Mutual Daily Mutterings
Quote of the day…
“I never drink water; that is the stuf that rusts pipes” – W.C. Fields
“Putting Out Fires…”
“Awww, how cute, he thinks he has it….”
Overview…”All for one, one for all…”
- Moves: risk on, kind of…unconvincing though… stocks ↑, bond yields ↑, curve ↓, credit spreads ↓, volatility ↓ and oil ↓….
- While the week ended on a high note, so to speak – it wasn’t a down day at least, so in the current environment, that’s a high note. The nexus of focus for investors through the week was the Fed’s +75 bp rate hike and subsequent signalling of a willingness to go hard again as required – but there is some dissension in the ranks, with some Fed members voicing +50 bp hikes as prudent enough. In my mind it’s not necessarily a question of willingness, but a question of capacity. Fears that more aggressive monetary tightening could push the US economy into recession helped tip the S&P 500 into a bear market (↓20% peak to trough), with the index erasing $1.9tn in market value on the week (the ASX 200 lost A$164bn).
- Fed speak…”former Treasury Secretary Lawrence Summers, who warned last year that inflation wasn’t as transitory as the Fed believed, now says that major components of the inflation index could accelerate in the months ahead. Any further upsurge in inflation toward, say, +9.0% YoY may force the Fed to persist with tightening for even longer, posing an additional upside risk to two-year yields.”
- Talking heads… “endless liquidity is no longer going to support large parts of the economy. The housing market is cooling, economic weakness is hitting both manufacturing and service sector activity, and recession fears are surging.” And…”a potentially rapid and violent bear market rally does become increasingly likely with each additional decline as the market is becoming oversold.”
- Despite uncertainty around the path of future earnings, along with talk of bear markets and recession, investors continue throw their hard-earned cheddar into US equities. According to EPFR Global data, US equity funds attracted US$14.8bn of inflows through the week to June 15th, their sixth consecutive week of additions. In total, US$16.6bn flowed into equities globally in the period, while bonds had the largest redemptions since April 2020 and just over US$50bn exited cash.
- According to Bloomberg analysis, to reach the level where investors are pricing in a US recession, the S&P 500 would need to sink to 3,586 vs current trading levels of 3,670. So, that’s another -2.3% to the down side, which is entirely plausible and probable.
- US markets will be closed on Monday in observance of the Juneteenth holiday, reopening on Tuesday. Apologies for my ignorance, but had never heard of this holiday until now. But, it’s an important one, it commemorates the emancipation of enslaved people in the US.
The Long Story….
- Offshore Stocks – US stocks plunged to their worst week since the pandemic began despite a slight pickup on Friday. Market participants continue to weigh up the Fed’s pledge to tame the inflation beast, with the possibility of the US economy tipping into recession. On the week there were no survivors within the S&P 500. With crude prices down -7.3%, Energy (-17.2%) was the worst of them all, followed by Utilities (-9.2%) and Materials (-8.3%). Even the better performers on the week soiled the bed, Staples (-4.4%), Healthcare (-4.5%) and Telcos (-4.6%). Technical indicators are suggesting markets are oversold, or close to it with RSI’s at 31.8 (<30.0 is oversold). Having said that, if you asked the question, “where’s the next 20% coming from, up or down?”, given the uncertainties and headwinds, the safer bet would be down. But, cash holdings are elevated, so investors are pumped and primed to add risk, which will likely happen when we have clear evidence that inflation has peaked. Consensus has that occurring this quarter.
- Despite the blood, gore and visceral carnage across global stocks, and the significant headwinds to earnings going forward, there are many ‘smart’ market pundits predicting some elevated year end levels for the S&P 500. One, from a large and well-respected US investment management firm, is calling the S&P 500 at 5,330 by year end, which would require a +45% rally in the next six months. Others, including the likes pf JPM and Credit Suisse, have targets that require the index to rally at least +30% to be met. On average, Wall Street strategists are predicting the S&P 500 will gain +22.0% from current levels…I love the enthusiasm, but wow, that’s a big call all things considered.
- Local Stocks – another tough day in the trenches with the ASX 200 dusting-1.8% on the day and -7.8% on the week. Tech (-10.8%) was the primary cellar dweller, with cell mates including Energy (-9.7%) and Materials (-8.6%). The best of the worst included Telcos (-3.5%), Staples (-3.7%) and Utilities (-5.3%). No shining lights anywhere on the week. Month to date the index is down -10.2%, with June well on the way to being the worst month since March 2020, the market’s ground zero for the pandemic, where it lost -21.2%. Aside from the pandemic hit, in March 2020, June is shaping up to be the second worst month for performance since the onset of the financial crisis in January 2008. Given the aggressive sell-off, technicals are flashing oversold. Futures are pointing to modest losses this morning.
- ASX 200 long run trend…
- Offshore credit – spreads drifted wider on Fed rate hike concerns and consequences for default rates – so far not showing any meaningful trend higher. No primary deals of any significance on Friday, or for the week given heightened volatility and risk uncertainty. Market pundits are predicting a light week ahead also, US$10bn – US$15bn. Spreads on US sub-investment grade corporate bonds surpassed +500 bps for the first time since Q4 2020 on default concerns. “A Bank of America Corp. survey last month said that about 40% of money managers had above-normal cash levels in their high-grade portfolios — the highest percentage in at least a decade. In a separate study, US corporate bond managers had nearly 3% of their portfolios in cash in May, near the highest levels since August 2021, according to preliminary data from Morningstar Inc. on mutual funds and exchange-traded funds.” (Bloomberg). So, if investors are waiting for better bargains, spreads won’t necessarily perform. Refinitiv Lipper data indicates that investors have been withdrawing money from high-grade funds, with at least 12 weeks of outflows, the longest such streak on record.
- Offshore cash spreads drifting wider on broader risk off tone …12-months
Source: Bloomberg, Mutual Limited
- Local Credit –trader’s thoughts…”some evidence of fatigue amongst local investors with few looking to extend themselves too far after a week of unrelenting volatility.” Any commentary around weekly spread moves comes with muted confidence given how fractured and sporadic flows have been. No primary activity of note given the volatile back drop. On the banks, majors specifically…traders note…”closing the long end of the curve wider and steeper, though flows were light. We observed some selling of 5-year offset by buying of 18-month paper. This validates our view that the curve has capacity to steepen further, perhaps aided by the onset of ADI issuance. No clarity on when this supply may eventuate, but suspect some concession may need to be offered. Worth keeping in mind the forthcoming barrage of senior maturities, a combined ~$5.75bn in the next 6 weeks which if un-refinanced could keep spreads supported. No flows of note.”
- Recent 5-year (May-27) major bank senior paper is being quoted around the +103 – 104 bps area (vs +105 bps issuance). These levels are still to the fat right side of historical averages, but the risk back drop is hardly constructive. If technicals stay supportive – i.e. no issuance of note, we might stay around these levels, perhaps grind a touch tighter. If, however, one of the majors is compelled to issue, we’ll likely see some chunky new issue concession – as per trader’s comments above, which will pressure secondary spreads wider. I have the curve suggesting 5-year at +109 bps, so let’s call that +115 – 120 bps levels at launch for any new primary deal, and probably settling around +115 bps at issue subject to volumes. The 3-year part of the curve is at +83 bps, so we’ll call that +85 – 90 bps for primary. Within that backdrop, I can’t see buying in secondary in enough volume to materially compress spreads – at best keep them stable. We’re here or wider for the near term, say the next 30 days, give or take a few basis points, but it’s a moving feast.
- Major bank tier 2 drifted wider also, +9 – 11 bps on the week, albeit on very little traded volume. CBA’s Apr-27 is pricing at +236 bps (vs +190 bps at launch), which implies a rough and dirty sub-to-senior multiple of 2.27x, which is ‘ok’. Further down the curve, the 2026 callable lines are at +220 – 228 bps, with a sub-to-senior multiple of ~2.40x (better) and the 2025 calls are at +205 – 208 bps and multiple of 2.45x (better again). ANZ remains the next likely candidate to issue tier 2 paper, if any of them are. ANZ was looking to launch a tier 2 line back in April, however, CBA cut their lunch and came to market ahead of them, issuing at +190 bps. Maybe CBA should send ANZ treasury something nice as an apology, a seasonal fruit basket perhaps. So, any new deal here and now by one of the majors, with a 10-NC-5 structure, would likely need to price around +265 – 275 bps area.
- The Bloomberg AusBond Credit (FXD) is down -2.04% on the week, -3.10% month to date, and is on course for the worst month on record after yields increased +96 bps since the end of May, up to 4.97%, ten-year highs. The FXD index has lost -9.36% year to date. The FRN index on the other hand continues to outperform, down only -0.01% on the week and month to date, or -0.42% year to date.
- Major bank 5-year implied spreads (senior)…
Source: Bloomberg, Mutual Limited
- Major bank curve…
Source: Bloomberg, Mutual Limited
- Bonds & Rates – higher and higher for ACGB yields, with yields +13 – 17 bps higher across the curve on Friday and some +40 – 50 bps higher on the week. Carnage for fixed rate fund managers and duration traders. The Bloomberg AusBond ACGB Index is down -4.4% month to date and -12.36% year to date, unprecedented losses for the Australian bond market. Option pricing has cash rates reaching 3.80% by year end, and peaking around 4.40% through the second half of 2023. RBA guidance, for what it is, has the terminal rate around 2.50% and consensus expectations are around these levels also, on average. RBA forecasts for CPI have the inflation measure peaking at +5.9% YoY in Q4 this year, before moderating back to within their 2.00% – 3.00% target range by mid-2024. Nice in theory, but if history has taught us anything about central bank forecasting, it is that they tend to undershoot reality, and I recall reading that RBA governor Lowe acknowledged recently that CPI will likely peak north of +6.0% YoY. So, risk of an overshoot is elevated, or at least extension of time frames on inflation, which is arguably what markets are pricing. Consensus – per Bloomberg – has CPI peaking at +5.70% YoY in Q3, but I’d call that stale and just downright wrong.
- In US treasuries it was a pretty wild week, +3 bps on Friday in 10-year yields to 3.22%, or -13 bps on the week. We witnessed wide trading ranges, 3.195% – 3.473%. At the front of the curve, 2-year yields were +8 bps on the day, and +11 bps on the week, with a wide 3.179% – 3.427% trading rage. Prior to the recent surprise US CPI print swaps markets were pricing in +180 – 200 bps of Fed rate hikes by the end. Factoring on the higher-than-expected CPI print, and subsequent rate hikes by the Fed, swaps are now pricing >280 bps of hikes and a terminal rate of at least 4.00% despite the Fed guiding around ~2.50%. A slower May CPI print might afford yield markets a reprieve and allow the Fed to moderate its pace of hikes, might, just might…maybe, maybe not.
- Fed speak…Fed Governor Christopher Waller stated in prepared comments and during a Q&A session he would support another +75 bp rate increase at the Fed’s July meeting, should economic data come in as he expects. He stated the “Fed is ‘all in’ on re-establishing price stability….I don’t care what’s causing inflation, it’s too high, it’s my job to get it down”. He also acknowledged “the higher rates and the path that we’re putting them on, it’s going to put downward pressure on demand across all sectors.” However, he said fears of a recession were “a bit overblown, maybe we have to go below trend growth for six months to a year, that’s OK. Maybe unemployment has to go up 4.00%, 4.50% — I think it would be 4.00% to 4.25%.” In his statements he also acknowledged the Fed’s shortcomings though the cycle, “by requiring substantial further progress toward maximum employment to even begin the process of tightening policy, one might argue that it locked the Committee into holding the policy rate at the zero lower bound longer than was optimal…but if we again face those challenges, we now have the additional insight that only experience can bring.” I’d suggest it’s ‘when’, not ‘if’.
- ACGB Curve week on week change…
- A$ Fixed Income Markets…
- Macro – nothing of note on Friday locally, while in the US… factory production unexpectedly declined in May, restrained by supply challenges and hints of cooler demand. The -0.1% MoM decline followed +0.8% increases in the prior two months. Total industrial production, which also includes mining and utility output, rose +0.2% last month. Further signs of US macro headwinds are increasingly hard to ignore…”the Atlanta Fed’s GDPNow model for 2Q 2022 sees real residential investment contracting 7.7% based on data through June 16. And with the average 30-year fixed mortgage now near 6%, the highest level since 2008, home builders are reining in construction despite a lack of supply. Housing starts dropped to a 1.549 million annual pace from a recent cycle high over 1.8 million. The consumer is also starting to show signs of weakness. Retail sales growth ex-autos was down marginally in May. But ex autos and gas, the number was a paltry 0.1% — suggesting some level of demand destruction is creeping in.” (Bloomberg). Overall, that paints a pretty grim and gloomy picture of an economy on the skids, more an H.R. Giger, less of a Monet! Not quite in recession yet, obviously, but the signs are there that one is around the corner. And with the pace of monetary tightening now accelerating mucho-grande, the potential for a full-scale downturn has risen considerably…and if the US slips into recession, you can guarantee collateral damage elsewhere.
- Some high level thoughts on underlying inflation from CBA…”Global inflation trends remains the dominant focus of financial markets. Headline inflation is too volatile to detect the inflation pulse. The volatile food and energy prices have pushed headline inflation up to multi decade highs in several economies. Core measures of inflation are preferred over the headline. But what measure is best? In most economies, core inflation is simply headline inflation excluding food and energy. That is generally a useful measure of core inflation. However, the pandemic and the war have dislocated supply and demand trends. We consider the ‘statistical exclusion’ measures of core inflation such as the trimmed mean give a better reading of the inflation pulse. The trimmed mean simply removes a set share of the largest price increase and the largest price decreases. Trimmed inflation is still very high and trending higher in many economies. By contrast, inflation appears to have peaked in some economies when using the usual core measure of inflation. The bottom line is interest rates need to increase a lot further in a range of economies.”
Source: Bloomberg, Mutual Limited
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Scott Rundell, Chief Investment Officer
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