Mutual Daily Mutterings
Quote of the day…
“You can’t be a real country unless you have a beer and an airline. It helps if you have some kind of a football team, or some nuclear weapons, but at the very least you need a beer” – Frank Zappa
“Not Enough Room For Both Mandates”
Overview…”Them’s fightin’ words!”
- Moves: risk on… stocks ↑, bond yields ↑, curve ↓, credit spreads ↓, volatility ↓ and oil ↑….
- After an initial stutter on COVID alert level rumours in New York, stronger US retail sales and factory production data gave investors a sense of optimism, boosting risk sentiment and driving stocks higher. One problem here, specifically with regard to retail sales, is it’s being fuelled by ‘revolving’ credit (i.e. credit cards), and as such, is unsustainable. The year-over year savings rate in the US has been declining since the pandemic cash infusion while revolving credit balances have been rising. Don’t believe the hype.
- Fed speakers, including the head-honcho, were out and about selling their monetary policy snake-oil, and the tone was decidedly hawkish. Powell said he and his merry band of policy wonks wouldn’t hesitate to throw down and raise rates above neutral if necessary. Problem is, the Fed “does not know with any confidence where neutral is” or at what level the policy rate will be “” No respite in rate hiking expected any time soon. Powell further reiterated, no one should doubt the Fed’s intestinal fortitude and resolve to curb inflation, which sits at multi-decade highs. Treasury yields rose on the back of these comment, with more policy-sensitive front-end tenors leading the way higher reflecting expectations for a series Fed rate hikes. The ECB also released some hawkish comments, with rate hikes expected in coming months.
- Anecdotally on inflation pressures (in the US), Colgate-Palmolive said it’s seeing signs that supply-chain blockages – a key source of prices pressures – are starting to clear. Within the depth of the Fed’s policy details is the central bank’s hope expectation that improvement in aggregate supply will reduce price pressures. Unfortunately, the Fed has no control or influence on aggregate supply. Their only lever is to smack demand over the nose with the rolled up monetary policy document, and that works through tightening financial conditions.
- Talking heads…”the market is in the middle of a powerful moment where it’s digesting a major and relatively rapid change in expectations for monetary policy and what financial conditions should look like to keep inflation under control. And so, we’ve already seen a lot of tightening in market financial conditions.”
- On the data front, some take aways from market watchers…”inflation may be weighing down market sentiment and causing concern for the Fed, but it doesn’t seem to be slowing down the consumer at the moment. That’s not to say that higher prices won’t start to creep into these numbers. After all we did see a decline month over month. And with a mixed bag on the retail earnings front today, it remains to be seen how investors will digest this read on the consumer.”
The Long Story….
- Offshore Stocks – it was a sea of green across the screens this morning as investors latched on to stronger US data – as superficial and unsustainable as it seems, and added risk. Hawkish Fed comments and resulting spike in yields were taken in their stride. The DOW rise +1.3%, the S&P 500 +2.0% and the NASDAQ +2.8%. European markets were somewhat buoyant also, up +1.0% – 1.5% across the board. Nine out of ten companies within the S&P 500 gained ground and only one sector retreated, Staples (-1.2%). Every other sector was up at least +1.0%, led by Tech (+2.9%), Materials (+2.9%), and Financials (+2.7%).
- In his musings overnight, Fed Chair Powell acknowledged that US financial conditions were tightening, A measure of financial conditions is tabled and charted below, Bloomberg’s Financial Conditions Index (BFCIUS Index). When the measure is <1.00 this signals’ financial conditions are contractionary and a headwind for risk assets, while a measure >1.00 signals financial conditions are accommodative and as such supportive of risk assets. Unfortunately, the index tends to tell us what we already know, it has minimal predictive benefits, which is obvious in the second chart below – the financial conditions index against the S&P 500.
- US Financial Conditions….
Source: Bloomberg, Mutual Limited
- Local Stocks – modest gains yesterday…nothing really worth writing about, just +0.3% gains in the ASX 200 with uppers and downers within the index almost equally weighted. More sectors retreated than advanced, 6 vs 5, with Energy (+2.1%) carrying the flag, supported by Utilities (+1.3%), and Materials (+1.1%). Underperformers on the day were Healthcare (-1.1%), Industrials (-1.1%), and REITS (-1.1%). Offshore leads are obviously positive, and importantly for the ASX 200, Materials in the US had a strong session, and the ASX 200 is heavily weighted to materials (24%). S&P 500 Materials and ASX 200 Materials are 88% correlated, so we should see a solid day in the ASX 200. Similarly, the S&P 500 Banks and ASX 200 Banks index’s are heavily correlated also, albeit moderately less than Materials, at 73% (second chart). Makes sense, Materials are more global, Banks have significant local idiosyncrasies. Most notable, most US mortgages are fixed rate, whereas here they’re mainly variable rate – so different degrees of leverage to interest rate cycles. US Banks had a solid session overnight also, which should flow through to the ASX 200 with banks representing 29% of the index. ASX 200 futures are up +1.0%.
- ASX 200 Materials vs S&P 500 Materials…
Source: Bloomberg, Mutual Limited
- ASX 200 Banks vs S&P 500 Banks…
- Offshore credit – a firmer risk backdrop precipitated a deluge of IG supply with eight borrowers pricing US$15.75bn overnight. On average issuers paid +11 bps in new issue concessions – a significant improvement on Monday’s +20 bps, and closer to YTD averages. Over books were solid at 3.5x covered vs 2.9x YTD average. There is the belief that last night’s constructive pricing outcomes will encourage issuers that have been sitting on the sidelines to consider moving forward with their issuance plans. Spreads inched tighter across cash and synthetics.
- 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 – a nothing day with spreads largely unchanged. Traders reiterated that liquidity conditions remain sporadic and traded volumes light. In the major bank senior space 5-year spreads are quoted at +101 bps, -4 bps inside where WBC priced their5-year senior deal last week. So far, my most recent call that we’ve hit the highs is playing out…admittedly, I made the same call around 10 bps ago, so in that context I’m still underwater. So be it, there’s always risk of overshoot when you nail a call on price levels to the mast. Tier 2 was unchanged on the day also with CBA’s Apr-27 quoted at +209 bps, the 2026’s at +196 – 201 bps and the 2025’s at +186 – 188 bps. With all majors having tapped the market in recent weeks / months, and the fact CBA priced a chunky covered bond inti Euro markets the other night, and NAB also launched in Euro markets, the need for wholesale funding looks light. Absence makes the heart grow fonder, so technically there is scope for spreads to perform.
- Major Bank 5-year senior paper…historical …
Source: Bloomberg, Mutual Limited
- Bonds & Rates – muted movement in bond yields yesterday on what was a relatively subdued day for news and data. The main event was the release of the RBA’s May Meeting minutes, which resulted in a little bit of intra-day movement, but there really wasn’t much in it. ACGB 3-year yields traded lower (yields) before the release (-1 bp), but then trended higher to close the day almost +4 bps higher (at 2.87%). Much the same intra-day trend in 10-year yields, ending the day +2 bps higher at 3.41%. Some meaningful moves offshore overnight on the back of hawkish Fed comments, which will place upward pressure on local bond yields. UST 2-years rose +13 bps to 2.70% and UST 10-years rose +10 bps to 2.99%.
- A$ Fixed Income Markets…90-day bank bills raised the bat
- Local Macro – main event yesterday was release of the RBA’s May meeting minutes. Some different takes on the details follow:
- “The Minutes from the May Board Meeting shed a little new information on the decision to raise the cash rate by 25 basis points; the first rate hike since 2010. The RBA Board considered three options for lifting the cash rate in May; a 15 basis point lift, 25 basis point lift or a 40 basis point lift. In the end the debate was between a 25 or 40 basis point lift. A 25bp hike from 0.10% to 0.35% was decided as a shift back to historical practices after the pandemic. However, the mere discussion of a 40bp move means it cannot be ruled out, particularly if, once again, data surprises on the upside. The RBA has shown from the decision in May that they are willing to change the play book based on the incoming data, both from official sources and the RBA’s liaison program.” And “We expect data over coming months to reflect the increased sensitivity of the Australian household to higher interest rates. This can already be seen in consumer sentiment data. We continue to expect a shallow rate hike cycle by the RBA with hikes of 25bp in June, July, August and November 2022 and one final hike in February 2023. We then see the RBA holding the cash rate at 1.60% over the remainder of 2023.” (CBA)
- “A 40bp rate hike was on the table in May and will likely be discussed by the Board in June, though the Board’s stated preference is to return “to normal operating procedures.” This suggests that going more than 25bp in June will require, as Lowe said in his post meeting comments, “a very strong argument to do so.” We think an upward surprise of 1% q/q growth in tomorrow’s Wage Price Index (WPI) could be enough to get the RBA over the line for 40bp, though if it comes in at our forecast of 0.8% q/q that prospect will recede. There is further important labour market data before June, with employment on Thursday and the national accounts measures on 1 June. With the Board “continu[ing] to be guided by the evidence on both inflation and the labour market” surprises in these data may be enough to support a 40bp move even without a very strong WPI.” (ANZ)
- “The RBA will most likely increase interest rates in June no matter what the WPI prints given “…the recent evidence on wages growth from the Bank’s liaison and business surveys was clear. The RBA is prepared to move in greater than 25bp increments if necessary, noting that May’s decision to lift interest rates by 25bps reflected “the historical practice of changing the cash rate in increments of at least 25 basis points” and that “an argument for an increase of 40 basis points could be made given the upside risks to inflation and the current very low level of interest rates. Standard operating procedure though appears to be moving in 25bp increments, with larger sized moves possible should WPI or CPI surprise materially or the unemployment rate continue to fall sharply. It’s also likely that the first of any larger sized move could be a 40bps increase to tidy up the non-standard cash rate of 0.35%, given the Board only considered 15, 25 and 40bps increase at the May Meeting. An outsized WPI print tomorrow (which NAB sees as unlikely) or another very strong Q2 CPI (much more likely), could see a rate rise of 40bps in either June or more likely August (NAB)
Source: Bloomberg, Mutual Limited
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Scott Rundell, Chief Investment Officer
T: +61 3 8681 1907