MIDDAY MACRO - 10/5/2021
Daily Color on Markets, Policy, and Geo-Politics
MIDDAY MACRO - DAILY COLOR – 10/5/2021
OVERNIGHT/MORNING RECAP & MARKET ANALYSIS
Narratives/Price Action:
Equities are higher, with tech and growth leading the way and the S&P and Nasdaq recovering from yesterday’s selloff
Treasuries are lower, with 10yr yields higher by 4.5 bps and the curve steepening after better than expected ISM-Service PMI data
WTI is higher, approaching $80 as energy supply concerns globally continue to intensify
Analysis:
A slight decoupling from the typical dance as growth and tech are outperforming despite Treasury yields pushing on recent highs as solid ISM Service PMI data showed that demand remains strong despite shortages and price increases, helping to continue/increase an overnight bounce in equities at the NY-open.
The Nasdaq is outperforming the S&P and Russell with Growth and Momentum factors, and Financials, Technology, and Communication sectors all outperforming.
S&P optionality strike levels have the zero-gamma level at 4418 while the call wall is at 4500. S&P bounced of lower gamma bound of 4275 yesterday but will face resistance around 4380. The technical levels have support at 4335, then 4310, and resistance at 4360, then 4400.
Treasuries are lower, as the 5s30s curve is steeper by 1.3 bps, and the 10yr finding support around 1.54% as traders begin to prepare for ADP and eventual the total jobs report Friday.
The upcoming reduction in liquidity conditions is looking less worrying than initially thought as tapering and the rebuilding of the Treasury General Account (TGA) shouldn't be too much of a drag on financial conditions into year-end, reinforcing our view that we can still see a meaningful melt-up in equities while a rise in Treasury yields remains orderly.
To start, there is a lot more money in the system than before the pandemic began with the expansion of the Fed’s balance sheet to $8.4 trillion, along with aggressive actions/expansions by other central banks elsewhere, providing a historical increase in the global monetary base backdrop.
*The U.S. M2 is increasing to $21 trillion
The global growth of money supply is certainly decelerating (as it should be given inflationary forces are increasing) but has yet to become contractionary.
Moving into year-end, we believe (assuming there is a debt-ceiling resolution) that any reduction in USD liquidity from a restocking of the TGA (which will not be brought back to near the crisis height of $1.8 trillion) will be offset by money coming out of the Fed’s Reverse Repo Facility, while tapering will only begin in December (continuing the monthly injection of $120 billion till then).
Next year, we see a gradual tightening in liquidity conditions as tapering commences, but this will initially be somewhat offset by lower levels of Treasury debt issuance. At the same time, the fiscal stimulus pulse, which is turning negative, could become more neutral throughout the year due to the passage and implementation of the hard and social infrastructure bills (although nothing like the effects of the Covid-response fiscal bills), something we know is longer-term but could have an initial positive 2022 impact depending on what is in the final passage. The bottom line, we don’t expect a meaningful decrease in government activity/stimulus under this administration.
Looking further out, we agree that there will be less excess liquidity globally moving forward, and this is a significant headwind for risk assets. However, and simply looking towards year-end, liquidity conditions are not going to become meaningfully restrictive yet.
Econ Data:
The ISM Services PMI edged up to 61.9 in September from 61.7 in August, beating expectations of 60. Faster increases were seen for Business Activity (62.3 vs. 60.1), New Orders (63.5 vs. 63.2), and Backlog of Orders (61.9 vs. 61.3). On the other hand, Employment (53 vs. 53.7), Supplier Deliveries (68.8 vs. 69.6), and New Export Orders (59.5 vs. 60.6) slowed. Price pressures intensified (77.5 vs. 75.4) and were notably commented on by respondents. The availability of temporary workers was reported in short supply for the 9th straight month. More generally, the labor costs rose across all categories (full, construction, part-time) for the 10th straight month.
Why it Matters: Simply put, demand continues to “far outweighs supply for goods and services.” The ISM clearly noted that "ongoing challenges with labor resources, logistics, and materials are affecting the continuity of supply." There were numerous comments from respondents emphasizing the continued supply chain issues from "lead times on electronics and computer chips have greatly increased" to "both domestic and international logistics are increasing lead times about six weeks for ocean freight and two weeks for domestic freight." A few respondents noted improvements in lead times and the implementation of workarounds to overcome logistical challenges, but they were in the minority. We continue to believe we are near peak supply-side impairment with the improvement in Delta, return to school, and the end of UEBs supplying more labor while the inventory builds for the holiday season are at their height. As a result, we believe the inflationary pressures from shortages and logistical cost increases are peaking as firms adapt and the urgency to restock inventories abates into year-end.
Policy Talk:
Unfortunately, it's worth taking a moment to discuss the potential repercussions of the recent trading activity of Fed officials, given it may affect the future selection of board members and regional presidents and hence the dovish-hawkish tilt of future policy. Following the early resignations/retirements of Fed Presidents Kaplan and Rosengren, we now have the potential for Vice-Chair Clarida to step down after moving investments a day before interest rates were cut, even though the transaction were a “pre-planned rebalancing to his accounts” and were “executed prior to his involvement in deliberations on Federal Reserve actions.” As a result, the Federal Reserve said that its internal watchdog plans to investigate trading activity by senior U.S. central bank officials more generally. This follows an internal examination of the central bank's ethics rules announced last month. The Fed’s efforts on restricting/regulating trading so far have not satisfied critics, many of whom are now seizing the moment to push their own agendas. And although Republicans want to erase conflicts of interest risks, Democrats, especially progressives like Elizabeth Warren, want to use it to diversify the Fed’s leadership further (and increasingly regulate the financial industry). Already, Powell has pledged to seek diverse candidates for the jobs vacated by Kaplan and Rosengren. This is likely given that the regional Fed bank boards that will run the searches and make the new hires now have far more women and minorities than when Rosengren and Kaplan were hired. Across all 12 regional Fed banks, 51% of the directors eligible to pick Fed chiefs are women, and 48% are minorities.
Why it Matters: Although one wants to be careful linking the selection of women and minorities to leadership roles as a tilt to more ESG and dovish monetary policy, it is certainly something to watch given the existing cultural changes already occurring. As a refresher, this ESG cultural tilt has been seen by several developments over the last few years. It started with the Fed Listens outreach program that led to the rewriting of the Long-Run Goals and Monetary Policy Strategy, which not only evolved price stability policy to be more flexible with the new PLT/AIT policy framework but also increased the importance of “maximum employment” as a policy goal. Coupled with the extensive/expansive use of 13-3 facilities during the pandemic that bypassed traditional banking channels, the expansion of 24-7-365 FedNow, the new Community Reinvestment Act, and climate-related regulatory changes underway, it is clear the Fed sees itself as having a more influential role in the world. As a result, we expect the likely appointees at the regional presidential level and likely at the Board as simply a continuation of the existing more dovish ESG focused trend. As always, personnel is policy.
TECHNICALS / CHARTS
FOUR KEY MACRO HOUSE CHARTS:
Growth/Value Ratio: Value is outperforming on the week, but growth has made a significant comeback today, with the Nasdaq close to +2% on the day while the Russell is only higher by +0.3%
Chinese Iron Ore Future Price: Iron Ore futures are higher on the week, higher by a little under 1% today as a base in prices continues to form
5yr-30yr Treasury Spread: The curve is steeper on the week, higher today by +1.4 bps as the long-end is under pressure while the belly is little changed
EUR/JPY FX Cross: The euro is higher on the week, moving higher by +0.4% today against the Yen, helped by the risk-on tone
HOUSE THEMES / ARTICLES
MEDIUM-TERM THEMES:
Real Supply Side Constraints:
10%: Delays soak up more than a tenth of boxship capacity – Lloyds Loading List
Containership capacity equivalent to 12.5% of the global fleet is unavailable due to delays caused by congestion in ports, despite the considerable increase in the amount of deployed tonnage. On the transpacific, this meant that despite the factual injection of significantly more vessel capacity, the cargo carrying capacity on a roundtrip basis had declined by 20% when looking at year on year and 10% when looking at the annual average over the past two years.
Why it Matters:
The impact of vessel delays is the most significant single element causing the severe capacity shortage driving up freight rates in the market. The latest August data now show the situation being even worse than at the beginning of the year and far exceeding the situation with bottlenecks in early 2015. The bottom line is bringing more vessels into the mix will not solve the problem. We need more port capacity, something that takes a long time to develop.
China Macroprudential and Political Tightening:
Still Contagious: Chinese property developers' ability to repay debt hits decade low - Reuters
Chinese property firms have been struggling to earn enough to make interest payments on their debt for some time. At the end of June, the aggregate interest coverage ratio of 21 big Hong Kong-listed Chinese real estate developers fell to 0.94, the worst in at least a decade. As a result, investors increasingly rattled by Evergrande’s troubles are further pulling back on the rest of the property sector, especially speculative-grade issuers.
Why it Matters:
China had already started to push property firms to cut excessive borrowing and land buying. The country's real estate firms accelerated efforts to cut debt last year after regulators introduced caps on three debt ratios. But their net debt-to-EBITDA held at 4.9 in June from 5.2 at the end of last year, a score considered risky by industry experts, suggesting it would take a long time to pay off the debt. As a result, they simply didn’t have enough time (before Evergrande changed sentiment) to deleverage and are now in a less investor-friendly environment, increasing the risk many will fail if Beijing continues to push the current policy path.
LONGER-TERM THEMES:
National Security Assets in a Multipolar World:
Launched: South Korea’s air force opens space ops center – SpaceNews
South Korea’s air force has launched a space operations center that will play a central role in drawing space policies for the nation’s armed forces as well as enhancing cooperation with domestic and international partners, including U.S. Space Force. This is the latest in a series of efforts by South Korea to enhance its space defense capabilities.
Why it Matters:
“Space will be a key warfighting domain, and we will have our weapons ready up there. We will help deal with threats to space security as well,” stated Gen. Park, South Korea’s Airforce Chief. We highlight this to show that developed nations are increasingly turning their military capabilities towards space. South Korea is also walking the fine line between continuing a deeply intertwined commercial relationship with China while looking for protection and (defensive) capabilities from the U.S.
Electrification and Digitalization Policy:
Gonebook: Understanding How Facebook Disappeared from the Internet - Cloudflare
A very technical article detailing why Facebook, Instagram, and WhatsApp stopped working yesterday, something we thought worth sharing due to the significant negative real economic consequences that occurred due to the event. Facebook Engineering has also posted its account on its blog. Basically, it was caused due to changes made to configurations on the backbone routers that coordinate network traffic between data centers, causing issues that interrupted communication.
Why it Matters:
Yesterday's events are a reminder that the internet is a very complex and interdependent system of millions of systems and protocols working together. That trust, standardization, and cooperation between entities are at the center of making it work for almost five billion active users worldwide. There was a notable decline in non-Amazon online sales due to the loss of Facebook and Instagram’s marketplaces, and countless businesses had their communications lost from disruptions to WhatsApp. The bottom line is that we are still building the foundation of our consumer society on shaky grounds.
Commodity Super Cycle Green.0:
Now India: India follows China in reporting extreme coal shortages – Splash247
According to the Indian Government’s Central Electricity Authority (CEA), out of the 135 thermal power stations in the country, 104 of them are at either ‘critical’ or ‘super critical’ levels of coal inventory. In terms of capacity, 77% of coal-fired plants are now at risk of halted production in days without an increased supply of coal persist. India’s power minister, R.K. Singh, told the local Indian Express newspaper today that electricity demand would be “touch and go” in the coming months.
Why it Matters:
The Indian government has been in negotiations for what it described as priority cooperation with Australia to secure stable inflows of the country’s coal. Historically, India has relied on Indonesia for thermal coal supply, accounting for 60.2% of monthly shipments on average but now competing increasingly with China there. “Imports remain the only option to meet demand” in the near term, Indian credit rating agency Crisil, part of the S&P Global group, wrote in a recent report. “In our view, coal inventory at thermal plants will improve only gradually by next March.” The bottom line is continued energy insecurity and inflationary pressures in India, China, and anywhere else needing coal for their electricity production.
ESG Monetary and Fiscal Policy Expansion:
Back at the Table: U.S. Trade Chief to Engage With China on Trump-Deal Shortfalls – Bloomberg
The Biden administration will directly engage with Beijing in the coming days to enforce commitments in their trade deal and start a new process to exclude certain products from U.S. tariffs. While the Biden administration won’t take any tools off the table when dealing with Beijing, it doesn’t intend to escalate the trade tensions, an administration official said in a call with reporters.
Why it Matters:
Tai’s recent speech focused on the Biden administration’s approach to the U.S.-China trade relationship and came after months of internal reviews and deliberations on dealing with Beijing’s economic practices. Even though China is far behind its agreed-upon purchase levels, the administration has yet to give details on timelines for existing commitments to be met and the potential for additional enforcement actions. Stepping back, although Biden and Congress more generally are talking tough on China, the current inflationary pressures reduces the leverage either has in enforcing a trade deal Beijing was likely never going to adhere to.
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