MIDDAY MACRO - 1/11/2022
Daily Color on Markets, Policy, and Geopolitics
MIDDAY MACRO - DAILY COLOR – 1/11/2022
OVERNIGHT-MORNING RECAP / MARKET WRAP
Price Action and Headlines:
Equities are higher, with dip buyers coming back in after morning selling as Powell sounded less hawkish during his confirmation’s Q&A, helping Tech/Growth outperform/catch-up
Treasuries are higher, as again Powell reduced QT fears while little new data and similar Fed rhetoric elsewhere have calmed selling pressures, helping the 10yr bounce below recent yield highs of 1.80%
WTI is higher, as analysts continue to call for a $100 priced barrel due to the potential peaking of Omicron in the next weeks increasing demand while supply fundamentals are still challenged
Narrative Analysis:
Equities continue to bounce as Powell sounded slightly more dovish, helping dip-buying continue with the Nasdaq now +4% off yesterday’s lows. Little new economic data and the same message from other Fed officials has both growth and cyclical sectors rising today while more defensives lag. Treasuries are also better bid, with the curve flattening back to near lows seen in December. The dollar is nearing the lows of its post-November range as the Euro is pushing on its 50dma.
The Nasdaq is outperforming the Russell and S&P with Growth, Momentum, and Small-Cap factors, and Energy, Consumer Discretionary, and Technology sectors all outperforming.
S&P optionality strike levels have the Zero-Gamma Level at 4693 while the Call Wall remains at 4800. There is still a high level of expected volatility with large volumes of options trading driving price action, although open interests have changed little. As a result, the rally is still more “short cover” driven, indicating prices should continue to be unstable.
S&P technical levels have support at 4670 (50 dma), then 4650, and resistance is at 4685 (current level), then 4710. The S&P dipped below its 50dma yesterday but recovered it today. A quick one-day recovery above the 50dma after a loss of it happening nine times in 2021 and was followed by new ATHs each time. A move below the 50dma would likely mean a test of the 200dma.
Treasuries are higher, as Powell’s Senate testimony’s Q&A alleviated QT fears somewhat while other Fed officials didn’t add any significant new information/more hawkish views. The 5s30s curve is flatter by 0.5bps to 56.7bps.
After a few days away due to personal reasons that stopped us from commenting on last week’s hawkish FOMC minutes, a mixed jobs report, and the choppy market price action that ensued, it is now worth highlighting our beliefs that markets are overestimating the speed at which the Fed will tightening and hence how quickly financial conditions will become punitive to risk-assets.
The market is trying to decide if the Fed’s historical approach of gradualism is dead. We believe that the Fed remains far “behind the curve” and even with a March hike and three quarterly hikes after as well as allowing the balance sheet to runoff as early as the summer, which equates to two rate hikes worth of financial condition tightening, the level of accommodation and strength of the economy is still supportive of risk assets appreciating from current levels. The bottom line is that the Fed has a long way to go before a meaningful correction in equities should occur due to tighter financial conditions.
*It will take some time for the Fed to “determine how to determine” where the “long-run” level of the balance sheet should be, needing a new Taylor Rule as r* is complemented/replaced by BS*
This view is emboldened by the ample amount of liquidity currently in the system, as evident by the rises in M2 to close to $22 trillion, while the Fed’s RRP facility holding is close to $2 trillion. This provides an entirely different backdrop from the one that caused the liquidity-squeeze/repo crisis in late 2018, leading to a significant sell-off in risk assets. Even with the tapering ending in March and an immediate “runoff” driven reduction of the balance sheet that is averaging around $-50bln a month, it would do little to change liquidity conditions meaningfully. The Fed will/should eventually move to a more structured selling of BS assets but given their historic patience in sequencing and the reduced urgency due to the coming drop in inflation, it is unlikely this will commence in 2022. The bottom line is that this will undoubtedly be a concern one day, but it is simply too early currently, with economic fundamentals outweighing any future drag the multi-year liquidity/reserve drain will have.
*Although a complicated discussion, we believe the Fed’s RRP facility and the eventual use of its traditional repo facility further out will limit funding volatility and successfully support the reduction of excess reserves on a multi-year time frame
Finally, regarding Friday’s job report and its influence on the Fed’s determination on whether it is approaching its “maximum employment” target, we would just say the NFP miss is much less important than the continued improvements in UER across various ethnic groups the stabilization/improvement in the prime-age participation rate. Recent Fed rhetoric clearly indicates that they are accepting a structural change to the EPOP level while also seeing a more “equitable” labor recovery. Hence they have effectively hit their employment target needed to normalize policy.
*Ignoring retirements and adjusting for the effects that the virus is still having (and hence will likely diminish throughout Q1), the prime-age participation rate is effectively at “full employment”
It is worth quickly highlighting the positive developments in Omicron and reviewing a few existing/continuing headwinds to the macro backdrop.
Omicron looks to be following trends seen elsewhere and peaking in areas that were first infected (NYC), meaning the U.S. as a whole is close to its peak. The hit to Q1 ’22 will hence be much less than Delta had on Q3 ’21, explaining why (when coupled with higher rates due to the Fed) cyclical and “reopening basket” orientated sectors are outperforming this year.
*Hospitalization are near record levels, with some areas seeing capacity strains, but as a percent of case counts, Omicron continues to look like a positive evolution of the Covid virus
Finally, two separate but important risks that are very much on our radar. First, China is still tightening regulation in specific sectors while allowing market forces to generally sort out the property sector while becoming more neutral/supportive on the macro monetary/fiscal policy front. As a result, the credit impulse is becoming increasingly positive, but financial conditions are still a drag. We need a stronger commitment from Beijing on the policy front to give us comfort in any sustainable recovery this year. This is on top of the continual threat of increased lock-downs due to Omicron, as they have yet to truly experience any meaningful wave (which is likely coming).
*Chinese credit growth historically picks up following cuts to RRR
Second, the continued threat Russia now poses not only to energy markets in Europe but potentially to invading Eastern Ukraine cannot be ignored. Although we continue to believe this is longer-term strategic posturing by Putin, who has genuine concerns over NATO’s encroachment and hence delegitimization of his regime, we note the probability of an accidental escalation has notably increased in recent weeks. We are watching current talks between the U.S. and Russia but still see the two sides far apart.
*“It would be well for your government to consider that having your ships and ours, your aircraft and ours, in such proximity... is inherently DANGEROUS. Wars have begun that way, Mr. Ambassador.” – Jeffrey Pelt – Hunt for Red October
In conclusion, the macro backdrop is undoubtedly not as supportive for risk assets as we saw at the beginning of October, which set the grounds for the S&P to rally 13% into year-end. It is, however, not as negative as recent price action dictates. The Fed has a long road ahead before it meaningfully removes liquidity and tightens financial conditions. The urgency to do this will diminish as growth and inflation slow into year-end, and longer-term structural factors return the economy to a more organic state. There is a lot of uncertainty, particularly regarding China and geopolitical risks, but these areas are still generally neutral for risk sentiment and real growth. As a result, we continue to stick with our long positions in our portfolio and advocate dip-buying (yesterday’s lows being a good area to consider now) in what should remain a choppy Q1 trading environment.
Econ Data:
The NFIB Small Business Optimism Index increased slightly in December to 98.9, up 0.5 points from November. 22% of small business owners reported that inflation was their single most important problem encountered in operating their business. 49% of owners reported job openings that could not be filled, an increase of one point from November. 48% of owners reported raising compensation, higher by four points from November and a 48-year record high reading. 57% reported capital outlays in the last six months, up 2 points from November with 29% expecting further Capex outlays. Owners expecting better business conditions over the next six months increased three points to a net -35%, but continue to remain pessimistic about future economic conditions as this indicator has declined 23 points over the past six months.
Why it Matters: The Optimism Index was little changed in December, with concerns about inflation catching up to labor shortages. Price raising activities reached levels not seen since the early 1980s. Labor markets continue to be tight, with half of the respondents reporting the inability to fill openings while plans to raise compensation are at record highs. Overall, the start to 2022 has been less encouraging than hoped for by small businesses, with Omicron exacerbating the shortage of skilled workers and continuing to cap production capacity. However, the near-term outlook is still positive given the level of demand for labor and continuing builds in inventory. Finally, added uncertainty over Fed policy is now adding to the general uncertainty over D.C. and state-level tax policy, weighing on future outlook.
*Inventory builds look to be stabilizing as the holiday season passes; otherwise, most subcategories improved
*Powell cited the rises in the Employment Cost Index (ECI) as the primary reason he supported a faster taper. NFIB compensation plans continue to rise, which has been a strong forecaster of rises in ECI
Policy Talk:
Federal Reserve Bank of Atlanta President Raphael Bostic added to the chorus of Fed officials calling for rate hikes in March and showing greater interest in reducing the Fed’s balance sheet sooner than in the past. Bostic currently supports three interest-rate increases for 2022 in his forecast. “If the numbers continue to come in the way they have over the past several months, I think a March liftoff would be appropriate,” Bostic said. He noted that employment remains more than 3 million below the February 2020 level, but data and widespread anecdotes, including rising wages, suggest a tight labor market. Despite uncertainty in measuring maximum employment, upward compensation pressure “sends a pretty clear signal that we have conditions conducive to a conclusion we are at full employment,” he said. “I really think that this is a good time to move.”
Clevland Fed President Loretta Mester (2022 voter) echoed Bostic this morning in an interview on Bloomberg, calling for a rate hike in March if the current economic momentum holds. She noted that inflation has become more persistent and broader and stressed that accommodation would remain very high even with a March rate hike.
*Despite the recent increases in rate hiking expectations for 2022, it's important to remember the December SEPs with a median of three hikes was before the Omicron uptick, which now has Q1 growth estimates being revised lower.
Finally, Chairman Powell has his nomination hearing in front of the Senate Banking Committee, where he has already released his testimony. He stressed that substantial progress had been made with “the economy is expanding at its fastest pace in many years, and the labor market is strong.” He noted that the financial system was more resilient due to increased capital and liquidity requirements, and the Fed continues to push for a faster payment system and the appropriate regulation to address climate change and cyber risks. He is currently speaking and so far noted he believes the Fed’s balance sheet is “far above where it needs to be,” and balance-sheet runoff later in the year will be warranted.
*Today’s nomination hearing will likely not elicit much new information on where Powell’s policy preferences are
TECHNICALS / CHARTS
Four Key Macro House Charts:
Growth/Value Ratio: Growth is higher on the day and week as Tech/Nasdaq is enjoying a relief rally
Chinese Iron Ore Future Price: Iron Ore futures are higher on the day and week as steel supply continues to drop while sentiment regarding FAI and residential construction turns more neutral
5yr-30yr Treasury Spread: The curve is flatter on the day and the week as Powell calmed fears that long-end Fed selling will be coming soon
EUR/JPY FX Cross: The Euro is stronger on the day and flat on the week and the day
Other Charts:
*The S&P has historically increased at an average of 7.4% the year following the Fed’s first rate hike of a cycle
*Buybacks have been the primary driver of returns since 2011 and are expected to be strong in 2022
*The U.S. Citi Surprise Index is back to 0 after rising in September to November period
*Household wealth certainly correlates well with increases in the Fed’s balance sheet
*The U.S. Consumers have been increasing the use of personal credit lines, helping keep aggregate demand high as stimulus-induced savings falls
*Capex for IT continues to increase while more traditional FAI is now below 50%
ARTICLES BY MACRO THEMES
MEDIUM-TERM THEMES:
Real Supply-Side Improvements:
Fed Studies: New Studies Find Unprecedented Impact from Supply-Chain Turmoil – WSJ
Prices for moving goods by ocean from China to the U.S. West Coast swung more than 72% from an early-pandemic low to a peak in 2021’s third quarter of more than 50% above the long-term trend for container shipping rates, researchers at the St. Louis Fed bank wrote in a recent report. Elsewhere, economists at the New York Fed developed a Global Supply Chain Pressure Index pulling together a range of measures “to provide a more comprehensive summary of potential disruptions affecting global supply chains.”
Why it Matters:
The report is one of the latest in a series of attempts by economic policymakers to assess the impact of supply-chain strains after nearly two years of turbulence during the pandemic, as issues ranging from commodities costs and the availability of raw materials to transportation costs have affected the global economy. We take comfort in the Fed's focus on understanding the inflationary pressures occurring from supply-chain disruptions. It will help reduce fears there as logistics slowly improve over ’22 and shipping costs fall, assuming China does not overreact to any Omicron uptick.
China Macroprudential and Political Loosening:
Updated: China Updates Dozens of Rules for Listed Companies – Caixin
The China Securities Regulatory Commission recently published 21 sets of amended or new regulations related to listed companies, changing or clarifying requirements for their management and the trading of their shares. This comes on top of Beijing implementing a more stringent cybersecurity review process for data-rich companies seeking foreign listings as the Cyberspace Administration of China steps up scrutiny over the troves of data that underpin the growing influence of domestic internet companies.
Why it Matters:
There are two important points to bring up here. First, the delisting of Chinese firms from foreign listings has been generally painful. For example, CNOOC’s mandatory delisting due to being part of the Chinese military-industrial complex caused the domestic share prices to drop and long-term investors to leave. Second, Beijing wants “all the data,” and it is moving aggressively to secure any and all data on its own citizens for its own use and ensure that foreign governments cannot use it against them. This shows how important Beijing believes personal data is and is problematic given how much data they have collected on foreign citizens.
LONGER-TERM THEMES:
National Security Assets in a Multipolar World:
Bad Deal: China applies brakes to Africa lending – FT
From almost nothing, Chinese banks now make up about one-fifth of all lending to Africa, concentrated in a few strategic or resource-rich countries. Annual lending peaked at $29.5bn in 2016, according to figures from the China-Africa Research Initiative at Johns Hopkins University, though it fell back in 2019 to a more modest $7.6bn. This indicates China is moving away from this high-volume, high-risk paradigm into one where deals are struck on their own merit at a smaller and more manageable scale.
Why it Matters:
The recent controversy over a Ugandan Airport highlights the challenges that African governments and Chinese banks face following a 20-year lending spree that has made Beijing the continent’s largest source of development finance. The article elaborates on the potential path forward and the debate about whether China’s lending terms were too punitive. One thing is clear, any soft power China gained from their multi-decade lending to Africa has become diminished due to growing debt servicing concerns.
Practical Use: Quantum advantage is the next goal in the race for a new computer age - FT
The first practical application for quantum computing will officially launch the quantum age. The prospect of finding a practical application for the technology has galvanized the industry in recent months and triggered a competition to be first. The industry’s shift in gear has been prompted by improvements to quantum hardware systems that were announced late in 2021, along with projections of the kind of systems that will be available two years from now. However, there has still been little actual use of quantum computing, given existing limitations.
Why it Matters:
Today’s quantum machines are known as NISQ systems, short for noisy intermediate-scale quantum. Their number of quantum bits, or qubits, is still limited, and the qubits are unable to hold their quantum states for more than a few microseconds, something that introduces errors, or “noise,” into calculations. One widely anticipated use for quantum computers, simulating complex molecules, opening the way to breakthroughs in drug discovery, and exploring new battery technology, is likely to be beyond the scope of the first practical systems and two to three years away. As we have highlighted, any developments here are essential to watch, given the national security implications.
Commodity Super Cycle Green.0:
Green Tokens: Cryptocurrency Traders Move Into Carbon Markets – WSJ
In recent months, millions of credits for offsetting greenhouse-gas emissions have been virtually tied to newly created cryptocurrency tokens and removed from circulation. Some market participants say the technology is bringing transparency and helping create new incentives for projects that benefit the climate, but not everybody is convinced. These credits, each standing for one metric ton of carbon dioxide, come from projects such as planting trees or setting up renewable-energy farms are traded on unregulated markets, fetching different prices depending on the carbon-removal activity.
Why it Matters:
The Taskforce on Scaling Voluntary Carbon Markets, an industry group, says making it easier to trade credits and trace them, such as by recording transactions publicly, would mean more companies could use offsets to meet their climate goals. Some participants in this fast-growing market want more transparency and common rules. An assortment of standards and murky prices make it hard to compare credits and ensure the projects actually benefit the climate. We expect an increase in capital to flow into these tokens, as seen in the increased interest in carbon credit markets elsewhere.
Snapped: Electric Vehicles Drive Growth for China Car Sales – WSJ
China’s car market snapped a three-year decline last year, helped by strong sales of electric vehicles, though the global chip shortage and Covid-19 outbreaks in the country disrupted some production. Sales of passenger cars in 2021 rose 4.4% from a year earlier to 20.1 million vehicles, the China Passenger Car Association said Tuesday.
Why it Matters:
China’s passenger-car market is likely to grow by 5% in 2022. Any growth is likely to come from electric-car sales, with analysts and industry executives expecting sales of internal-combustion-engine cars to remain flat or decline slightly this year. However, the soaring cost of raw materials, especially those used in electric-vehicle batteries such as lithium and cobalt, is likely to loom over the industry.
ESG Monetary and Fiscal Policy Expansion:
Programs: The U.S. to Spend $10 Billion to Boost Small Businesses – WSJ
The State Small Business Credit Initiative will direct $10 billion to states, territories, and tribal governments for programs that provide venture capital or encourage private lenders to issue loans to small firms. The program revives a policy put into place following the 2007-2009 recession when banks cut back on lending to small firms.
Why it Matters:
The rollout comes as other parts of President Biden’s small-business agenda are stalled amid broader uncertainty over the fate of his spending plan for healthcare, education and climate-change programs. The State Small Business Credit Initiative initially will set aside $1.5 billion for businesses owned by socially and economically disadvantaged people. Another $500 million was earmarked for businesses with fewer than ten employees.
Current Macro Theme Summaries:
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