Hawkish Talk and Mixed Data is Causing Consolidation - MIDDAY MACRO - 11/17/2022
Color on Markets, Economy, Policy, and Geopolitics
Midday Macro – 11/17/2022
Overnight and Morning Recap / Market Wrap:
Price Action and Headlines:
Equities are lower, with communication/tech sectors and growth factor outperforming, while small caps lag, driving indexes below their weekly post-CPI range
Treasuries are lower, with the curve flattening as better-than-expected data and more hawkish Fed commentary this week continue to weigh heaviest on the front-end
WTI is lower, approaching $81.50, despite stronger global demand in recent months and larger-than-expected domestic draws yesterday
Narrative Analysis:
Equities are lower today (but off morning lows), which were mainly driven by St. Louis Fed President Bullard claiming Fed funds rates could go as high as 7% based on a model that has never been used to guide policy. With weaker data this morning and better-earnings results last night, on top of pretty much every Fed official giving their opinion this week going into the November Opex tomorrow, markets are bouncing around, consolidating after last week’s CPI-driven move higher. Treasuries are also weaker, with the front end up close to 10bps, adding some headwinds to risk assets which had been recently enjoying lower real rates and looser financial conditions. Oil is notably lower, falling over 4% on the session, although energy equities are higher, and traders see the move being driven by poor optionality positioning, not a change in fundamental outlook, as views on growth domestically and in China have seemingly only improved this week. Copper is also down, retracing much of its recent gains in the last few sessions. The agg complex is also weaker, with an improved outlook for supply trending grains and beans lower. Finally, the dollar is stronger, with the $DXY around 106.7, helped by weakness in the Yen and Aussie Dollar.
The S&P is outperforming the Nasdaq and Russell with Momentum, Low Volatility, and High Dividend Yield factors, and Health Care, Technology, and Consumer Staples sectors all outperforming on the day. Factor and sector leadership on the week remains similar to last week, with Technology and Growth continuing to lead on the week, although Energy and Momentum are up and flat, respectively, showing a mixed level of leadership
@KoyfinCharts
S&P optionality strike levels have the Zero-Gamma Level at 3947 while the Call Wall is 4100. Yesterday again saw very large volumes at the 4000 strike, with 150k calls trading & 75k puts. The call activity, which is likely call selling, adds to resistance at that level. Conversely, there was a lot of put activity below, which translated to an uptick in open interest at 3900 & 3950, likely short-term in nature. As a result, the level of negative gamma is picking up, increasingly signaling volatility should rise. There is still a bullish tilt coming out of tomorrow's OPEX, but once in December, things could get more negatively skewed.
@spotgamma
S&P technical levels have support at 3925, then 3900, with resistance at 3990, then 4035. After two weeks of a nearly straight uptrend, where S&P pushed 345 points from the November 3rd low, the market is now firmly in basing mode, chopping up both longs and shorts and putting in an inside day yesterday. Consolidation periods form chart patterns, which helps provide a clue as to what the next leg is. The action since Friday, unfortunately, has not formed one decisive pattern and has instead formed two simultaneously. There are two possible interpretations, with the 1st being a bearish head and shoulders, which are 50/50 patterns. The second is a “broadening formation,” shown in purple in the below chart, which leans bullish. Still unclear which pattern will win out.
@AdamMancini4
Treasuries are lower, with the 10yr yield at 3.77%, higher by 8.1 bps on the session, while the 5s30s curve is flatter by -3.8 bps, moving to -5.1 bps.
Deeper Dive:
Today’s “Deeper Dive” will mainly focus on U.S.-China relations following the Biden-Xi meeting earlier in the week at the Bali G20 Summit. However, in a quick summary of recent data, Fed speakers, and markets, it's worth highlighting a few points. First, as expected, given the overtly negative level of sentiment and positioning, markets clearly got ahead of themselves following the better-than-expected CPI report last week. Momentum has now cooled, and positioning looks better balanced in equities going into Friday’s Opex. The fact that a further rally to new recent highs elicited by better (weaker) than expected PPI data on Tuesday quickly reversed due to geopolitical concerns (that later turned out to be non-eventful) shows headline risks can quickly emerge, bringing sentiment back down to earth and gaping prices lower. In many ways, a more sustainable rally needs more defensive positioning. A rising put wall and neutral gamma position would better support a sustainable and gradual rise in indices than the short-covering rallies we have seen. Either way, it seems markets want to go higher as, despite hawkish Fed rhetoric attempting to push back on recent loosening in financial conditions, the week's general tone has been more risk positive. Both major readings of inflation (PPI and import/export) received fell, while regional surveys showed on aggregate less pricing pressures. Retail Sales and Industrial Production reports continued to be resilient, despite indications that demand is falling, as seen elsewhere. Housing continues to weaken. However, recent drops in Treasury yields look to have moved mortgage rates lower, and starts/permit data show multi-unit demand is still strong. The household has increased its leverage levels while banks reported tighter lending conditions, but labor indicators continue to show expansion (despite headlines), and real disposable income will become increasingly more positive as wage gains are likely more sticky than CPI. Being the ever-optimist, nothing this week changed our view that a softer landing isn’t possible, and inflation can’t fall faster than expected in Q1, capping the need for 25 bp hikes past a 5% terminal rate.
St. Louis Fed President Bullard highlighted an important Fed belief (during high inflation periods) that the Fed funds policy rate should make up the difference between target and actual inflation, what looks to be a 2% (target) + 5% (terminal FF rate) = 7% (CPI) loose concept currently. With this rule, it is still possible for the Fed to cut by the end of ’23, given our belief that headline and core inflation will likely have a 3% handle by Q4. When added as a guiding principle on top of the more cautious and methodical approach to further rate hikes, we think the Fed’s reaction function is significantly more risk-friendly in Q1 ’23, as it increases optionality around the baseline in a two-sided way. New data, especially on inflation, are much more important now (as stated by Waller yesterday) than they were earlier in the process, given that policy is now tighter, there are notable lagged effects in the system, and tentative optimistic signs in the data. This doesn’t mean one should rush into more duration/policy-sensitive sectors (which have been hardest hit), but it certainly skews the risk-return to favor less chance of a policy error which could cause a harder and more prolonged downturn leading to a deeper drop in future earnings, and hence require a further discount to valuations and multiples. It is unclear if the market has fully recognized this new dynamic given the oversized move to the CPI data but the lack of follow-through following PPI this week, something we see as leading CPI. Of course, there were a lot of other factors at play throughout the week.
*Morgan Stanley recently lowered their inflation projections but, as with Goldman, still see core service inflation remaining sticky
*Goldman’s more sticky inflation outlook may be predicated on a rosier growth picture as they see consumers remaining more resilient than others
*The implied terminal Fed funds rate has not materially changed on this week's data, Fed speakers, or geopolitical events
*After approaching +3%, our mock portfolio is now at 1.35% (since inception), with the -6% pullback in copper off recent highs hurting the most while our S&P long and dollar short positions continue to perform as expected
It is worth highlighting some takeaways from the Biden-Xi meeting early this week at the G20 Bali Summit. At the highest level, the over three-hour-long meeting certainly seemed to put a floor to the ongoing deterioration in relations between the two countries. But in reality, nothing substantive or structural changed despite more positively toned language out of both sides summarizing the meeting/relationship. Actual actions always matter more with China, which has made an art of not following through with promises to foreign powers. Given the highly nationalistic “Wolf Warrior” rhetoric exhibited by Xi during the recent 20th Congressional Party gathering, it is especially appropriate to be skeptical that material actions will be taken currently. However, the fact the U.S.–China relationship knife isn’t falling further was seen as a positive by markets, helping investor sentiment broadly by reducing geopolitical fat-tail event risk worries. Chinese markets were significantly helped by the perceived improvement in relations while also higher by newly announced further stimulus measures aimed at the housing sector and continued beliefs that the zero-Covid policy era’s end is approaching.
Following the meeting, the U.S. said the two sides would resume cooperation on issues including climate change and food security and that Biden and Xi jointly chastised the Kremlin for loose talk of nuclear war over Ukraine. “They welcomed ongoing efforts to address specific issues in U.S.-China bilateral relations and encouraged further progress in these existing mechanisms, including through joint working groups,” one readout said. However, in reality, this meeting was not about starting new working groups but instead resuming more day-to-day non-high-level strategic existing ones that were run out of the U.S. embassy in the wake of Pelosi’s visit to Taiwan. China had stopped engaging in any level of communication, and the hope now is that at least more normal levels will restart, which, funnily enough, is the easiest way to stem misunderstandings and undeterred escalations.
Chinese Foreign Minister Wang Yi called it a “new starting point,” saying the meeting went longer than planned (for good reasons). Both sides “hope to stop the tumbling of bilateral ties and to stabilize the relationship,” he said in a briefing with state-run media. Biden said both countries have a responsibility to “prevent competition from becoming anything ever near a conflict,” and Xi said the two sides “need to find the right direction” and “elevate the relationship.” However, plenty of disagreements remain over topics including Taiwan, technology, and human rights. But tensions seemingly have eased, with China’s statement offering the U.S. more incentives to work together and issuing fewer warnings than other recent communications.
In summary, there was a warmer tone, with China noting a “candid, in-depth and constructive” conversation. “Constructive” was missing the last time they spoke in July. Regarding where tensions still remain, Taiwan remains the number one red line. However, in another sign that tensions have been dialed back, Xi told Biden that the U.S. must abide by the “One China policy” rather than the “One China principle,” as he did in July. Further there, the idea of “Succeeding in Parallel” was delivered. “The world is big enough for the two countries to develop themselves and prosper together,” Xi said, adding that “under the current circumstances, China and the United States share more, not less, common interests.” Piggybacking on this concept, greater economic cooperation was called for, with Xi acknowledging that the two economies are deeply integrated, and both face new tasks in development.
There was no mention in the official Chinese readouts regarding the use of nuclear weapons by Russia, although verbally, this was discussed and shunned by Xi. Important to remember that China sided with Russia to oppose calling the Russia-Ukraine war a “war” at the G20 and voted against a UN draft resolution on Ukraine-related compensation. Without China’s support, Putin and the Russian economy would be much worse, so relationships there are being watched very closely. Regarding future actions, Secretary of State Blinken plans to travel to China early next year to continue the conversation. Treasury Secretary Yellen also met with PboC Gov. Yi Gang for more than two hours at the G20 summit. They discussed the volatility in energy and commodity markets and the economic outlook for the two countries, according to a U.S. readout of the meeting. The People’s Bank of China called the exchange broad and constructive but didn’t offer further details.
Finally, Covid case counts continue to increase in China (but no new deaths have been reported, which is impressive!). Just a few weeks ago, local officials would have locked down many or all of the several major cities that had cases rising to numbers this high. Now they are running a real-time optimization experiment on how high new cases can go without getting out of control. The following weeks will be a critical tell on which way the zero-Covid policy will go. If officials can resist broader lockdowns in some of these cities, and especially Beijing, then it is likely that top leadership really has changed the approach to managing Covid in a material different way, even if they still call it "Dynamic zero-Covid." Oh, and where was Xi’s face mask in Bali?
*Case numbers have risen, as has the patience of local residents under lockdown, with greater levels of protests seemingly occurring. Has Beijing played their hand too far here?
*Activity continues to be below pre-pandemic levels, and the toll on growth and confidence keeps rising
Econ Data:
Retail sales rose by 1.3% in October, the strongest increase in eight months, after a flat reading in September and beating market forecasts of a 1% gain. Much of the gains came from motor vehicles and gasoline stations, the first benefiting from improved supplies while rises in gas prices helped the latter. However, retail sales were still higher by 0.9%, excluding these two categories. Increases were seen in sales at food services and drinking places (1.6%), food and beverages stores (1.4%), nonstore retailers (1.2%), furniture (1.1%), building materials (1.1%), and health and personal care (0.5%). On the other hand, sales were down for electronics (-0.3%), sporting goods, hobby, musical and books (-0.3%), and general merchandise stores (-0.2%).
Why it Matters: A more positive report than expected, even when adjusting for inflation, with the consumer remaining more resilient than expected even in areas that have seen reduced demand, such as goods, which retail sales mainly capture. With inflation increasingly falling for goods due to increased levels of discounting that is likely coming from retailers as well as generally reduced cost pressures, it will be interesting to see if retail sales can continue to stay positive in the face of a deflationary durable goods backdrop. In the meantime, we do take comfort in the broad improvement from the prior month in most categories.
*Both the headline, Ex Autos & Gas, as well as the control group saw notable monthly increases, beating expectations
*Clearly, the outsized move in Gasoline Stations was driven by the rise of gas costs at the pump, with inflation likely helping gains in food-orientated categories too, but core retail should increasingly be seeing deflationary pressures emerging
*When adjusting for inflation, retail sales have been much less impressive over the post-pandemic period
*Online purchases continue to maintain a much higher percentage of sales than before the pandemic, as consumer behavior looks to have structurally changed
Industrial production decreased by -0.1% in October, after a 0.1% increase in September and missing market expectations of a 0.2% gain. Manufacturing output rose by 0.1% MoM, below expectations for a 0.2% increase, mainly supported by durable goods (0.5%). Motor vehicle production rose 2.0%, consumer goods output increased 0.1%, the output of construction supplies dropped by -0.7%, while business equipment output rose by 0.8%. Finally, mining output fell by -0.4%, and utilities production declined by -1.5%. The capacity utilization rate fell to 79.9% in October from 80.1% in September.
Why it Matters: Headline industrial production came in lower than expected as final product production rose, but construction and materials production, as well as drops in mining and utilities (likely weather-related) output, cooled. The main drivers of gains in durables were motor vehicles and machinery, while nondurable manufacturing fell by -0.3% MoM due to drops in food & beverage (-0.3%) and petroleum & coal (-1.9%) production. The more Capex-orientated business equipment categories saw decent increases on the month, with transit equipment (1.0%), infotech equipment (0.9%), and industrial equipment (0.7%). This actual activity counters recent weakness in Capex intentions seen in various business surveys and will reflect positively on the Q4 GDP reading.
*The headline reading was slightly negative on the month due to weakness outside of durable goods manufacturing but has been relatively stable given the increasing demand weakness seen in other manufacturer’s data (regionals, ISM, NFIB)
*Motor vehicle production continues to play catch up as material shortages improve and inventory levels normalize. Outside of this, most other categories cooled on the month
The Producer Price Index rose 0.2% in October, the same as a downwardly revised 0.2% increase in September and below market forecasts of 0.4%. This brings the annual headline rate to 8%, while the core rate was flat on the month, moving the annual rate to 6.7% YoY. The overall cost of goods increased by 0.6% on the month, mainly due to a 2.7% increase in energy, which was pushed higher by a 5.7% jump in gasoline costs. Overall, food costs increased by 0.5% MoM, a drop from the 1.3% MoM increase last month. “Less Foods and Energy,” goods decreased by -0.1%. Overall service costs fell by -0.1%, the first decline since November of 2020., helped by drops in Trade (-0.5%) and Transportation and Warehousing (-0.2%), while Other services were higher by 0.2% MoM. Within intermediate demand in October, prices for processed goods fell by -0.2%, thanks mainly to declines in cold rolled steel sheet and strip, which dropped by -16.5%. Unprocessed goods declined by -11.7%, significantly helped lower by a drop in natural gas prices, which fell by -37.8%. Finally, the prices for intermediate service demand rose by 0.3%, with over half of the October rise due to a 6% increase in prices for business loans.
Why it Matters: There is now clearly a trend lower underway in PPI. Further, although lower than expected, the headline number was heavily influenced by the large monthly increase in gasoline, and when stripping that and the effects of food were down by -0.1%. Gasoline prices have been falling in November, as are some food categories, so we expect a reversal in next month’s report. We also know there has not been an improvement in new orders for manufacturers, so weaker demand should increasingly continue to reduce pricing pressures for goods, especially unprocessed goods. All of which indicates the trend lower should continue. Looking more closely at the guts of the reports, there was an even larger and broader decrease in the cost of goods throughout the four stages of PPI input price measures. Clearly, we are not out of the inflation woods, but the further cooling in the PPI data is an encouraging and leading indicator that consumer inflation will trend lower.
*Both headline and core PPI readings continue to definitively trend lower, helped by weaker actual data and more favorable annual comparables
*The drop in natural gas prices over the month helped to drive down overall unprocessed PPI, but unprocessed food (-3.1%) and nonfood materials less energy (-5.3%) also fell significantly
*Without energy, there would have been a much more dramatic drop in the headline PPI rate
*Annualizing the last four months would give you a flat PPI
Import prices decreased by -0.2% in October, following a -1.1% decline in the previous month and compared with market expectations of a drop of -0.4%. Fuel prices were down by -1.3%, while nonfuel edged down by -0.1%. Compared to the same period last year, import prices advanced by 4.2% YoY, the least since February 2021, after rising 6% in September. Export prices fell by -0.3% in October, slightly below market expectations of a -0.4% decline and following an upwardly revised -1.5% decrease in the previous month. Monthly decreases were seen in both agricultural (-1%) and non-agricultural (-0.3%) outbound sales. On a yearly basis, prices for exports have risen by 6.9% YoY, easing from the downwardly revised 9.2% jump in the prior month.
Why it Matters: Both import and export prices have declined for four months, although October's decline was by the least amount. The main driver of weakness for import prices in October was fuels, somewhat supporting our belief that we will see further drops in prices there as to be reflected in next month's CPI/PCE reports. Further drops in agriculture export prices confirm what has been seen in future markets, as the agg complex has generally seen prices cooling. It is also interesting to see the pick up in annual drops, given this was the period last year when prices began to rise, with Q1 ’22 being the strongest period of gains for both import and export price gains, meaning there should be considerable drops coming in the annual rate in Q1 ’23 if monthly gains remain flat to negative.
*Import prices are now higher by 4.2%, a significant fall from the 13% YoY reached in March
*Annual gains in export price have also fallen a long way and will likely fall even further in Q1
Housing starts declined by -4.2% to 1.425 million in October, after falling by a downwardly revised -1.3% in September, and compared to market forecasts of 1.41 million. Single-family housing starts dropped by -6.1%, while multi-units decreased by -0.5%. Starts were down in the Northeast (-34.7%), the Midwest (-11.1%), and the West (-10.6%), while starts went up in the South (6.7%). Compared to October 2021, housing starts are lower by -8.8%. Building permits fell by -2.4% to 1.526 million in October, the lowest since August 2020 and compared with market expectations of 1.512 million. Single-family authorizations declined by -3.6%, while the multi-unit starts fell by -1.0%. Permits were down in the West (-12.9%) and Northeast (-7.0%) but were up in the South (2.4%) and unchanged in the Midwest.
Why it Matters: Housing activity continues to weaken, with total housing starts -8.8% below year-ago levels and building permits down -10.1% on the same basis. The question now is whether there is still a large mismatch in the supply and demand of housing that was so prevalently seen in the historically low level of available inventory over the last two years. Here the story looks to be diverging, as multi-unit starts and permits hold up better than single-family given the increased demand in urban areas, which has driven rents higher and hurt affordability there. This trend will likely continue for a few more months until returning to a more normal level, increasing urban housing supply and reducing rent pressures in the long run.
*Monthly changes in starts have been more volatile than permits, but given the known headwinds, it is likely both will continue to fall
*Single-family starts are rentering a more historically normal range while multi-family continue to rise
The NAHB housing market index fell to 33 in November from 38 in October and below forecasts of 36. All three HMI components posted declines in November. Current sales conditions declined to 39 from 45, sales expectations in the next six months went down to 31 from 35, and traffic of prospective buyers fell 5 points to 20. Looking at the three-month moving averages for regional HMI scores, the Northeast fell six points to 41, the Midwest dropped two points to 38, the South fell seven points to 42, and the West posted a five-point decline to 29.
Why it Matters: This is the eleventh month of declines in the headline index and is the lowest reading since 2012, excluding the immediate onset of the pandemic. To bring more buyers into the marketplace, 59% of builders report using incentives, with a big increase in usage from September to November. For example, in November, 25% of builders said they are paying points for buyers, up from 13% in September. Mortgage rate buy-downs rose from 19% to 27% over the same time frame. And 37% of builders cut prices in November, up from 26% in September, with an average price of reduction of 6%. This is still far below the 10%-12% price cuts seen during the Great Recession in 2008. However, supply-side impairments are still hurting builder's profitability. “Even as home prices moderate, building costs, labor and materials -- particularly for concrete -- have yet to follow,” said NAHB Chief Economist Robert Dietz.
*Homebuilder optimism continues to freefall with no bottom in sight…
*With all three sub-indexes showing housing is clearly in recessionary territory
The NY Empire State Manufacturing Index rose 13.6 points to 4.5 in November, compared with market expectations of -5.0. New Orders (-3.3 vs. 3.7 in Oct) decreased into contractionary territory, while Shipments (8.0 v.s -0.3%) moved back into expansionary territory. Unfilled Orders (-6.8 vs. -3.7) weakened further while Delivery Times (2.9 vs. -0.9) remained near neutral. Inventories (16.5 vs. 4.6) grew significantly. Labor market indicators pointed to a stronger employment picture, as the Number of Employees (12.2 vs. 7.7) and Average Workweek (6.9 vs. 3.3) both increased. Finally, on the prices front, both Prices Paid (50.5 vs. 48.6) and Prices Received (27.2 vs. 22.9) increased. Firms expect business conditions to worsen over the next six months, with every sub-index lower other than the expected average workweek. Expected levels of Shipments (-10 vs. 5.6) fell notably, while Capex (14.6 vs. 22) and Tech Spending (6.8 vs. 11) intentions moved lower.
Why it Matters: Although the overall index rose back into expansionary territory, the underlying sub-index level indicated weaker demand and more inflationary pressures were experienced. Supply-side pressures also worsened, with longer delivery times and labor needs growing. Inventory levels were also back near yearly highs going into the holiday season. The declines in current New Orders and Unfilled Orders, as well as a greater weakness in expected future conditions more broadly, indicate that coming general business conditions will likely continue to trend lower into contractionary territory despite November’s bump higher. However, specific to Fed-focused measures, future price expectations, and employment intentions, there is still an expected cooling there.
*The headline index moved back into expansionary territory due to increases in Shipments, Employment, and Inventory, but New Orders fell again into contractionary territory
*The more alarming part of November’s report was the notable drops in the majority of Six-Month Ahead sub-indexes
The Philadelphia Fed Manufacturing Index fell to -19.4 in November from -8.7 last month, the lowest since May of 2020 and well below market expectations of -6.2. New Orders (-16.2 vs. -15.9 in October) moved slightly more negatively as did Unfilled Orders (-22.9 vs. -22.5), signaling no improvement in new demand. Shipments (7 vs. 8.6) remained positive but also fell slightly, while Delivery Times (-8.8 vs. -12.6) improved but remained in negative territory. Inventories (-6.5 vs. -1.7) worsened. The inflationary picture was mixed, with Prices Paid (35.3 vs. 36.3) marginally improving while Prices Received (34.6 vs. 30.8) rose. The Number of Employees (7.1 vs. 28.5) fell sharply, as did the Average Employee Workweek (1.4 vs. 10,4), but remained in expansionary territory. Expectations six months ahead for New Orders, Shipments, and Unfilled Orders all rose somewhat notably. Forward price measures and employment expectations all fell. Finally, Capex (6.4 vs. 4.4 intentions rose slightly.
Why it Matters: The majority of the headline decline came from weaker inventory and employment sub-indexes. There was little change in actual activity and new demand readings, with capacity also unchanged. Price reading worsened on the whole but also were little changed. Future expectations actually improved on the whole in regard to what is best for growth and the inflation picture, with higher demand, lower inflation expectations, and a more balanced demand for labor. Further, still positive Capex intentions underscore what was seen in the recent industrial production data; firms continue to invest. Finally, this month’s special questions asked firms to forecast the changes in prices of their own products and for consumers overall over the next year. Regarding their own prices over the next year, firms’ forecasted an expected increase of 4.8%, down slightly from 5% when asked in August. Firms reported an increase of 7.5% in their own prices over the past year, down from 10.%in August. The firms’ median forecast for the rate of inflation over the next year was 5%, down from 6%, while the overall longer-term inflation level rose to 4% from 3%.
*The overall current activity reading fell further due to cooling in employment and inventory readings, while future activity increased due to improvements in new orders and shipment expectations
*Is the worse in, with firm future expectations improving? Unlikely, given where some of the current sub-indexes need to go to reflect the coming economic slowdown and lower inflation
*Interesting decreases in inflation expectations while the 10yr inflation outlook rose
The NY Fed’s Survey of Consumer Expectations showed increased inflationary expectations, mainly due to increases in expected gas and food costs. Unemployment expectations reached the highest level since April 2020, while expectations for credit access worsened. However, household income growth expectations increased to a new series high.
One- and three-year-ahead inflation expectations increased to 5.9% and 3.1% from 5.4% and 2.9%, respectively. Meanwhile, the median five-year-ahead inflation expectations rose by 0.2 percentage points to 2.4%. Inflation uncertainty increased at the short-term horizon and declined at the medium-term horizon.
Expectations that unemployment will rise increased to 42.9%, the highest reading since April 2020, from 39.1% in September. Expected earnings growth increased slightly to 3%, staying within a year+ long range.
Expected household finances were more positive, with overall expected household income over the next year increasing to 4.3%, a series high, from 3.5% in September. However, perceptions over credit access worsened, with a series high of 56.7% of households reporting it is harder to obtain credit than a year ago.
Why it Matters: Expectations for inflation rose in the short-term more than expected but remained well anchored further out, which should give the Fed some comfort. At this point, Fed officials are aware of the strong effects rising gas prices immediately have on consumers’ shorter-term inflation expectations, and gas prices have risen since the last survey. The worsening view on unemployment expectations and credit access indicates that consumers are increasingly concerned with their future ability to maintain purchasing power. This should lead to less labor market turnover and generally reduce wage pressures. Of course, this would be even more true if inflation expectations were falling (as it would reduce the urgency to negotiate wages higher), something we see happening given the recent resumption of gas prices lower and some relief in food and durable goods costs. We still expect real disposable wages to become positive in 2023, improving consumer confidence and keeping aggregate demand from contracting to a level consistent with a prolonged deeper recession.
*Rising gas and, to a lesser extent, food prices moved overall inflation expectations higher in the November report
*Price change expectations for gas reached zero two months ago but are now back at more historically normal levels. There is still no cooling in rent expectations.
The NY Fed’s Quarterly Report on Household Debt and Credit showed an increase of $351 billion, or 2.2%, to $16.51 trillion in the third quarter of 2022. Balances now stand $2.36 trillion higher than at the end of 2019, before the pandemic.
Mortgage balances rose by $282 billion in the third quarter and stood at $11.7 trillion, representing a $1 trillion increase from the previous year. Mortgage originations, which include refinances, stood at $633 billion in the third quarter, representing a $126 billion decline from the second quarter and a return to pre-pandemic levels.
Credit card balances increased by $38 billion, a 15% year-over-year increase and representing the largest quarterly increase in over 20 years. Aggregate limits on credit card accounts increased by $82 billion and now stand at $4.3 trillion.
Auto loan balances increased by $22 billion to $1.5 trillion. The volume of newly originated auto loans was $185 billion, a slight reduction from the previous quarter but still elevated compared to the average volumes seen through the 2018-2019 period.
Student loan balances declined slightly by $15 billion and now stand at $1.57 trillion.
The share of current debt becoming delinquent increased for nearly all debt types. The delinquency transition rate for credit cards and auto loans increased by about half a percentage point, similar to increases seen in the second quarter.
Why it Matters: With the larger than expected increase in credit card debt, rising delinquency rates (all be it off historically low levels), and falling mortgage origination, this report is increasingly showing a consumer that has exhausted savings, turning away from bigger ticket items, and relying on revolving credit to maintain their purchasing power levels in the face of higher inflation. We know this story, it's been developing for some time, and the Q3 Household Debt and Credit report further validates it. Notably, despite a pick up in delinquency, most categories are well below or near the bottom of pre-pandemic historical ranges, signaling things are not yet trending towards “recessionary” levels.
*Outside of mortgages, the most significant increase was in credit card (+38 bln) and auto (+22 bln) debt
*Delinquency rates for credit cards, student loans, and auto loans had been stable or trending lower until recently, which has seen modest increases. More is likely to come, although it is unlikely we will follow the 2008 path
The October 2022 Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) Report showed tighter lenders tightening credit standards and lower levels of overall demand.
C&I loans generally showed tighter credit standards, while there was weaker demand for loans to firms of all sizes.
Banks reported tighter standards and weaker demand for all commercial real estate (CRE) loan categories.
Lending standards tightened or remained unchanged across all residential real estate loan categories and demand weakened for all such loans outside of HELOCS, which saw higher demand (but tighter standards too).
Standards tightened for credit card loans and other consumer loans, while standards for auto loans remained unchanged. Meanwhile, demand strengthened for credit card loans, was unchanged for other consumer loans, and weakened for auto loans.
The survey also included special questions that asked how much lending standards had changed over the year based on FICO scores. Banks reported they were less likely to approve such loans for borrowers with weaker FICO scores (<680) in comparison with the beginning of the year, while they were more likely and about as likely to approve credit card loans and auto loans to strong credit applications (+720 FICO).
The survey also asked banks about their assessments of the likelihood and severity of a recession in the next year and of the expected changes in banks’ lending standards should a recession occur. Most banks assigned a greater than or equal to 40% probability that a recession would occur. Most banks also indicated that if a recession were to occur, they would expect it to be mild to moderate in severity, with banks reporting expectations to tighten standards across all loan categories should this occur.
Why this Matters: In line with what you expect at this point in the cycle, banks are tightening their lending standards, and demand is falling, either due to higher rates or a less optimistic outlook. The report showed that only 40% expect a mild recession, and although credit standards were tightening in almost all categories, it was still stable in autos and loosening for better credit-worthy consumer borrowers, indicating that bankers are not completely tightening the credit spigot yet.
*After loosening quickly following the initial onset of the pandemic, the net percent of firms tightening overall credit standards is well above historically normal levels
*The tightening standards coincides with a significant drop in loan demand, with firms of all size now being in the contractionary area
*Although credit card demand is still positive and growing, as seen elsewhere, demand for auto and other consumer loans is now declining, according to bankers surveyed
Policy Talk:
Another busy week for Fed officials with Waller, Brainard, Cook, Williams, Harker, Bostic, Jefferson, Mester, Daly, Bowman, Kashkari, and of course, everyone's favorite hawk, Bullard speaking, with even a House testimony by the Vice Chair of Supervision Michael Barr to the Financial Services Committee. To summarize, initial hawkish comments from Waller had limited lasting effects on markets thanks to more dovish thoughts from Brainard, but as the week wore on, views of sustained but smaller rate hikes to a higher terminal level from George and others, culminating in today's presentation from Bullard, finally led to a more unified push back on the recent easing in financial conditions, helping markets give up recent gains and leading to volatility rising. However, we handicap the more hawkish-driven price action today by noting an increasing number of Fed officials leaning towards greater restraint/patience and data dependence to gauge the effects “cumulative” policy tightening has had on inflation due to the increasingly uncertain lag effect in play. We highlighted several speakers below but given that almost everyone spoke only chose four.
Governor Christopher Waller, speaking last Sunday at a UBS conference in Australia, said last week’s CPI print “was just one data point” and “we’ve got a long way to go to get inflation down.” On policy, Waller said, “real rates are not even in restrictive territory yet.” He said, “rates are going to stay - keep going up - and they're going to stay high for a while until we see this inflation get down closer to our target.” Currently, Waller and Bullard seem to be the leading voices at the FOMC table. Still, as we shift to the next phase of the hiking cycle and more concerned/dovish voices grow, we feel market reactions will be diminished to hawkish comments from this camp. This was seen following Waller's comments Sunday, which elicited little negative price action. Waller spoke again on Wednesday and echoing his Sunday remarks and further solidifying a likely 50 bp hike in December.
"We've still got a ways to go. This isn't ending in the next meeting or two. We're looking at moving in paces of potentially 50 bps at the next meeting or the next meeting after that. We've got to see this continue because the worst thing you can do is stop, and then it takes off again, and you're caught."
"The market seems to have gotten way out in front over this one CPI report. Everybody should just take a deep breath and calm down. We're going to see a continued run of this kind of behavior and inflation slowly starting to come down before we really start thinking about taking our foot off the brakes here. We've got a long, long way to go unless, by some miracle, incomes start dropping off very rapidly, which I don’t think anybody expects.”
"I've just been amazed to watch rates go up almost 400 basis points in about seven months, eight months, and the markets haven't collapsed. We don’t have a financial crisis or anything along those lines. We've got to have a good level, and we got it there fast, and we didn’t break anything.”
“Households are in good shape, and household balance sheets are in very good shape. I can't speak for Chair Powell, but as I watched the press conference, that was the signal to quit paying attention to the pace and start paying attention to where the endpoint is going to be."
St. Louis Fed President James Bullard gave a presentation titled “Getting into the Zone” at an event in Louisville. He argues that “the policy rate is not yet in a zone that may be considered sufficiently restrictive.” His presentation noted a rule-based approach would suggest the rate should be somewhere above 5%, perhaps substantially higher. He caveated this need for a higher rate level by saying it even included “generous assumpitons” that would favor a more dovish policy, not a pure Taylor rule-based approach. Bullard also acknowledges that his model does not capture “policy inertia,” something that takes into account the speed policy is tightened. We find it funny when Fed officials talk about rule-based policy, given we have never had that. By his model, the Fed should have begun raising rates in June of 2021, and although he was one of the earliest voices to point out the impending inflation danger and not a voter in ‘21, the Committee’s policy decisions in the second half of 2021 did not have and dissenters, including from Waller. However, Bullard did not want to be out hawked by Waller this week and thought it appropriate to remind markets that their camp is currently the loudest voice at the table.
“Thus far, the change in the monetary policy stance appears to have had only limited effects on observed inflation, but market pricing suggests disinflation is expected in 2023.”
The literature has a well-studied answer to this question: the policymaker should raise the policy rate more than one-for-one with deviations of inflation from target, known as the “Taylor principle.”
“The St. Louis Fed’s financial stress index is so far indicating a relatively low level of financial stress despite the higher policy rate this year.
Federal Reserve Vice Chair Lael Brainard spoke earlier in the week at a “fireside chat” event at Bloomberg’s Washington bureau. She echoed other Fed speakers in favoring a slowing in the size of rate hikes in December, highlighting the uncertainty over the lag effects that cumulative tightening would have on inflation and the real economy. She noted that “risks are going to be more two-sided as we get further into restrictive territory,” and this would increasingly weigh on the decision-making process moving forward. “By moving at a more deliberate pace, we’ll actually be able to see how that cumulative tightening is playing out,” Brainard said. “Exactly what that path looks like, I think, is really hard to say right now, but I think it will be very much better at balancing those risks by virtue of being able to take on board more data.” Brainard stopped short of explicitly endorsing the idea that the Fed would likely need to raise rates higher than previously projected in September.
“There are likely to be lags, and it’s going to take some time for that cumulative tightening to flow through, so it makes sense to move to a more deliberate and a more data-dependent pace as we continue to make sure that there’s restraint that will bring inflation down over time.”
“The most recent CPI inflation print suggests that maybe the core PCE measure that we really focus on might also be showing a little bit of a reduction. That would be welcome. I think the inflation data was reassuring, preliminarily, just in terms of showing a slowing in categories that I had been anticipating.”
“I think it’s important to remember that wages have actually not kept up with inflation. Real incomes have actually, on aggregate, fallen, even though wages are higher than what would be consistent with a run rate associated with 2% inflation, they really are in the middle there, and they are coming down.”
Atlanta Fed President Raphael Bostic posted an essay on the Atlanta Fed Website Tuesday, highlighting the difficulty in knowing the lag effects tighter policy has on inflation. He noted that historically the lag effect could take 18 months, but forward guidance has likely shortened the lag. As a result of this uncertainty, Bostic will be looking at other data (primarily labor market data) to help him understand where the ultimate level of policy tightening should go. He indicated that goods inflation peaked, but service inflation was still rising. Ultimately he needs to see a “better balance between demand and supply in labor markets because most service industries are labor-intensive.” He concluded by saying that a recession is “not a foregone conclusion, and we will try to avoid one if at all possible.”
“…there is considerable uncertainty about how these policy lags will play out… In fact, one school of thought suggests that the lags may be shorter in part because of policy guidance that, in effect, allows financial markets to react to policy before we implement it.”
“We at the FOMC calibrate policy today knowing we won't see its full impact on inflation for months. In those circumstances, we must look to economic signals other than inflation as guideposts along our path.”
“We will need to see increases in services prices slow, too. So far, we haven't. The PCE price index shows the pace of monthly increases in services prices ticked up in three of the past four months.
“Despite some declines in the huge number of job vacancies, the labor market remains tight as openings still far exceed the number of job seekers. That creates upward pressure on wages.”
Technicals and Charts:
Four Key Macro House Charts:
Growth/Value Ratio: Growth is flat on the day and the week, and Large-Cap Growth is the best-performing size/factor on the day.
Chinese Iron Ore Future Price: Iron Ore futures are higher on the day and on the week.
5yr-30yr Treasury Spread: The curve is flatter on the day and on the week.
EUR/JPY FX Cross: The Euro is stronger on the day and the week.
Other Charts:
Less inflation leads to lower yields (and rate volatility), which weakens the dollar, allowing equities to move higher. Add in the negative positioning that needed to be changed/covered, and many sectors/indexes are up double-digit from recent lows.
Call option volume rose significantly following the October CPI report with little new put demand, increasingly pointing to a reduced level of hedging. We now need to see put activity also increase, raising the put wall, hedging levels, and tightening trading ranges, giving the market a more neutral gamma level that can sustain a longer, slower rally, not a whipsaw short-covering one that may ultimately fail
However, as long as earning estimates are falling, we are still likely in a bear market, although the bottom in prices usually comes before the trough in estimates.
Shrinking margin fears continue to be the driver of negative earning expectations, but with increased levels of cost-cutting, falling supply-side inflationary pressures, and a still resilient consumer, will things be as bad as feared?
The majority of the forecasted earnings weakness is in growth, an area seeing increasing levels of cost-cutting.
Cash holdings are still high, something likely to continue until the Fed reaches its terminal level and starts the third stage of the current policy tightening cycle.
The MOVE index, rate volatility, is finally coming down more meaningfully as it looks like yields may have peaked for the cycle.
*Corporate debt has also benefited from lower levels of Treasury volatility as well as an improving inflation picture which has driven a dash to grab yields as debt coverage ratios still look healthy
GS put together the above to remind investors how various strategies work throughout the cycle. We are in the slowdown phase, and companies with strong balance sheets and buyback/dividend programs have outperformed.
The IMF’s Chart of the Week shows that there has been a steady worsening in recent months for purchasing manager indices that are tracking a range of G20 economies.
Falling PMIs and general slower economic growth indicate commodity demand should fall, lowering prices for industrial metals, something @VrntPerception is forecasting
Consumer confidence continues to fall in China with the zero-Covid policy weighing heavy there, leaving people living day-to-day and keeping consumption and investment weak while savings rise.
Inflation-adjusted retail sales have grown by 0% in the last three years in China.
As a result of the weakness in China, Asian stocks (the majority being in China) are increasingly cheap based on P/B.
Global money supply growth is fading quickly… index including Eurozone, China, Japan, and others are seeing a contraction in M2 growth, reaching -5.4% YoY -@biancoresearch
The world's population hit 8 billion on Tuesday, according to UN projections. Countries in sub-Saharan Africa are the main contributors to growth.
Article by Macro Themes:
Medium-term Themes:
China Macroprudential and Political Situation:
Sliding Back: China Dials Back Property Restrictions in Bid to Reverse Economic Slide – WSJ
China’s central bank and top banking regulator issued a wide-ranging series of measures aimed at bolstering housing demand and supply, according to a notice circulated on Friday to the country’s financial institutions and officials involved in policy-making. Beijing has rolled back some of the previous rules aiming to reduce debt in the industry, changing the “three red lines” approach that limited developers’ abilities to raise financing unless their debt ratios were below specific thresholds. The latest easing didn’t undo the policies completely, but it has given developers and lenders more room, such as repayment period extensions and allowing banks more time to reduce their property loans.
Why it Matters:
The new bundle of 16 measures represents the single biggest step yet to rescue a sector that has for decades been a key pillar of growth for the world’s second-largest economy. The new measures are “massive in scale” and amount to “targeted credit easing for the property industry,” said Dan Wang, chief economist at Hang Seng Bank China, who drew a contrast with previous rounds of incremental support measures. “These property measures, on top of announcements of Covid loosening, are a clear indication that Beijing’s efforts to support growth are intensifying,” said Michael Hirson, head of China Research at 22V Research, a New York-based firm focused on investment strategy.
Longer-term Themes:
Electrification and Digitalization Policy:
Evolving: What Ukraine’s cyber defense tactics can teach other nations – FT
Kyiv’s cyber tactics, including switching data to the cloud, partnerships with western companies, and using Elon Musk’s mobile Starlink terminals to connect to the internet via satellite, have proved highly effective. AWS cyber security experts and IT professionals trained Ukrainians in cyber security, teaching them how to switch data from on-premise IT systems to the cloud, where it could be better protected. Specifically, they shared intelligence on cyber threats, such as malware from “state actors” from Russia or elsewhere, that could affect AWS customers in Ukraine. A decentralized network of Ukrainian IT volunteers, or “hacktivists,” has further bolstered the country’s cyber defenses, says Pierluigi Paganini, adviser to the European Union Agency for Cybersecurity.
Why it Matters:
Although some security experts are surprised that Russia’s cyber attacks have not been more effective, they also praise Ukraine’s tactics. “Generally speaking, Russia’s cyber attacks haven’t had a destabilizing impact on Ukrainian infrastructure,” notes Bob Kolasky, a former assistant secretary specializing in cyber security within the US Department of Homeland Security. According to cyber security experts, Russia has also faced a barrage of cyber attacks since invading Ukraine. Governments and companies are being advised to study Ukraine’s successful cyber security tactics and update their own security policies accordingly.
Evolving: Ransomware Gangs Shift Tactics, Making Crimes Harder to Track - Bloomberg
Ransomware gangs increasingly use their own or stolen computer code, moving away from a leasing model that made their activities easier to monitor, new research shows. Numerous prominent hacking groups in recent years have functioned by leasing their malicious software and computing infrastructure to other bad actors in what’s known as ransomware-as-a-service. But now, the number of smaller hacking groups has rapidly increased, with many deploying their own code or stealing it from others, according to Allan Liska, a threat intelligence analyst at Recorded Future Inc. The shift has coincided with a reduction in activity by some higher-profile groups, according to research by Liska.
Why it Matters:
Liska said changes in tactics may be because the groups fear being targeted if they’re part of a big group. “In the last year, ransomware has become a race to the bottom among ransomware groups,” Liska said. As a result, gangs are “stealing from each other, lying even more than usual to victims and creating havoc among investigators and law enforcement.” The U.S. Department of Justice on Thursday announced it had charged a dual Russian and Canadian national for allegedly working with the LockBit ransomware gang. Hackers associated with the Netwalker and REvil extortion groups have pleaded guilty in recent months.
ESG Monetary and Fiscal Policy Expansion:
Concerned: Regulator demands more details of inflation impact on U.S. companies – FT
The Securities and Exchange Commission has been firing off letters to some of the largest companies in the U.S., demanding they give investors more information on how inflation is affecting their businesses. Staff at the regulator have become concerned that some companies’ financial reports gloss over the impact of rising prices on profits and liquidity. “…we are asking that you should explain how it has affected results of operations, sales, profits, capital expenditures, or maintenance you may do,” said Sarah Lowe, deputy Chief Accountant at the SEC office of corporation finance.
Why it Matters:
The SEC said earlier this year that it would use its filing review process to demand more information about how the war in Ukraine was affecting some companies and to ask for extra disclosures about ongoing disruption to global supply chains. The addition of inflationary impacts to the list of demands reflects concern at the agency that many executives involved in the preparation of financial reports have never lived through a period of rising prices. Companies must respond in writing to the SEC’s sometimes pointed comments and are expected to follow the regulator’s demands in future filings.
Please Stop: U.S., Allies Announce $20 Billion Package to Wean Indonesia Off Coal – WSJ
Wealthy countries, including the U.S. and some of the world’s biggest banks, backed a $20 billion funding plan to steer Indonesia, the world’s largest coal exporter, toward renewables as part of efforts to help emerging economies decarbonize. The funding was announced at a meeting of G-20 leaders and is aimed at one of the thorniest climate challenges. Developing countries such as Indonesia, India, and South Africa say they can’t afford to transition quickly to renewable energy. But if they stick with fossil fuels, carbon emissions will rise as their economies grow.
Why it Matters:
The money will be used to invest in low-carbon energy so that 34% of Indonesia’s power generation will be renewable by 2030, roughly double the rate of deployment currently planned. Further, investments in planned coal plants will be redirected to renewables. The plan also aims to close coal plants ahead of their intended lifespans. Hitting these targets would mean emissions from Indonesia’s power sector peak by 2030, seven years sooner than current projections. This also aligns Indonesia closer to the West (verse China) due to the capital investment, which the U.S. and its allies will likely repeat elsewhere.
Appendix:
Current Macro Theme Summaries:
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