MIDDAY MACRO - 2/15/2022
Daily Color on Markets, Policy, and Geopolitics
MIDDAY MACRO - DAILY COLOR – 2/15/2022
OVERNIGHT-MORNING RECAP / MARKET WRAP
Price Action and Headlines:
Equities are higher, with all sectors but energy rising on the day thanks to more positively perceived developments between Russia and Ukraine
Treasuries are lower, with the long-end under notable pressure due to the more risk-on tone and hotter than expected PPI print
WTI is lower, as reduced geopolitical fears and better optics regarding Iran negotiations are causing a retracement of recent gains
Narrative Analysis:
Equities are higher, with European bourses leading the way as overnight headlines indicated a de-escalation in the current Russia-Ukraine situation. Today’s economic data is helping small-caps outperform as the Empire State Survey reduced margin pressure concerns while a hotter than expected PPI has the Treasury curve bear steepening, causing some retracement of overnight gains in the Nasdaq. Oil is under significant pressure due to the reduced geopolitical risk premium, while the dollar is also lower due to the more risk-on tone.
The Russell is outperforming the Nasdaq and S&P with Small-Cap, Momentum, and Growth factors, and Consumer Discretionary, Technology, and Materials sectors are all outperforming.
S&P optionality strike levels have the Zero-Gamma Level lower to 4557 while the Call Wall is at 4700. The current gamma buildup seems heaviest at 4400 and 4500 levels. The market is quite fluid and driven by negative gamma and vanna flows in this range. An extended rally fueled by declining implied volatility and put decay could push markets back up into the 4520-4550 area, which is where heavy resistance was last week.
S&P technical levels have support at 4430, then 4395, and resistance is at 4460 (220dma), then 4500. After a move back into a higher range overnight, the S&P is now basing for a further move back into the 4500s given momentum. However, resistance at the 200dma around 4460 level held. This level needs to be recaptured quickly, or this is a fake bull bounce.
Treasuries are lower, with the 10yr yield now at 2.047%, rising 5bps today, while the 5s30s curve is steeper by 5.2 bps to 42.3bps.
The situation between Russia and Ukraine has moved to the forefront of traders’ minds as a barrage of headlines and developments is keeping markets volatile. We continue to believe an invasion of the Donbass region is the highest probability outcome but by no means assured. As a result, we expect markets to remain hyper-sensitive to related headlines with the “fog of war” still being relatively thick.
Russia’s goals remain to achieve a political settlement on Ukraine not joining NATO and Donbass becoming a more Russia-influenced autonomous region. This will further call into question the credibility of Western U.S.-led collective security guarantees without starting a real war and losing access to international markets. Putin is playing 3D chess on a multi-decade timeframe, and this is just one more move in his longer-term game plan.
*The real area at risk is Donetsk and Luhansk, with the majority of residents being more Russian speaking/orientated
An invasion in the immediate (before February 20th) seems unlikely for several reasons. Russia continues to want to negotiate, with their demeanor being more business-like than an aggressor. The removal of U.S. personnel/assets from Ukraine reduces the risk of American casualties and was a major complaint (against “trainers”) from Russia. Furthermore, there has been no additional request for a NATO response force or any blockade of the Sea of Azoz.
*'We don't want war in Europe' Putin says in talks with German Chancellor Scholz today. Where does the Kremlin get all these long tables?
More anecdotally, the Russian media is behaving differently than it did before the Crimea invasion, where it prepared Russian citizens more extensively verse now, where it has Russia increasingly looking like the victim. Furthermore, there is significantly less effort by the military to hide and secure its assets. It almost seems as if Russia wants everyone to see all their “toys”, not something one would be doing if a full war effort was underway.
*Daily headlines in RT News have a significantly different feel than the lead up to the annexation of Crimea
*Anyone with a Twitter account can find out where Russia’s build-up of tanks/troops have been with medical and logistical and leadership camps now even being known
However, several things indicate that an invasion of the two regions in the part of Ukraine known as Donbass may eventually still occur. Russia's parliament, the Duma, voted on Tuesday to ask Putin to recognize two Russian-backed breakaway regions in eastern Ukraine as independent, choosing not to consult the Russian Foreign Office before forwarding the appeal to the president.
*The recently passed bill targeting the official recognition of the Donbass region as independent was expected to go to FM Lavrov for amendments. The fact it didn’t is a negative development
Stepping further back, the removal of NATO and U.S. assets opens up Ukraine to a more open conflict. Secondly, the level of military hardware and their positioning continue to indicate some level of incursion is likely given the costs incurred to move the military assets there so far. Finally, delaying beyond February will cause Russia to lose leverage. The season and current energy crisis support action sooner than later.
*Although reports indicate 10k troops are heading back to bases in Russia, the situation on the ground still leaves amble assets to make moves
Finally, Putin cannot look “deterred,” as his credibility among the Russian people is on the line given the size of the military buildup and the need to deflect/distract from Covid and economic (inflationary) hardships at home.
*When a countries future is all in the hands of one person, that person cannot look weak, especially when it is an authoritarian regime
There are several things to watch moving forward in the following days/weeks:
If the U.S. supplies further weapons (escalatory)
Whether Normandy Format negotiations are rescheduled (de-escalatory)
Whether Moscow engages in any confidence-building measures such as further reduction of troop levels or the Vienna Document to identify unusual troop movement (de-escalatory)
Moscow’s formal response to the U.S. / NATO “non-letter” and Biden’s other offers
Whether Ukraine is willing to change its official doctrine that Crimea should be returned by force or its position on joining NATO (de-escalatory)
And to a lesser degree, where oil prices go and how JCPOA 2.0 negotiations evolve (whether Russia is at the table)
*The removal of U.S. military trainers and no further influx of weapons would be a good sign that the situation is de-escalating
Putting it all together, it is clear that the situation is far from clear or over, and developments over the following days/weeks will be critical to how markets interpret whether an incursion/invasion is coming. We were encouraged by further reports of “business-like” behavior by the Russian side today in meeting with Germany in Moscow. This counters the passage/developments around the “Donbass Bill” yesterday in the Duma. As a result, we continue to believe an incursion/annexation of Donbass is still the most likely outcome but by no means assured. We also believe the long-term effects on markets will be minimal after an initial increase in cross-asset volatility if there is an invasion. Admittedly, this is not the most helpful analysis but we wanted to highlight developments and what to watch for.
*Accusations of a “genocide” of Russians in Donbass will be the ultimate reason Putin uses for an invasion which he will say is needed to save his fellow “countrymen” in that region, but after that, Russia will be hard-pressed to find reasons for further invasion
ADMINISTRATIVE NOTE IN APPENDIX
Econ Data:
Producer prices jumped 1% month-over-month in January, following an upwardly revised 0.4% rise in December and double the market forecasts of 0.5%. Cost of goods increased 1.3%, rebounding from a 0.1% fall in December, mainly due to motor vehicles and equipment (0.7%), food (1.6%), and energy (2.5%). Prices for services advanced 0.7%, the same as in the previous month, namely hospital outpatient care prices (1.6%). Annual producer inflation edged lower to 9.7%, easing slightly from a 13-year high of 9.8% in the previous two months but above market forecasts of 9.1%.
Why it Matters: Not a great sign for the direction of CPI as it takes some time for PPI to push/pull on the end consumer prices. When coupled with today’s Empire State survey, which showed a drastic increase in Prices Received, indicating firms continue to have success passing on costs, we now question whether we will see a plateauing and decline in CPI in the coming months as previously expected. Alongside the lack of any moderation in annual rates, the three-month rates are very rapid, with the core PPI, for example, up 8.5% at an annual rate between October and January. Also, pipeline prices (intermediate demand processed and unprocessed goods) continued to surge. This report was a big deal, and we are surprised it didn’t elicit more of a negative price response, given that the recent CPI only reflected some of the PPI pricing pressures reported today.
*With a reacceleration in PPI, it is hard to see CPI meaningfully declining until things change at “the gate”
The New York Empire State Manufacturing Index rose to 3.1 in February from -0.7 in January, below market expectations of 12.15. New Orders (3.1 vs. -0.7 in Jan) and Shipments (1.4 vs. -5) bounced back, and Unfilled Orders (14.4 vs. 12.1) continued to increase. Delivery Times (21.6) were unchanged. Labor market indicators pointed to a solid increase in employment and a longer average workweek. The Prices Paid sub-index was little changed and remained near its recent peak, and the Prices Received index reached a new record high. Plans for capital and technology spending remained strong. Looking ahead, while firms generally expect conditions to improve over the next six months, optimism over future business conditions dipped to its lowest level since mid-2020.
Why it Matters: Although the report showed broad-based improvement in February, the post-Omicron bounce back was less than expected. There was no real improvement in the supply-side orientated indicators we often highlight. Margin pressures were reduced, with firms showing a strong ability to pass on price increases while prices paid stabilized. Finally, the weakness in future outlook indicators shows that inflation continues to cloud and weaken confidence. However, expected price measures did fall while expected Capex and technology spending only marginally decreased. The majority of the general business condition decline came from declines in inventory expectations, indicating that the inventory restocking cycle may be peaking.
*Although missing expectations, activity bounced back from January lows in the NY region with broad-based sub-index improvements
*Prices Received took a notable tick higher while Prices Paid decreased, indicating profit margins expanded for survey respondents in February. Future expectations for both decreased, as seen above.
Policy Talk:
In an interview last Friday, Kansas City Fed President Esther George said expanding the Fed's asset portfolio or using quantitative easing makes removing accommodation more complicated, especially when raising interest rates and selling bonds at the same time. "There was an explicit recognition that introducing quantitative easing was going to complicate monetary policy," she said. "So I don't think we can avoid the complexity that has come with a decision to deploy this tool. At the same time, she added, "what you don't want to do is oversteer here." The comments complimented the last FOMC meeting’s “statement of principles” for managing a reduction of the balance sheet. The principles said the Fed would primarily rely on the Fed Funds rate as the primary way it adjusts its policy setting. The statement also called for primarily reducing the bond portfolio passively by allowing securities to mature without replacing them. Ms. George said she hadn't yet formed a view over how much the Fed would need to raise interest rates this year. "What we have to do is be systematic," Ms. George said. "It is always preferable to go gradual...Given where we are, the uncertainties around the pandemic effects, and other things, I'd be hard-pressed to say we have got to get to neutral really fast." She noted that it would likely be appropriate to sell MBS holdings over Treasuries which she seemed more inclined to let mature naturally.
*Esther George is coming across as more dovish than her reputation suggested in recent interviews
St. Louis Fed President James Bullard followed up his last Friday’s performance by telling CNBC yesterday, “we need to front-load more of our planned removal of accommodation than we would have previously. We’ve been surprised by the upside on inflation.” He is worried that inflation expectations are getting away from the Fed. “Our credibility is on the line here, and we do have to react to the data,” he added. “However, I do think we can do it in a way that’s organized and not disruptive to markets,” Bullard said, adding that Fed should raise the Fed Funds rate by an entire percentage point by July. “I think my position is a good one, and I’ll try to convince my colleagues that it’s a good one,” he said. Regarding the 7.5% consumer inflation rate in January, Bullard said, “my interpretation was not so much that report alone, but the last four reports taken in tandem have indicated that inflation is broadening and possibly accelerating in the U.S. economy.” In keeping with the Fed’s ESG tilt and focus on minority and lower/moderate-income families, he highlighted the damage inflation was doing. “The inflation that we’re seeing is very bad for low- and moderate-income households,” he said. “People are unhappy, and consumer confidence is declining. We have to reassure people that we’re going to defend our inflation target, and we’re going to get back to 2%.” Bullard, funny enough, went from calling for more stimulus than most at the beginning of the pandemic to now being one of the most hawkish members. As a voter, he does have some weight, explaining why the markets reacted so decisively to his comments last Friday. However, he did say he would defer to the Chairman, reducing the odds of as decent.
*Picture of an unpopular guy right now in the bull camp
TECHNICALS / CHARTS
Four Key Macro House Charts:
Growth/Value Ratio: Growth is higher on the day and the week. Small-Cap Growth is the best performing size/factor on the day.
Chinese Iron Ore Future Price: Iron Ore futures are lower on the day and week. Beijing has increasingly signaled it means to push back on speculation in industrial metal markets, spooking traders.
5yr-30yr Treasury Spread: The curve is steeper on the day and week, with the long-end under more pressure due to the general risk-on tone.
EUR/JPY FX Cross: The Euro is higher on the day and the week, as reduced fears of a Russian invasion of Ukraine have it outperforming the more safe-haven orientated Yen
Other Charts:
Cross-Asset volatility is clearly elevated, led by the MOVE index
China Tech is outperforming U.S. Tech due to easier domestic liquidity, a receding government crackdown, and historically low valuations, but earnings growth will be challenged
There have been large outflows from cash and money market funds, but where is it going?
The Fed's Global Supply Chain Pressure Index continues to fall, indicating improvement in global logistics.
TSA Checkpoint travel numbers have recovered halfway back to pre-pandemic levels
ARTICLES BY MACRO THEMES
MEDIUM-TERM THEMES:
Real Supply-Side Improvements:
Worse: Chip backlogs stretch to 2 years, vexing Sony and electronics makers – NikkieAsia
Lead times for chip orders in February grew five to 15 weeks longer than in October, according to U.S. electronic component distributor Sourcengine. As a result of the delays in chip supplies, production for certain electronics is again capped in Japan. This shortage is causing manufacturers to bolster chip inventories to avoid such production cuts, stoking demand and causing the “shortage” feedback loop to continue.
Why it Matters:
We highlight this not as a sign things are improving, although chipmakers are responding by boosting supplies, with wafer shipments increasing 14% in 2021, but as a sign that future gluts in supply may be coming. The buildup in chip inventory by manufacturers may, in part, eat into future demand. A sales slump in the products that use the chips would result in a supply gut, underscoring the fragility of the current dynamics.
China Macroprudential and Political Loosening:
Looser: PBOC Pumps in More Liquidity, Spurring Gains in Chinese Stocks - Bloomberg
Chinese banks in January extended a record amount of loans after the PBOC lowered borrowing costs for the first time since 2020 last month. The People’s Bank of China injected a net 100 billion yuan ($15.7 billion) into the banking system with its medium-term lending facility while leaving the borrowing rate unchanged.
Why it Matters:
The latest move, seen as a prelude by many to further easing, comes as the economy struggles with repeated Covid outbreaks, a slowdown in the property sector, and signs of weak domestic demand. “This sends the signal from the PBOC that it’s still willing to keep liquidity conditions quite ample and market rates at relatively low level to support credit demand,” said Zhi Xiaojia, an economist at Credit Agricole CIB in Hong Kong. “There is room for further policy actions in 1H, including both RRR and policy rate cuts, as growth pressures remain, especially in the property sector and related to private consumption demand.”
Evolving: China’s Approval of Pfizer Pill Opens Door to Ending Covid Zero – Bloomberg
Pfizer’s Paxlovid’s conditional approval over the weekend makes it the first foreign pharmaceutical product China has endorsed for Covid-19. Paxlovid’s approval also eases concern that China, the world’s second-biggest pharmaceutical market, was actively avoiding foreign treatments when it came to Covid.
Why it Matters:
China’s surprise decision to clear Pfizer Inc.’s coronavirus pill for use offers rare insight into how Beijing may be planning to move beyond the Covid Zero strategy and gradually give way to a more flexible approach. “It creates favorable conditions for a return to normal on the Chinese mainland, including exchanges with the rest of the world,” Nomura’s Analyst Zhang said. “But more details need to be learned.”
LONGER-TERM THEMES:
National Security Assets in a Multipolar World:
Needed: Russia could hit U.S. chip industry, White House warns - Reuters
Peter Harrell, who sits on the White House's National Security Council, and his staff have been in touch with members of the chip industry in recent days, learning about their exposure to Russian and Ukrainian chipmaking materials and urging them to find alternative sources, the people said. According to a market research group's report, over 90% of U.S. semiconductor-grade neon supplies come from Ukraine, while 35% of U.S. palladium is sourced from Russia.
Why it Matters:
Neon is critical for the lasers used to make chips, is a bi-product of Russian steel manufacturing. It is purified in Ukraine. Neon prices rose 600% in the runup to Russia's 2014 annexation of the Crimean peninsula from Ukraine since chip firms relied on a few Ukrainian companies. Palladium is used in sensors and memory, among other applications. The price of palladium futures has significantly risen in recent weeks. The bottom line is that any prolonged conflict that disrupts production/trade would increase already rising costs/prices for chips.
Growing: China’s biggest chipmaker SMIC posts record revenue despite U.S. sanctions - CNBC
SMIC recorded 2021 revenue of $5.44 billion, up 39% year-on-year, the fastest growth rate since 2010. Profit came in at $1.7 billion, marking a 138% year-on-year rise. SMIC is also continuing to invest heavily, and the Company said that it plans to spend the equivlant of $5 billion in investment capital as it tries to get three new plants off the ground in Beijing, Shanghai, and the southern Chinese city of Shenzhen. The Company said that it would add more production capacity in 2022 than it did in 2021.
Why it Matters:
That record performance came despite SMIC being put on a U.S. trade blacklist called the Entity List in 2020. “The global shortage of chips and the strong demand for local and indigenous manufacturing brought the Company a rare opportunity, while the restrictions of the ‘Entity List’ set many obstacles to the Company’s development,” SMIC said in a statement. The bottom line is that despite losing access to needed technologies to make advanced semiconductors, SMIC and Beijing are powering ahead with domestic development, reducing the leverage western nations have on the industry/country.
Electrification and Digitalization Policy:
Face-Off: Texas Sues Meta Over Facebook’s Facial-Recognition Practices – WSJ
The Texas attorney general filed a suit against Facebook on Monday, charging that the social-media giant’s longstanding and now discontinued use of facial-recognition technology violated that state’s privacy protections for personal biometric data. In a statement, Mr. Paxton said the company’s capture of facial geometry in photographs that users uploaded from 2010 to late last year resulted in “tens of millions of violations” of Texas law.
Why it Matters:
Facebook previously settled another lawsuit over its facial-recognition practices for about $650 million. That class-action suit filed in 2015 was brought under Illinois’s biometric privacy law, which is similar in some respects to the Texas law. Both laws require individuals’ consent before their biometric identifiers can be captured. The Texas lawsuit, in particular the size of the civil penalties being sought, points to the impact that increasingly widespread privacy laws could have on big tech companies’ operations.
CyberPunks: How Russia Has Turned Ukraine Into a Cyber-Battlefield – Foreign Affairs
Since 2014, hackers affiliated with the Russian government have interfered in Ukraine’s elections, targeted Ukrainian government agencies and private-sector companies with destructive malware, and carried out cyberattacks against electric utilities that caused widespread power outages. In recent weeks, the Ukrainian government has been hit by a series of cyberattacks (possibly conducted with the support of the Kremlin) that defaced government websites and wiped out data on some government computers.
Why it Matters:
Operations in cyberspace will not by themselves be enough to achieve Putin’s ultimate objective of bringing Ukraine firmly into Russia’s sphere of influence and preventing NATO from expanding into Russia’s backyard. But cyber-operations can give Moscow a battlefield advantage, frustrate Ukrainian efforts to respond militarily to an invasion, and sow division and confusion among the Ukrainian public, all of which bodes ill for Kyiv. In addition to giving Russia a military advantage, this type of cyber-espionage operation could also help Russia prepare for an eventual occupation of parts of Ukraine.
Commodity Super Cycle Green.0:
HYDRO: Hydrogen Cars and Buses Seize the Spotlight at Beijing’s Winter Olympic Games - Bloomberg
More than 1,000 hydrogen vehicles are traversing the streets of Beijing and Zhangjiakou, where ski jumping and snowboarding events are being held. The vehicles include more than 800 buses from automakers, including Beiqi Foton, Geely, and Yutong. Toyota’s hydrogen-powered Mirai cars and Coaster vans are also running through the Olympic venues, ferrying athletes and Olympic staff. Compared to EVs, whose batteries can drain faster in cold weather, hydrogen-powered vehicles are better suited for wintry climates.
Why it Matters:
The use of hydrogen vehicles at the Olympics could herald what’s to come in the future. While most global automakers, from Volkswagen to Ford to General Motors, toss tens of billions of dollars toward pivoting to battery-electric vehicles, you can’t underestimate the ability of the Chinese state when it throws its political and administrative power behind a new industry. We highlight this under our Green.0 section to highlight that the future will have a combo of various “green” energy sources for transportation depending on the conditions on the ground.
ESG Monetary and Fiscal Policy Expansion:
Greenfrastructure: The U.S. readies funding for clean hydrogen, concrete – Argus
The US Energy Department today launched a public input process to guide how it should spend up to $9.5bn the 2021 infrastructure law set aside for funding "clean" hydrogen projects over the next five fiscal years. The US Transportation Department is separately working on an effort to encourage federal transportation projects to make use of low-carbon concrete, asphalt, and other construction materials.
Why it Matters:
The injection of billions of dollars in funding will encourage the innovations needed to cut emissions in hard-to-decarbonize sectors like steel production and cement, administration officials say. The White House has increasingly focused on climate-related funds in the bipartisan infrastructure law, as regulatory initiatives get bogged down in court and Democrats show no signs of being close to passing a sprawling budget bill with an estimated $555bn in funding for clean energy and climate change.
Due to our goal to produce a value-adding experience, we will be producing the Midday Macro newsletter only twice or three times a week (something already occurring but we now formally acknowledge) The off days will be used for deeper analysis of relevant topics/themes. We currently find ourselves resource/time-constrained to produce a daily at the level we believe adds real value to our target audience, the sophisticated retail investor.
Thanks for reading as always,
Mike
Current Portfolio Results:
Current Macro Theme Summaries:
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