might make sense.” That followed remarks on Friday from St. Louis Fed President James Bullard, who said the central bank should front-load hikes to push rates to 3.5% at year’s end, which, if successful, would push down inflation and could lead to policy easing in 2023 or 2024.” (Bloomberg).
- ECB president, Christine Lagarde, doesn’t appear to be as hawkish as some of her central bank colleagues would perhaps prefer. Lagarde’s prospective timetable for two 25-bp hikes has left some officials slightly miffed, preferring instead to keep the option of moving faster open. Her intention to exit subzero monetary policy by the end of the third quarter would effectively exclude a +50 bp move.
The Long Story….
- Offshore Stocks – solid gains across Northern Hemisphere markets, although I couldn’t see too much in the way of news or data to get excited over, which tends to support the short covering scenario touched on above. The DOW rose +2.0%, the S&P 500 +1.9% and the NASDAQ +1.6%. European markets were up +1.5% on average. It was a broad-based rally with 84% of the S&P 500 gaining ground and no sector was left behind. The charge higher was led by Financials (+3.2%), followed by Energy (+2.7%), and Tech (+2.4%). Bottom of the tables was populated by Discretionary (+0.6%), Healthcare (+0.8%) and Utilities (+1.2%).
- Last night’s rally has come despite continued concerns around the trajectory of earnings amid an uncertain inflation path and a tightening Fed – these doubts and concerns won’t have dissipated. They remain and still weigh on investor risk appetite and confidence. “We have seen many of the capitulatory signs we would expect to see at a tradeable bottom, but not all of them. This suggests the market is on the cusp of bottoming, but does not rule out another positioning flush-out.” (Bloomberg). Last night’s gains also comes’ despite broad-based expectations of further downside over the remainder of the year. According to over 1,000 respondents to a Bloomberg survey, median expectations are for the S&P to bottom out at 3,500 this year, which would represent a -27% from January’s peak (4,796) and another -12% from current levels (closed at 3,972 last night). Just 4% of respondents expect that the S&P 500 had already bottomed within the current cycle.
- Local Stocks – markets were largely indifferent to the weekend’s election result, at face value. The ASX 200 rose just +0.05%, although more sectors retreated (seven) than gained (four). Materials (+0.8%) led from the front, followed by Tech (+0.4%) and Energy (+0.3%). While Utilities (-0.9%) took line honours for worst performing sector, Financials (-0.4%) did all the damage to the broader index. Staples (-0.4%) also weighed in the index. With the bounce in offshore markets overnight, futures are pointing to modest gains (+0.3%) in local markets. I doubt this is a cyclical turn, rather just a death spasm, a last gasp of fight. The ASX 200 is down just -6.3% from historical peaks (7,622 in Aug-21), materially better than the -27% fall observed in the S&P 500 (peak to now). The ASX 200’s greater weighing to resources (rising commodity prices) and lack of material weighting to tech has underpinned this relative strength. Nevertheless, if consensus estimates in the US prove accurate, and we witness a further -12% sell-off in the S&P 500, the ASX 200 will get caught in the jet-wash and lose ground also.
- ASX 200 Relative Strength Indicators…
Source: Bloomberg, Mutual Limited
- Offshore credit – a relatively quiet start to the week in US IG primary markets in what is expected to be a US$20bn issuance week (shortened week with US long weekend coming up). Spreads closed a smidge tighter in cash, perhaps -2 bps, and similar moves in CDS with CDX -2.5 bps and MAIN -4.5 bps. Senior Financials closed -5.2 bps tighter and Sub Financials -10.8 bps tighter.
- Historical offshore spreads, with AU FRN for context…
Source: Bloomberg, Mutual Limited (the ‘Line in the sand’ is the level where credit spreads are deemed to be restrictive from a macro perspective)
- Local Credit – not a lot to table today, most traders and buyers of credit were likely busy attending the KangaNews DCM Conference in Sydney, which is where I was. The major bank senior curve closed unchanged with 5-year at +103 bps and 3-year at +77 bps. The consensus view from the conference was that spreads at current levels represented value and the constrained liquidity conditions was the main impediment to any meaningful tightening. On the matter of liquidity, several traders stressed that prevailing liquidity conditions was global, not just local. In the tier 2 space, also no change. CBA’s Apr-27 is quoted at +211 bps, while the 2026 calls are at +198 – 206 bps, and the 2025 calls at +188 – 190 bps.
- Some trader comments…”domestic spreads continue to outperform; on-going two-way flow in recent senior deals leading volumes on the desk. Interesting to see offshore investors return to the AUD senior fixed-rate secondary market; 3yr bonds ~3.90% and 5yr ~4.25% a reasonable place to park cash for AA- rating.“ I’m still constructive on the outlook for spreads and even more confident that spreads have peaked for now.
- Bonds & Rates – market reaction to the election result was muted, which is not too much of a surprise in the end. A very modest increase in yields, so directionally the market behaved in line with my expectations (I said last week that if Labor won yields would rise). Monetary policy will have more of an impact on rates and yields going forward rather than who resides in the Lodge, as it should be. In this regard, RBA Assistant Governor, Chris Kent, spoke at the KangaNews DCM conference yesterday and during Q&A touched on where neutral rates rest, his response was a wide 2.0% – 3.0% at the moment (model derived), but though the level was very “uncertain” and “changes over time.” A later panel at the conference included several bank economists who opined on where they thought the neutral rate sits. Responses ranged from 2.25% (WBC) to 3.00% (ANZ).
- In his speech, Assistant Governor Kent, touched on the RBA’s thinking around quantitative tightening, although he didn’t use this terminology. Kent stated the RBA had no intention to actively reduce the bank’s balance sheet by selling bonds. Rather, they would stick to a passive approach, where they let maturing bonds sail off into the sunset. The rationale being the bank consider raising the cash rate as the best means by which to ease back on monetary policy. Additionally, the board feared that actively selling bonds would complicate issuance. Lastly, by not selling now, when bond buying is needed in the future, markets would have greater confidence and clarity around how long the RBA would be holders (and provide monetary accommodation).
- Some other titbits of information from Kent’s speech and Q&A session. While ‘stagflation’ is obviously a concern, it is not deemed a ‘pressing issue’ by the board right now. Kent also stressed the level of cash rates was what matters, not the trajectory. Which is very valid given where rates are at the moment. With the current cash rate still only 0.35%, that’s very rare air historically, and still very accommodative. So, while the RBA is hiking rates, it’s not really a matter of tapping the breaks, but rather easing off the accelerator.
- “Minutes of the most recent Federal Reserve rate-setting meeting will give markets insight this week into the US central bank’s tightening path. St. Louis Fed President James Bullard said the central bank should front-load an aggressive series of rate hikes to push rates to 3.5% at year’s end, which if successful would push down inflation and could lead to easing in 2023 or 2024.” (Bloomberg). Minutes are due out on Thursday.
- A$ Fixed Income Markets…
- Macro – “the US economy needs supply-side interventions rather than interest-rate hikes by the Fed, said Nobel laureate economist Joseph Stiglitz” (Bloomberg). A US centric comment, but one that could easily be transferred to any western or developed nation at the moment. And this, “the IMF may need to further trim forecasts for economic growth this year but doesn’t expect a global recession, according to Kristalina Georgieva.” (Bloomberg). Both referencing comments made at the World Economic Forum in Davos.
- Some commentary on Biden’s China tariffs comment…”news overnight that President Biden may reconsider some US tariffs imposed on China, and that China is looking at providing significant tax relief of more than 150bn yuan (USD21bn) to cushion virus impacts, certainly looks like a positive from a global growth perspective. However, these developments may do little to address underlying inflation pressures. Lower US tariffs may alleviate inflation symptoms, but could also bolster US demand for imports, adding to already-stretched global supply chains. China’s support will certainly cushion against a marked slowdown, but may not do much to bolster supply capacity. Government policy aimed at supporting the demand side of the economy may need to be offset by higher than otherwise interest rates, working against future private sector investment and therefore productivity.” (ANZ)
Source: Bloomberg, Mutual Limited
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Scott Rundell, Chief Investment Officer
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