MIDDAY MACRO - 1/5/2022
Daily Color on Markets, Policy, and Geopolitics
MIDDAY MACRO - DAILY COLOR – 1/5/2022
OVERNIGHT-MORNING RECAP / MARKET WRAP
Price Action and Headlines:
Equities are lower, with similar price action continuing today as tech/growth is again under pressure while more cyclical sensitive sectors are outperforming, helped by a stronger than expected ADP report
Treasuries are lower, with the belly underperforming, giving a slight pause to the steepening of the curve
WTI is higher, helped by the passage of the OPEC+ meeting and U.S. inventory data showing a larger than expected drawdown
Narrative Analysis:
The S&P continues to chop around in its post-X-mas day rally range with the tech sector and growth factor again underperforming. A stronger-than-expected ADP report increased expectations for Friday’s jobs report and further emboldened the growing view that economic growth will be stronger and the Fed may reach its employment mandate sooner than initially expected. Treasuries continue to be under pressure, in line with the strengthening growth/Fed narrative. Despite the recent back-up in real rates, the DXY is drifting towards the lows of its recent range.
The S&P is outperforming the Russell and Nasdaq with High Dividend Yield, Value, and Small-Cap factors, and Materials, Energy, and Utility sectors are all outperforming.
S&P optionality strike levels have the Zero-Gamma Level moved higher to 4770 while the Call Wall fell to 4800. The 4800 level is still the largest gamma strike, with support around 4780. Resistance lies at 4815 and 4830. The Call Wall falling to 4800 is a bearish development, indicating limited upside call appetite with traders more focused on the sectorial rotation.
S&P technical levels have support at 4770, then 4745, and resistance is at 4815, then 4845. The S&P continues to be stuck in a chop/basing mode, with the overall trend higher as long as price action is above 4745.
Treasuries are lower, as the selling pressure resumed following a stronger than expected ADP report after some end-of-day strength and consolidation overnight. The 5s30s curve is flatter by 1.7bps to 69.2bps.
Markets continue to look through the current Omicron wave that has renewed supply-chain fears, delayed office reopenings, and caused lockdowns globally while also becoming more comfortable with future Fed policy as an improving outlook on economic fundamentals is increasing needed term premium and causing a rotation into more cyclical oriented sectors/factors.
Increases in real yields have primarily driven the move higher in longer-dated Treasury nominal yields as growth expectations are increasing due to the market becoming less concerned with Omicron and more comfortable the Fed won’t raise rates too restrictively.
*10yr real yields are higher by 11 bps YTD, explaining around 90% of the move in 10yr nominal yields
The cross-asset class performance further confirms the improved real growth outlook over the last two days with cyclical orientated sectors such as financials, energy, industrials, outperforming technology, health care, and utilities. More generally, Small-cap value has outperformed large-cap growth.
*While still well within a year-long up channel, the Nasdaq has been underperforming the Russell post-Christmas
Improved growth outlook and reduced Fed policy error fears can be best seen in the rise in medium-term rates in the future, as measured by five-year forward five-year real rates, a favorite measure of inflation expectations for the Fed, which have risen close to +25bps YTD, moving the 5yr5yr forward real rate to around -80bps.
*5yr5yr forward real yields, one of the Feds favorite measures of inflation expectations, increased around +25bps YTD
In our last daily newsletter in December, we highlighted that we believed growth, especially Q1, was being downgraded too far based on Omicron and Fed fears, and it looks like markets now agree. There are certainly still headwinds in play from both Omicron and Fed coupled with other macro risks that will keep cross-asset volatility volatile. Still, nominal Treasury yields need to rise further to reflect the momentum of the real economy and a more neutral/tighter fed policy, and rises in real rates will drive this.
*JPM’s 10-yr Treasury Fair-Value model sees yields -35bps too low given where other variables currently are
However, with the above all said, we do not yet see a compelling case to chase this move out of more defensive/growth names into more cyclical/value ones, although we did position for it at the end of December. As we stated, persistent elevated cross-asset volatility will allow for a more tactical trading environment in Q1. We have a greater conviction in this view based not only on the macro backdrop but also on current seasonals, which are negative for Treasuries and more mixed for equities.
*The S&P historically doesn’t meaningfully rally until mid-March, and given its strong adherence to seasonal factors last year, we see this as a headwind currently
This “choppier” environment will persist until we have clarity on a few things:
How quickly Omicron peaks and its effect on global supply-chains, particularly China and South East Asia, and hence inflationary pressures through that channel. If the current wave peaks by mid-January (globally), we believe the hit to growth and disruptions to logistics will be minimal.
*The CDC is reporting 78.4% of people 5yrs+ have at least one vaccination shot, causing the current wave to send far fewer as a percent of cases to the hospital
Whether the Fed’s “maximum employment” criteria will be met in the spring, making March a live meeting for a rate hike, cementing four hikes in 2022, and moving forward expectations when quantitative tightening starts. This Friday’s job report will shed further light on whether the participation rate improved further after increasing last month.
*The Fed is using many measures to gauge the labor market, and Powell characterized conditions as “tight,” but EPOP, or the participation rate of prime-age workers, holds more weight than other measures
Is Beijing committing to easing policy meaningfully, or will it continue its “Common Prosperity” regulatory crackdowns? There have certainly been signs of a course change, but it is still very much a “two feet forward, one back” environment causing financial markets to continue to be skewed to the downside. If global growth is to gain meaningful momentum and risk assets to rally further, China will need to be a more positive pulse.
*Any improvement in global risk sentiment will depend on the Chinese economy and financial markets having a more positive tone
The bottom line is developed world consumers are strong enough to keep demand constructive in 2022 while emerging markets should begin to further recover from a more severe pandemic drag. Still, risk assets, particularly in the U.S., are stretched and, in many ways, priced to perfection. Markets need to have greater clarity on real growth and how quickly/severely financial conditions will tighten. This won’t occur until the Omicron “fog-of-war” lifts, and the Fed clarifies its balance sheet policy intentions. While the effects of Omicron will be clearer sooner, Fed policy will likely not be clear until March, supporting higher volatility till then.
*The consumer keeps getting head faked as new waves of Covid stop the full reopening of the economy and continue to create inflationary pressures
TECHNICALS / CHARTS
Four Key Macro House Charts:
Growth/Value Ratio: Value is higher on the day and week as sector rotation continues to occur due to rising yields, helping Mid-Cap Value be the best performing size/factor for a second day
Chinese Iron Ore Future Price: Iron Ore futures are higher on the day and week despite weakness in domestic equities there, attempting to break out of its longer-term downtrend
5yr-30yr Treasury Spread: The curve is flatter on the day and steeper on the week as ADP weighed heaviest on the belly
EUR/JPY FX Cross: The Euro is stronger on the day and week and the day despite the EZ PMI Composite showing the weakest growth since March
*Implied volatility in Treasury markets is not surprisingly elevated relative to equity volatility levels
*ISM Prices Paid sub-index lead the Headline CPI by around 3-month and the recent sharp decline is now historically more consistent with inflation nearer to 3%
*Traditional lending to businesses is finally starting to pick up and resume the pre-pandemic trend
ARTICLES BY MACRO THEMES
MEDIUM-TERM THEMES:
Real Supply-Side Improvements:
Revising Plan: Shippers Plan New Strategies, Stopgap Measures to Ease Freight Pain – WSJ
Businesses rattled by high logistics costs and freight bottlenecks are extending the workarounds they adopted during the pandemic and taking on new strategies to ease their supply-chain pain in the new year. Some are extending their use of stopgap measures, such as storing goods in idle truck trailers, while others are making deeper efforts to wring additional capacity from strained distribution networks or trim costs by sourcing products and raw materials closer to home.
Why it Matters:
With the seasonal rush fading, the tactics companies undertook during 2021 remain pressing because shipping rates are expected to climb further in 2022 as robust U.S. consumer spending pushes ongoing strong freight demand and the supply-chain crunch. The article gives numerous examples of some of the measures smaller to mid-size firms are taking to mitigate the logistical challenges.
China Macroprudential and Political Loosening:
Sustainable: Lockdown of Chinese City Leaves 13 Million Stranded – WSJ
A week and a half into one of the biggest pandemic lockdowns in China, residents of Xi’an voiced desperation online about challenges in getting food and medical care. Omicron has yet to make significant inroads in China. When Xi’an first locked down, officials said the recent wave of infections had been caused by the Delta variant. That is still the case, a national health official told state media on Tuesday.
Why it Matters:
Online complaints of tens of thousands of stranded residents show how local officials must weigh the costs of extreme restrictions, such as rolling lockdowns and mandatory quarantines, against the benefit of keeping the case count low, in what Beijing calls a zero-tolerance Covid-19 strategy. We believe that Beijing will have to eventually pivot from its zero-tolerance stance to a more practical “learning to live with it” one. However, as with all things regarding authoritarian states, leadership can not look wrong. Beijing will need to craft a policy evolution better reflecting the lower severity of the virus now.
Safer: Chinese banks cut back traditional lending as concern over economy mounts – FT
Chinese banks rushed to meet their annual state-imposed lending quotas last month by buying up low-risk financial instruments rather than issuing loans. The rise in demand for banker’s acceptance bills, which are technically classified as loans but yield very little, imply that banks preferred to lose money on low-yielding bills rather than risking greater losses by issuing their own loans at higher rates of interest.
Why it Matters:
Beijing wants banks to lend more, especially to small and medium-sized enterprises in government-favored sectors such as agriculture and new energy vehicles. Banks are reluctant to do so, however, because they believe China’s slowing economy has reduced the pool of qualified borrowers. We believe regulators will now pressure banks to forgo the banker’s acceptance option and do direct lending.
LONGER-TERM THEMES:
Electrification and Digitalization Policy:
e-CNY: China Launches Digital Yuan App in Pilot Cities Nationwide - Caixin
China has launched a smartphone app for making payments and transfers with the digital yuan, as the country plows ahead with tests of its central bank digital currency. The app is now open to users in 12 cities and regions, including Shenzhen, Suzhou, Chengdu, and Shanghai, as well as the hosts for the upcoming Winter Olympic Games, Beijing, and Zhangjiakou.
Why it Matters:
The central bank has been developing the digital yuan since 2014. Mu Changchun, head of the PBOC’s digital currency research institute, said in early November last year that 140 million individual and 10 million corporate digital-yuan wallets had been created, and transactions in the digital currency reached around 62 billion yuan. No date has been announced for a full rollout. Mu has repeatedly stated that the digital yuan is a replacement for cash and is centrally controlled by the PBOC.
Commodity Super Cycle Green.0:
Mandates: EPA hears two-sided protest to blending mandate changes – Argus
U.S. refiners and biofuel groups today renewed respective arguments against the U.S. government's handling of renewable fuel blending standards, following a pivotal policy update issued in early December. The EPA's latest update attempted to strike a balance between the interests of refiners and biofuel producers but ended up potentially overstepping their authority
Why it Matters:
The EPA's early December proposal included a few policy changes favorable to the development of US renewable fuel industries, including a less friendly approach to exemption waivers historically granted to small petroleum refiners looking to avoid compliance with blending standards. But the agency overstepped its "legal authority" by proposing a retroactive cut to 2020 renewable fuel blending percentage standards originally finalized in late 2019 and lower-than-expected standards for 2021, biofuel advocates argued in a virtual hearing today.
No More: Global exodus from fossil fuel holdings tops 1,500 institutions - NikkeiAsia
More than 1,500 pension funds, universities, and other organizations around the world have announced that they will divest from fossil fuel assets, doubling from five years earlier and underscoring the surge in sustainable investing. These institutions have roughly $40 trillion in assets under management.
Why it Matters:
As of the end of December ‘21, 1,502 groups had announced they would partly or fully divest from fossil fuel companies, according to figures from international environmental organization 350.org and elsewhere. The count is up by 195 from the end of 2020, the biggest rise in three years. We highlight this to point out the continuation of the existing ESG trend and its effects on fossil fuel investment.
Current Macro Theme Summaries:
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