MIDDAY MACRO - DAILY COLOR – 3/11/2022
OVERNIGHT-MORNING RECAP / MARKET WRAP
Price Action and Headlines:
Equities are lower, with only the Dow Jones Index higher currently as overnight gains increased on positive headlines in the morning that Putin was getting closer to negotiating. However, things reversed when market participants remembered not to believe anything Putin says
Treasuries are mixed, with the curve flattening back to near recent lows as Fed hike expectations increased post-CPI report yesterday, putting greater pressure on the front-end and belly of the curve
WTI is higher, but continuing to be volatile as a collapse in the Iranian negotiations added to the current drama with OPEC+ continues to insist more supply is not warranted while the Biden administration tries to repair ties in the Middle East and make new friends (with Venezuela)
Narrative Analysis:
These days will age you extra fast as cross-asset volatility remains high, to say the least. There is growing uncertainty regarding the macro backdrop as the Ukrainian war intensifies, inflation is everywhere, and China continues to see Omicron cases increase, leading their equity markets to continue to sell off drastically. Equities in the U.S. are lower, with tech and consumer discretionary sectors underperforming, while European markets are hanging onto gains despite little progress occurring on the Ukraine/Russia negotiation front while increasing levels of war crimes are renewing calls for energy sanctions. Oil as a result and helped by the deterioration of JCPOA 2.0 negotiations is rising again, after falling nearly $30 in two days. Treasuries continue to drift lower, with the 10yr yield now back around 2%. Meanwhile, “King Dollar” continues to appreciate, with the $DXY back above 99 as the ECB's more hawkish tilt failed to help the Euro materially.
The S&P is outperforming the Nasdaq and Russell with High Dividend Yield, Low Volatility, and Value factors, and Financials, Materials, and Healthcare sectors are all outperforming.
S&P optionality strike levels have the Zero-Gamma Level lower to 4377 while the Call Wall is at 4400. The key range is framed by the large open interests at 4000 and 4300. In between that range, we expect price action to remain fluid. If markets get above 4300, implied volatility should fall, and we see 4400 as the primary resistance area into the March FOMC. Regarding the bottom of the range, dealers are long tail-risk, which suggests dealer hedging requirements may be reduced below 4100, implying support around that area.
S&P technical levels have support at 4225, then 4200, and resistance is at 4295, then 4335. The down channel from early January highs is now increasingly turning into a triangle or coiling pattern. This pattern can still fill out or chop for a while but what is clear is that whatever way it breaks will see a significant move. A true breakout to the upside would be above 4400, where the top of the down-channel currently is, while a break below 4150 would negate the triangle formation and new lows would likely come.
Treasuries are mixed, with the long-end better bid following this week's supply being digested. The 10yr yield is now at 1.99%, falling 1.3bps on the session, while the 5s30s curve is flatter by 4.3bps to 40.2bps.
Deeper Dive:
We are reluctant to take too much comfort from any headlines out of Russia and believe the market is unrealistically reacting to any positive news. The reality is that the current conflict in Ukraine will likely only end with regime change in Kyiv or Moscow (and this may take months/years), and the overall macro backdrop would still not be supportive of risk assets even if the fighting ended today. Instead, the persistence and, in many ways, increases of inflationary pressures and tightening financial conditions indicate a weaker growth outlook just as central banks will be reducing excess liquidity. As a result, we believe that the market is now rangebound at best (being closer to the top of that range currently), with weaker growth and less liquidity capping earnings growth and multiple expansion for equities while generally weighing on other non-commodity correlated risk-assets and keeping the trend negative.
We continue to believe we are in the early stages of a prolonged conflict with Putin becoming more frustrated by the lack of expected progress on the battlefield. At the same time, domestic support for him weakens in Russia as the effects of the economic collapse and removal from the world are increasingly felt by the populous there.
*It is hard to know where the real opinion of the Russian people lies but given the punishment, any protesting should be seen as a significant act
Western media seems overly eager to cover news of Russian failures and insufficiently attentive to the harsh fact that the invaders continue to advance on more than one front and are increasingly targeting civilians, changing the nature of the war.
*Russian operations around Kyiv remain largely stalled while forces remain pinned down around Mariupol, attempting to reduce the city by siege and bombardment, elsewhere gains are slowly coming
Some military analysts believe the Russian invasion force has around two weeks left before serious logistical and supply problems force Putin to the negotiating table. However, it is unclear what to believe other than Russia’s military force is weaker than initially thought. This now makes it more dangerous given the position they now find themselves in, leading to a change in tactics with increased targeting of civilians, committing war crimes, and increasing the odds of further (energy) sanctions.
*Increased civilian deaths, many targeted as they tried to flee combat zones and the bombing of non-military targets, such as a hospital/maternity ward in Mariupol, will eventually lead even Germany to capitulate on energy sanctions
As long as the war continues, the uncertainty surrounding energy markets will remain, and as a result, inflationary pressures and worries over central bank tightening will grow while growth outlooks weaken. Currently, as it stands, whether through official sanctions or buyer boycott, there are now 8 million barrels a day of Russian exports missing from the global market. With OPEC+ spare capacity and new production in the U.S. limited and only so much strategic reserve releases can do for Europe and Asia, as well as negotiations with Iran now collapsing, oil markets will remain tight for some time.
*At current price levels, oil is expected to have an almost -1% drag to growth in the U.S. and likely much more in Europe and non-producing Asian economies.
As a result of the continued uncertainty, there is no reason for the current market trends/themes to meaningfully change. Following the recent CPI report, which showed no meaningful relief in inflationary pressures, the Fed will use its economic projections to show a faster pace of tightening due to rising inflation expectations while also downgrading its growth outlook for this year and next. Although the passage of the event should reduce implied volatility and potentially lead to a short-covering rally, fundamentally, there will be little reason for a meaningful rally to begin despite better seasonalities.
*The market increased the number of expected hikes for this year closer to seven following the CPI report.
As a result of all that we have discussed, we caution chasing any rallies. Instead, our view is that the S&P will remain rangebound between 4400 and 4100, levels that have strong technical and optionality resistance or support. However, the tail-risk remains that an escalation in the conflict or further sanctions against Russia will push the S&P lower through the bottom of this current range. Extrapolating this on global risk-asset more generally, any improvements in current economic activity (from a further reopening) that may be supportive to equity and credit markets will be discounted, as the future outlook weakens on increasing inflationary fears. We would look for a drop in oil back toward the $80-90 range as a sign that this negative narrative could change.
*We underestimated the persistence and broadening aspects of the current inflation pulse before the Ukraine invasion and now see even more reason for concern as the coming drag/tax on consumption will significantly slow growth
Econ Data:
Headline consumer prices increased 0.8% month-over-month in February, above 0.6% in each of the previous two months and in line with market forecasts. This moved the annual inflation rate to 7.9%. Excluding food and energy components, core prices increased 0.5% from a month earlier and 6.4% from a year ago. Increases in the indexes for gasoline (6.6%), shelter (0.5%), and food (1%, the largest since April 2020) were the largest contributors. The annual headline inflation rate accelerated to 7.9%, the highest since January of 1982. On a year-over-year basis, energy remained the biggest contributor, increasing 25.6%, with gasoline prices surging 38%. There were also continued increases in the cost of shelter (4.7% vs. 4.4% in January), and food (7.9% vs. 7%), namely food at home (8.6% vs. 7.4%). Finally, there were continued increases in both new vehicles (12.4% vs. 12.2%) and used cars and trucks (41.2% vs. 40.5%). Shelter costs, which are considered to be a more structural component of the CPI, making up about a third of the overall index, rose 0.5% from the prior month. Rent of primary residence increased 0.6% MoM, the largest advance since 1987.
Why it Matters: February’s report continues to show a more persistent and expansive inflationary pulse. February was expected to be the peak in the growth velocity, but now economists expect readings to continue to increase despite growing negative base affect pressures. This is due to the Ukraine war, and Biden’s ban on Russian energy imports tightened oil supplies which sent prices of gasoline and other commodities to some of the highest levels on record this month. So far this month, the retail price of regular-grade gasoline has increased 19.3% to $4.32 a gallon, according to American Automobile Association data. Food prices climbed 1% from the prior month, but this is likely to continue to rise given coming grain shortages. Compared with February last year, the 7.9% jump in headline CPI was the biggest since 1981. The bottom line is our own expectations that peak inflation was occurring in the December to February period looks to now be very wrong given the new developments in commodity markets. However, we continue to believe that demand destruction is increasingly occurring due to higher prices and weaker consumer sentiment, and as a result, the spread between headline and core inflation will widen in the next two quarters. This, in turn, will put the Fed in a trickier place in managing its message and implementing the right policy.
*“In February, CPI saw a boost from vehicle-related areas (new cars & rentals) and pandemic affected services (airfares & hotels). Rental inflation remains very buoyant, and the monthly contribution from food & energy was strongest since October.” – Renaissance Macro Research
The University of Michigan consumer sentiment fell to 59.7 in March from 62.8 in February, below market forecasts of 61.4, preliminary estimates showed. The Current Economic Conditions index fell to 67.8 from 68.2, while the Index of Consumer Expectations sank to 54.4 from 59.4. The year-ahead expected inflation rate rose to 5.4%, its highest level since 1981, and expected gas prices posted their most significant monthly upward surge in decades. Personal finances were expected to worsen in the year ahead by the largest proportion since the surveys started in the mid-1940, pointing out that the high inflation rate is impacting incomes.
Why it Matters: March’s first consumer sentiment reading was the lowest reading since November of 2011, as inflation expectations rose sharply due to an expected surge in fuel prices. Consumers held very negative prospects for the economy, with the sole exception of the job market. The greatest source of uncertainty is undoubtedly inflation and the potential impact of the Russian invasion of Ukraine on it. In the March survey, 24% of all respondents mentioned the Ukraine invasion in response to questions about the economic outlook. The impact of this recognition was associated with a drop of 13.2 Index points in the Index of Consumer Expectations across all households. The difference was much larger for those who held higher inflation expectations: the difference was 33.5 Index-points on the Expectations Index for those who expected under 5% compared with over 5%.
*Notable declines in the Index of Consumer Expectations due to fears around increasing gas costs are weighing on the overall sentiment index
Real average hourly earnings decreased -0.8% in February at a seasonally adjusted rate. Real average weekly earnings decreased -0.5% over the month due to the change in real average hourly earnings combined with an increase of 0.3% in the average workweek. Real average hourly earnings for production and nonsupervisory employees decreased -0.6% MoM. On an annual basis, real average hourly earnings decreased by -2.6%.
Why it Matters: Despite the fact that wage increases are occurring across the board for supervisory and nonsupervisory, manufacturing and service sectors, and job stayers and switchers, real wages continue to fall. As a result, real disposable income is increasingly falling, and a greater portion of it is going to energy and food. If this trend continues, it will increasingly weigh on discretionary goods and service purchases. As a result, firms in these sectors will be faced with decreasing demand, reduced pricing power, and continued rising costs. This is what the market is increasingly pricing in as the forward outlook for the consumer materially weakens.
*The first two months of the year showed a reversal in the improvements that real average hourly earnings experienced in Q4 ’21
*Consumer confidence and aggregate demand will remain pressured as long as wages underperform inflation
The number of job openings decreased to 11.263 million in January from an upwardly revised 11.448 million in December and above market expectations of 10.9 million. The number of quits edged down in January to 4.3 million (-151K). By industry, the largest declines were in accommodation and food services (-288K), transportation, warehousing, and utilities (-132K), and the federal government (-60K). Job openings increased in other services (+136K) and durable goods manufacturing (+85K). Job openings decreased mainly in the West region.
Why it Matters: There was a slight decrease of a little over 200K in job openings. Separate private-sector figures showed that employers had more than 10.8 million openings at the end of February, according to job search site ZipRecruiter, a slight increase from the prior month’s estimate. Indeed, another job-search site, estimates there were 10.7 million job openings in mid-February. The Labor Department numbers lag behind private-sector data by about a month. As a result, it is still unclear if the level of openings has peaked. We see any meaningful decrease in openings (and quits) as showing further improvement in labor shortages but also further evidence that the labor market is continuing to tighten, increasing wage pressures.
*Job openings and quit rates are still well above pre-pandemic levels as labor markets remain tight despite improvements in the participation rate
Policy Talk:
The European Central Bank unexpectedly accelerated its wind-down of monetary stimulus at their March meeting, signaling it’s more concerned about record levels of inflation than weaker economic growth as Russia’s invasion of Ukraine threatens to propel prices even higher. Despite this more hawkish tilt, Lagarde said that "in all scenarios," inflation is projected to decline progressively and settle around the 2% target in 2024, suggesting that medium-term inflation is not running persistently above target, and the new policy adjustment is a faster normalization, not a tightening. The ECB’s growth projections for the year were lowered to 3.7% from 4.2%, while inflation was upgraded to 5.1% from 3.2%. Lagarde continues to attribute the bulk of inflation increases to energy prices, but she says price increases have become more "widespread" and the ECB increased its expectations for core inflation for the year to 2.6% from 1.9% at the last meeting in December. She went on to note banks are as profitable as they were before the pandemic, and there are no signs of stresses in money markets following the Russian invasion of Ukraine. She says the situation in Ukraine will negatively affect the Eurozone’s growth, but the ECB's growth forecast barely changed after 2022.
Why it Matters: Lagarde highlighted that discussions at the meeting were “intense,” and there were various views around the table. She noted that the plans to end purchases sooner than expected were not an acceleration of normalization but instead increased optionality so the ECB could respond to any new developments if needed. By ending asset purchases earlier, she believes the ECB now can delay raising rates, an attempt to compromise with the more hawkish members on the committee who carried the day. The outcome defied the expectations of economists who anticipated a delay in significant policy decisions to allow time to assess the implications of Russia’s invasion. Markets took the more rapid withdrawal of asset purchases as a sign that rate rises are nearing, with money markets now betting on a quarter-point increase in October, compared with December earlier. They see two more hikes in the first half of 2023, taking the key rate to 0.25%. The Governing Council now says any hikes will be “gradual” and take place “sometime after” bond purchases end rather than “shortly” after.
*Since Russia’s invasion two weeks ago, Lagarde and her colleagues have been trying to evaluate how badly the EU will be affected by sanctions, trade disruptions, and above all, surging energy costs.
Charts and Technicals:
Four Key Macro House Charts:
Growth/Value Ratio: Value is higher on the day and week. 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 as Beijing is again warning of punishment for speculation and encouraging inventory releases while rising covid cases has stimulus expectations rising
5yr-30yr Treasury Spread: The curve is flatter on the day and week, as the brief steepening that occurred last week has completely reversed
EUR/JPY FX Cross: The Euro is higher on the day and the week, helped by a recovery in risk assets in there while the ECB delivered a mixed yet arguably more hawkish message
Other Charts:
Higher dividend-yielding stocks have historically outperformed in higher inflation periods
Incredible pull back across tech with over 60% down more than 25% from recent highs.
The effects of higher inflation are increasingly shifting spending behavior by consumers
The growth in the working-age population continues to weaken, leading to concerns that less availability will ultimately lead to greater wage-spiral inflationary pressures
Airfreight rates are still near recent highs showing that the initial increased demand from lack of traditional shipping options is now increasingly reflecting higher fuel costs
Omicron is increasingly taking root in China, leading to a dramatic drop in risk assets there as renewed fears over lockdown reduce growth and earnings expectations.
5.5% is at the top end of all projections for Chinese growth for this year. Most prominent is the International Monetary Fund (IMF), which lowered its estimate from 5.6% (October 2021) to 4.8% (late January 2022).
Articles by Macro Themes:
Medium-term Themes
China Macroprudential and Political Loosening:
Slow Go: China’s Two Sessions: Ready, Aim, Spend - CSIS
Premier Li expanded on why Beijing has set the lowest growth target in several decades in a Government Work Paper. He highlighted a long list of challenges that China has. Domestic challenges include: “lots of debt, an aging population going over the demographic cliff, an unenthusiastic private sector chastened by the ongoing “common prosperity” campaign, flagging household consumption, and policy opacity and unpredictability.” He further spoke to the more “hostile” international environment, made worse now by the conflict in Ukraine, which in his words, “is increasingly likely to further hamper trade and investment ties.”
Why it Matters:
Beijing leadership is showing zero signs that it is wavering from its zero-Covid strategy. CSIS’s expectation is that China is unlikely to abandon zero-Covid before late this year, until after the 20th Party Congress and when there is a credible domestic mRNA vaccine ready to be widely distributed across the country. It's also notable that “common prosperity” was barely mentioned in the government’s reports or discussed at the Two Sessions. Finally, The messaging from the two conferences does not suggest any changes to the country’s climate goals.
Longer-term Themes:
National Security Assets in a Multipolar World:
Boosting: Biden Enlists Business Executives to Push Bill Countering China Tech Threat – WSJ
Biden is reaching out to top executives and governors of two auto-industry states to implore Congress to pass legislation that appropriates $52 billion to boost domestic silicon-chip manufacturing. The Senate in June passed its $250 billion version of the measure, the U.S. Innovation, and Competition Act, on a bipartisan basis. The House approved its version, called the America Competes Act, along mostly party lines, with Republicans objecting to measures in that version aimed at addressing issues such as climate change, human rights, and social inequality.
Why it Matters:
The need to secure critical materials and production capabilities has been one of the biggest takeaways from the pandemic, and although the effects of the bill will not be immediately felt, it shows a growing bi-partisan acknowledgment of the problem. The Biden Administration has been reaching out to the private sector much more in recent weeks, showing an acknowledgment of the need to have a more harmonious relationship to accomplish policy goals.
Electrification and Digitalization Policy:
Too Granular: Police Use of Google Location Data to Find Robbery Suspect Is Ruled Unconstitutional – WSJ
Police in Virginia violated the Constitution by analyzing location data of Google users near a 2019 bank robbery, a federal judge said. The ruling deals a blow to a fast-growing law-enforcement technique that relies on tech companies’ collection of granular information about users’ whereabouts. Judge M. Hannah Lauck of the U.S. District Court for the Eastern District of Virginia said Thursday that the so-called geofence warrant violated the Fourth Amendment’s protections against unreasonable searches by accessing users’ location data without probable cause they might be suspects.
Why it Matters:
Interesting development on the digitalization policy front as abuses of geolocational tracking is becoming more widespread by government and private actors. We highlight it to show there are some limits to who and why certain consumer data provided by private firms can be used by government officials.
Thwart: The secret U.S. mission to bolster Ukraine’s cyber defenses ahead of Russia’s invasion - FT
Months before the Russian invasion, a team of Americans made up of soldiers with the U.S. Army’s Cyber Commandcivilian and civilian contractors and some employees of American companies that help defend critical infrastructure from the kind of cyberattacks that Russian agencies had inflicted upon Ukraine for years. The U.S. had been helping Ukraine bolster its cyber defenses for years. Still, this surge of U.S. personnel in October and November was different: it was in preparation for the impending war.
Why it Matters:
So far, experts who have watched the Russian cyber assaults have been confused at their lack of success, as well as the slower tempo, intensity, and sophistication of what Russian-government hackers are known to be capable of. Officials in Ukraine and the US are careful to describe the work of the “cyber mission teams” as defensive, compared with the billions of dollars of lethal weapons that have poured into Ukraine to fight and kill Russian soldiers. Russian attacks have been blunted because “the Ukrainian government has taken appropriate measures to counteract and protect our networks,” said Victor Zhora, a senior Ukrainian government official.
Surge: Russians Are Finding Ways Around Putin’s Internet Blockade – Bloomberg
Providers of virtual private networks, or VPNs, are recording a surge in usage from Russia after the Kremlin cracked down on Facebook and other services as part of a broader effort to silence dissent and limit information about its invasion of Ukraine. “In the past week, we saw traffic to our website from Russia increase by around 330% week over week,” Harold Li, vice president of ExpressVPN. “A lot of sources of information that people would traditionally turn to to find the truth are either blocked or at risk of being blocked,” said Proton Chief Executive Officer Andy Yen. He also said, “to get the truth today in Russia, you need a VPN.”
Why it Matters:
VPNs are widely used and legal around the world and use encryption to create private connections between a user’s computer and a server in another city or country. Given recent changes that impose prison terms for people spreading “fake news,” VPN users are taking significant risks in Russia. It is likely that the Russian government will increasingly try and target and block VPN users, something we know little about but imagine is of growing importance to Russia and other authoritarian regimes.
ESG Monetary and Fiscal Policy Expansion:
To Say the Least: Biden and the Oil Industry Are at Odds, Clouding Effort to Tame Gasoline Prices – WSJ
President Biden further stoked tensions between his administration and the oil industry on Tuesday while announcing a U.S. ban on Russian oil imports, with the president saying “it’s no time for profiteering or price gouging.” In Houston, where oil-and-gas companies were gathered for an annual conference, Mr. Biden’s scolding the industry on national television didn’t go over well. It was a gratuitous swipe at oil producers, said Mike Sommers, head of the American Petroleum Institute, the largest U.S. trade group for oil-and-gas companies, “as if we would take advantage of this moment to price gouge.”
Why it Matters:
Industry officials say the administration’s tough posture toward oil and gas production has sent a signal to Wall Street that carbon businesses aren’t welcome. They say it contributes to a poor investment outlook, with investors already skeptical of the returns on U.S. oil operations, pushing companies instead to buy back shares or increase dividends. That, in turn, has slowed growth in U.S. production and helped drive prices higher. For this to reverse, the administration in conjunction with Congress will need to send clear signals it is on the side of the industry, something we believe will increasingly be seen.
Too Far: US lawmakers protest Biden outreach to Venezuela – Argus
The Biden administration's diplomacy with Venezuela and potential sanctions relief for Caracas that the White House hopes will offset lost Russian oil supply appears to be a bridge too far for some senior U.S. lawmakers. "I am extremely concerned that the administration would consider purchasing oil from Venezuela," Senate Foreign Relations Committee Chairman Bob Menendez (D-New Jersey) said at a hearing today on the fallout from Russia's invasion of Ukraine. He was echoed by other congressional members who are against any support for the Maduro regime, highlighting the challenges Biden has in securing new sources of oil supply both domestically and abroad.
Why it Matters:
The U.S. administration is not considering a major change in its Venezuela policy, but is justified to look at potentially enabling imports of Venezuelan oil, Undersecretary of State Victoria Nuland told the Senate panel. Venezuelan state-owned PdV is ready to increase production significantly to help offset any drop in crude supplies stemming from Russia's invasion of Ukraine, Venezuelan President Nicolas Maduro said last night, after holding the first high-profile meeting with US diplomats since Biden took over. We question how much can be produced given the state of their infrastructure, with the total added daily barrel count likely being close to 300K.
Current Macro Theme Summaries:
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