MIDDAY MACRO - 2/25/2022
Color on Markets, Policy, and Geopolitics
MIDDAY MACRO - DAILY COLOR – 2/25/2022
OVERNIGHT-MORNING RECAP / MARKET WRAP
Price Action and Headlines:
Equities are higher, with value and cyclical factors/sectors leading the way in what started out as a short-covering relief rally yesterday that is now gaining more traction as technicals and optionality become more supportive
Treasuries are lower, with a more risk-on tone and inline PCE inflationary data helping to reverse earlier overnight gains with the 10yr back at the key psychological 2% level
WTI is lower, as no new energy-specific sanctions and continued expectation for an Iran deal are causing a further reversal in the invasion driven rally
Narrative Analysis:
We have been reluctant to put pen-to-pad given the high level of cross-asset volatility and general uncertainty of the situation in Ukraine. With that said, two things are clear, Ukraine continues to fight, and risk-assets are bouncing. What started in a more growth/tech-positive way yesterday has turned into a broader rally as expectations for reduced central bank tightening and failure to impose the harshest retaliatory sanctions have created a more supportive backdrop. Commodity markets and implied volatility measures support the idea that the worst-case scenario is not occurring despite the Ukrainians fighting for their lives. Market implied inflation measures have come off highs while Treasuries are increasingly focusing back on the Fed rather than receiving a flight-to-safety bid. Oil is back around $90 rather than $100, reentering its monthly range after a brief spike. The dollar continues to benefit from the heightened geopolitical risk, although the Euro has made a speedy recovery from yesterday’s lows.
The S&P is outperforming the Russell and Nasdaq with High Dividend, Value, and Low Volatility factors, and Material, Financials, and Health Care sectors are all outperforming.
S&P optionality strike levels have the Zero-Gamma Level lower to 4420 while the Call Wall is at 4600. Implied vol is not dropping as much as the strong positive price action would suggest, showing that demand for downside protection remains. However, yesterday's high level of put selling looks to be continuing today, helping the short-covering rally continue and moving the S&P closer to the zero-gamma level.
S&P technical levels have support at 4340, then 4260, and resistance is at 4395, then 4450ish. Things are moving fast, and a major bottom may have formed as the neckline of the longer-term head-and-shoulder formation was recaptured. However, the trend channel is still down, with the 4450 area now being the critical breakout zone.
Treasuries are lower, reversing overnight gains with the 10yr yield now at 2%, rising 3bp, while the 5s30s curve is flatter by 1bps to 40bps.
Deeper Dive:
Putin may be having buyer's remorse as Ukraine looks to be putting up a stronger defense than initially expected. However, we are still in the very early stages of what could potentially be a very long-lasting conflict. We don’t believe there is now a diplomatic off-ramp as Putin cannot accept anything other than a decisive victory. As a result, the outcome of the war in Ukraine will create a new Putin-era, or the Western-led rules-based order system will prevail. Until the outcome is clear, markets will continue to be headline-driven, although we expect the longer the conflict continues, the less impactful it will become to price action, especially as energy sanctions have yet to materialize.
The slate of the latest sanctions imposed by the “West” is serious and will significantly impact the Russian economy. These sanctions are a combination of additional export controls, deny access to critical technologies/inputs needed for defense purposes, and financial blocking sanctions that are more damaging than the loss of SWIFT access, which is still on the table but ultimately not as impactful as targeting individual financial institutions.
*The list of countries imposing sanctions will likely grow, but more importantly are the countries staying out of it, such as India and China
We still have not seen any sanction on the Russian Central Bank or energy exports, with Europe continuing to buy natural gas through Ukrainian pipelines today. Europe’s need for natural gas and oil is delaying/denying the implementation of what would be a truly revenue-destroying action for the Kremlin. At this point, the longer the conflict continues, the less likely these sanctions will be implemented as Europe refuses to go all-in (not to mention the carve-outs for diamonds and luxury goods in the current enacted sanctions)
*Russian gas supplies through Ukraine jumped almost 38% on Thursday and are expected to increase further by about 24% on Friday, according to data from Ukraine’s grid operator.
Looking forward, we are watching for how long Kiev can hold out, the level of civilian casualties there and elsewhere in Ukraine, and the level of Russian fatalities to determine if the conflict's momentum/trajectory is changing. It is still our base case that Russia will eventually annex all of Ukraine. However, Russia is failing to achieve tactical goals relatively early in the campaign and looks somewhat disorganized given how long they had to plan/prepare. Troop morale is reportedly lower than expected, with many soldiers not expecting such stiff resistance. As a result, initial momentum looks to be lost now, and Russian Command may need to pivot or reassess goals.
*Ukraine vows to fight on and is having some early success at stalling the Russian's momentum
Finally, we will be watching today’s NATO meeting to see if there is an increase in western force posturing and whether new capabilities will be introduced. We are not expecting much direct military aid to Ukraine as Congress and the E.U. are already showing due to the risk of conflict escalation. Instead, there will likely be a “Charlie Wilson War” black-ops approach if the conflict drags on. We are also closely watching developments in the Black Sea, given any adverse turn in Turkey’s posturing to Russia following any maritime incidents could add additional pressure on Putin to recalibrate his longer-term goals.
*A Romanian flagged vessel was reportedly hit by a missile/shell launched from a Russian navy vessel
The Ukraine invasion initially reduced expectations that central banks would remove accommodation as quickly as initially fears despite adding further headline inflationary pressures through increases in energy and food prices. We think this logic is wrong and saw yesterday’s significant reversal in price action in U.S. stocks as a short-covering bounce (given observed movement in option positioning and dealer hedging), not a material change in future financial condition expectations. However, we are still under the belief that the Fed and ECB will likely underwhelm what is currently priced in for the year. As a result, we think today’s positive follow-through price action is indicative of a more prolonged relief rally starting based on improving macro fundamentals and the passage of the initial risk event.
What is the data actually telling us? After an Omicron winter pause, the economy is accelerating and beginning to “fire on all cylinders.” We see this across many indicators, with this week’s hard (Claims, Housing, and Durable Goods) and soft data (Markit PMIs, Regional Fed Surveys, and Consumer Confidence) generally trending positively and beating expectations. As a result, we expect Q2 growth expectations to increase even if Q1 remains below trend.
*Expectation and forecasts are still clouded due to the high level of inflation, but a surprisingly resilient consumer and continued inventory restocking should keep growth strong.
We are not yet seeing a significant decrease in inflationary pressures, with supply chain issues improving somewhat, but business surveys continue to indicate upward price pressures will persist for some time. We continue to expect a fall in pricing pressures over the year, which would allow the Fed to undershoot the currently high level of expected tightening (by markets and sell-side economists). Still, We have yet to see any material change as demand for goods is still above historical norms while material and labor shortages persist.
*There are tentative signs of improvements along the supply chain, but it is very much two steps forward, one back
*Consumers are quickly changing their behavior as the “herd” moves on from the pandemic, shifting from goods to services although intentions have weakens due to inflationary pressures
As a reminder, the path of tightening (or loosening) is never fully defined and is different every cycle. At this point, we know three of the current FOMC voters are open to a 50bps hike (Bullard, Bowman, and Waller), but when digging deeper into their statements/speeches and in conjunction with others on the committee who are both voters and non-voters, there is still a wide divergence of views given the uniqueness of the situation.
*Market implied odds for a 50bp hike in March have fallen but are still non-trivial however every Fed official is saying it’s going to be data-dependent
The bottom line is the Fed has never been here before, coming off a supply-side impairing pandemic that has caused 7% headline inflation fueled by an unprecedented fiscal and monetary stimulus-response with the economy in a strong position but still a high level of uncertainty around the future outlook due to the “stop and go” effects the pandemic waves have had on consumer and labor’s behavior.
*Google mobility data show ak turnaround in visits to workplaces, retail & recreation sites like restaurants and shopping centers, and transit stations.
Putting it all together, we believe the Fed will enact five 25bp rate hikes this year and the commencement of QT in June at an initial rate of $60bln but moving higher to $100bln and primarily being focused on shedding MBS assets into year-end. Looking at the economy, the labor market, and the inflationary situation, as well as discounting the effects of the current geopolitical situation abroad, Fed policy is certainly wrong-footed but it’s not time to panic and overly tighten policy too quickly.
*Today's PCE data moves the “real” fed funds rate to its most negative level in modern history
Finally, financial conditions have tightened, with markets already doing some of the Fed’s work for them. However, we continue to believe that they will not tighten to overly restrictive levels as to induce a recession or a protracted bear market in risk assets. Coupled with our belief that there will eventually be a moderation of the current pandemic-driven inflationary pulses over the summer, we see some room for risk-assets to recover their current yearly losses.
*Still a long way to go before global financial conditions become restrictive to actual growth
The bottom line, the pullback exacerbated by the Ukraine conflict is likely the dip to be cautiously bought (with the big assumption that there will be no worsening of geopolitics). Seasonals are improving while optionality indicates a strong level of support close to current levels. Technicals are still negative, but the improving economic backdrop and generally stronger than expected earnings story coupled with (slightly) more attractive valuation levels indicate a more positive outlook for equities is possible into summer.
*The Nasdaq saw the largest intraday swing since 2008 yesterday, often a sign of a trend reversal
Econ Data:
Fourth-quarter GDP expanded at a 7% annualized rate, after increasing 2.3% in the third quarter. The most significant upward contribution to growth was from private inventories (4.9 percentage points), namely motor vehicle dealers. The second GDP estimate showed a bigger rise in fixed investment (2.6% vs. 1.3% in the advance estimate), mainly due to nonresidential construction. On the other hand, both personal consumption (3.1% vs. 3.3%) and exports (23.6% vs. 24.5%) increased less than initially expected. The economy advanced 5.7% in 2021. The price index increased 0.6% in January and 6.1% on an annualized basis, and excluding food and energy prices, core-PCE increased 5% YoY. Finally, personal income growth was flat in January, while personal consumption expenditure grew by an annualized 2.1% on the month.
Why it Matters: Q4 was the strongest quarterly growth since the record growth of 33.8% in Q3 2020, while the end annual GDP gain for 2021 was the strongest since 1984. The data broadly continued to highlight the robustness of consumer demand and showed a temporary but relatively subdued impact from the Omicron wave. On the more negative side, there were no gains in nominal personal income, as the end of monthly child tax-credit payments offset a 0.5% advance in wages and salaries. This led to the continuation of a six-month trend of declining real income levels. Finally, there continues to be no slowing in the monthly increases for the personal consumption expenditures price index, which the Fed uses for its inflation target.
*Despite the continued uncertainty due to the pandemic and high levels of inflation, the U.S. economy had one of its strongest years of growth since the early ’80s
*“With COVID-19 cases and hospitalizations falling sharply since January, it stands to reason that “pandemic affected services” will be more of a tailwind for consumer price inflation in the months ahead.” – Renaissance Macro
New orders for durable goods rose 1.6% MoM in January, following a revised 1.2% gain in December and beating market expectations of a 0.8% increase. Excluding defense, new orders were up 1.6%, and excluding transportation rose 0.7%, with both readings beating market forecasts. It was the fourth straight month of increases, underpinned by transportation equipment (3.4% vs. 1.7% in December), mainly nondefense aircraft. Support also came from orders for machinery (2.3% vs. 1.3%). Meanwhile, orders for nondefense capital goods excluding aircraft, a closely watched proxy for business spending plans, rose 0.9% verse 0.4% in December.
Why it Matters: The pickup extends a trend of steady growth in equipment expenditures that began in May 2020 as companies seek to improve efficiency in the face of higher materials and labor costs. This is best seen in the continued strength of core capital goods shipments which climbed 1.9%. Bookings for motor vehicles decreased 0.4% after a 1.8% rise in December which showed the renewed supply-chain pressures over the winter due to Omicron.
*January report beat expectations given the increased uncertainty seen in other business surveys that indicated Capex plans might be beginning to soften.
Pending home sales declined -5.7% in January, versus expectations of a 1% rise. Contract signings dropped in three of the four major US regions, led by a -12.1% plunge in the Northeast, while the West posted the only gain. Compared with a year earlier, contract signings were down 9.5% on an adjusted basis and declined by 9.1% on an unadjusted basis.
Why it Matters: January’s decline marked a three-month drop in transactions and the sharpest drop since February 2021. The figures suggest that homebuyers are still struggling to get into a housing market marked by record prices and lean inventory. “Given the situation in the market -- mortgages, home costs, and inventory -- it would not be surprising to see a retreat in housing demand,” said Lawrence Yun, NAR’s chief economist.
*Pending Home Sales often lead Existing Home Sales, which have hit a one-year high in January
The University of Michigan consumer sentiment rose to 62.8 in February from a preliminary of 61.7. The expectations gauge fell to 59.4, better than a preliminary of 57.4, while the current economic conditions subindex fell further to 68.2 verse an initial reading of 68.5 in the preliminary estimate. On the price front, consumers see inflation at 4.9% in a year, less than 5% in the preliminary estimate. The 5-year outlook was also revised lower to 3% from 3.1%.
Why it Matters: Although the final February reading improved on the preliminary number, the reading was the lowest level of consumer confidence in the past decade. “The February descent resulted from inflationary declines in personal finances, a near-universal awareness of rising interest rates, falling confidence in the government's economic policies, and the most negative long-term prospects for the economy in the past decade” reported the surveys chief economist, Richard Curtin. Interviews were conducted prior to the Russian invasion, so its impact is yet to be felt. There continues to be a solid partisan bias in respondents, with Republicans leaning respondents significantly more negative, although the gap closed slightly regarding Current Economic Conditions.
*The headline and two sub-indexes both fell in February as inflation and government policy have respondents becoming more negative
*The overall index is now at lows not seen since the GFC, with views on the long-term prospects for the economy being heavily hit by the high level of inflation
*Growing difference between the Conference Board consumer survey and University of Michigan, potentially showing a partisan effect in sample or questioning
TECHNICALS / CHARTS
Four Key Macro House Charts:
Growth/Value Ratio: Value is higher on the day, but Growth is still higher on the week due to the Nasdaq outperformance yesterday. Large-Cap Value is the best performing size/factor on the day.
Chinese Iron Ore Future Price: Iron Ore futures are lower on the day and week.
5yr-30yr Treasury Spread: The curve is flatter on the day and week.
EUR/JPY FX Cross: The Euro is higher on the day and the week, as a post-invasion reversal is still underway.
Other Charts:
Equity returns following rises in the VIX into the 30s are skewed to the upside, but tail risks are higher.
This chart is also making the rounds, showing that conflicts are generally positive for equities once the “threat” turns into an “act”
We may have hit peak “bearishness” yesterday, with sentiment now near historic lows
Being long crypto is akin to a short equity volatility position as correlations between the two asset classes continue to strengthen
78% of S&P companies have beaten revenue estimates to date for Q4, which is the 3rd highest % since FactSet began tracking this metric in 2008.
Any pullback in oil will likely be short-lived due to longer-term bullish fundamentals.
Meanwhile, the renminbi has been quietly appreciating to levels not seen since 2018 despite growing expectations for further policy easing
ARTICLES BY MACRO THEMES
MEDIUM-TERM THEMES:
Real Supply-Side Improvements:
Step Back: Boxport congestion worsening rapidly – Splash247
Logistics giant Kuehne+Nagel’s has developed what it terms as a Global Disruption Indicator, which tallies the cumulative teu waiting time in days based on container vessel capacity in disrupted hot spots. The total teu waiting time shot up to cross 15m days for the first time. Under normal, pre-pandemic circumstances, the waiting time would be less than 1m teu days.
Why it Matters:
“Stronger than expected US retail sales in January along with low retail inventories will likely keep Asian manufacturers, ports and carriers busy for the next few months,” a new report from US platform project44 forecast said. Danish supply chain research company Sea-Intelligence has predicted that an increase in March and April in the number of vessels scheduled to deliver cargo from Asia to North America will add to port congestion due to known schedulings going higher and smaller ships being less efficient. The bottom line is there are still logistical bottlenecks in play; although pricing pressures have subsided somewhat.
China Macroprudential and Political Loosening:
Old School: China Fights Latest Debt Crisis With Firm That Caused Last One – Bloomberg
In a sign of growing urgency within Xi Jinping’s government to stabilize the world’s second-largest economy, regulators have asked Huarong and other so-called AMCs in recent weeks to buy property assets from troubled developers and formulate plans for taking over or restructuring smaller lenders. Authorities are also considering fresh funding for AMCs, a move that would increase their capacity to prevent stresses in the real estate market from spilling over into the banking system
Why it Matters:
Some AMCs have returned to the offshore bond market after they were cut off during the Huarong scare, given the belief Beijing is changing its posture towards them. “Big AMCs are arguably the best or even the only suitable candidate to play a quasi-government role in resolving risks,” said Muse Zheng, general manager of Heilongjiang-based Great Financial Asset Management Co. Huarong, Cinda, and other bad-debt managers could help cushion banks that have taken up the slack regarding property market financing lately.
LONGER-TERM THEMES:
National Security Assets in a Multipolar World:
Tech Block: U.S. to Restrict Russia Foreign Tech Imports Over Ukraine Attack - Bloomberg
President Joe Biden will invoke the so-called foreign direct product rule, the Commerce Department’s Bureau of Industry and Security said in a statement on Thursday. The rule has been used against Huawei Technologies Co. to restrict the company’s ability to use Taiwan Semiconductor Manufacturing Co. and others to fabricate their chips. Thursday’s rule also imposes stringent controls on 49 Russian military end-users, which have been added to the BIS’s so-called Entity List, which prohibits American firms from doing business with them without first obtaining a U.S. government license.
Why it Matters:
The goal of the export control measures "is really to degrade Russia's ability to have industrial production in a couple of key sectors," Peter Harrell, who sits on the White House's National Security Council, said in a speech last month. Through an expansion of the scope of products, a stricter “policy of denial” standard of review for license applications, and a black listing of Russian companies with ties to the military, the U.S. will keep critical technologies it owns from reaching Russia. However, this is less effective with trading partners elsewhere, such as China, stepping in.
What’s Next?: Asia's arms race: China spurs military spending spree - NikkeiAsia
Perhaps in line with Asia's economic rise over the past decade, military expenditure in the region grew 52.7% between 2010 and 2020, according to data from the Stockholm International Peace Research Institute. This compares to a 14.4% climb in Europe and a fall of 10.6% in North America. And Asian nations still have scope to increase spending further, as they spend significantly less as a share of gross domestic product than other major powers -- China spent just 1.23% of its GDP on its military in 2021, compared to 3.29% in the U.S.
Why it Matters:
China spent $207.3 billion on its armed forces in 2021, according to the London-based International Institute for Strategic Studies. That is 43% of the regional total. While this is dwarfed by the $754 billion spent by the U.S., China's outlay rises to $332 billion on a purchasing power parity basis. As all eyes focus on Putin and the Russian military, it's certainly worth remembering the fast pace China is now growing its military force.
Commodity Super Cycle Green.0:
Bid Up: 'These Waters Are Hot': U.S. Auction Opens Up Offshore Wind Rush - Bloomberg
Two dozen companies will compete in bidding on a lease area expected to support 500 towering wind turbines off the coasts of New York and New Jersey called the NY Bight, a shallow stretch of the Atlantic Ocean between Long Island and New Jersey. Experts say bids could top $3,000 an acre, which would put the total price tag for the almost 500,000 acres close to $1.5 billion. The Biden administration has said they want enough offshore wind farms to power 10 million homes by 2030 and is planning six more auctions from California to the Carolinas.
Why it Matters:
The stakes are high since each company can only win one plot of the ocean, under a new rule that could benefit U.S. wind developers that are accustomed to being shouldered aside by big European competitors. Not everyone is excited about the prospect of hundreds of new turbines, each almost as tall as the Eiffel Tower, being planted in the Atlantic with fishermen, tourist advocates, and even environmentalists pushing back. However, lessons have been learned, and many of the original problems to building windfarms offshore are now reduced.
Current Macro Theme Summaries:
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