MIDDAY MACRO - 3/1/2022
Color on Markets, Economy, Policy, and Geopolitics
MIDDAY MACRO - DAILY COLOR – 3/1/2022
OVERNIGHT-MORNING RECAP / MARKET WRAP
Price Action and Headlines:
Equities are lower, with yesterday’s end of day month-end rally continuing overnight but reversing during the European session as fighting intensified in Ukraine, increasing further sanctions/escalation fears
Treasuries are higher, with government bonds globally generally well bid as a flight to safety continues despite rises in food and energy prices increasing future inflationary pressures while not increasing rate hike expectations, helping the curve notably steepen today
WTI is higher, as the probability of energy sanctions against Russia increases due to growing civilian casualties, and OPEC shows no intentions of increasing production. Markets doubt how effective any SPR releases will be, while there have been limited new developments in negotiations with Iran
Narrative Analysis:
Ugly day for equities after the S&P managed to rally into month-end yesterday as institutional buying flows forced somewhat of a short-squeeze. That positive price action reversed overnight as fighting intensified in Ukraine, with concerns now growing that Russia will have its energy exports sanctioned if civilian casualties continue to increase. This drove oil up over +10% on the day while Treasuries are benefiting from a flight to safety bid, causing the curve to significantly steepen due to reduced expectations for Fed tightening and growth more generally. The dollar is again near recent highs as well, helped by the increased geopolitical risk premium being priced into the markets.
The Nasdaq is outperforming the S&P and Russell with Low Volatility, Growth, and Momentum factors, and Energy, Real Este, and Consumer Staples sectors are all outperforming.
S&P optionality strike levels have the Zero-Gamma Level lower to 4434 while the Call Wall fell to 4550. Because the geopolitical and monetary outlook remains uncertain there is no meaningful “risk-on” occurring and demand for downside protection persists. As a result, this is a market being moved around by put option positions/flows. Yesterday’s end-of-day rally was a good example of this as it was primarily driven by short-covering and ran out of fuel as it approached the gamma-neutral level around 4400.
S&P technical levels have support at 4300, then 4260, and resistance is at 4330, then 4360. The 4280-60 area must hold, or the longer-term head-and-shoulder neckline will be broken, significantly increasing the probability of a much deeper correction. On the other side, the 4400 area will provide a strong resistance level to break given it is the down channels upper band. As a result, given everything else, the S&P will likely chop between 4300-4400 given no significant positive/negative headlines.
Treasuries are higher, as the flight to safety continues in the face of a worsening situation on the ground in Ukraine. The 10yr yield is now at 1.72%, falling 7bp, while the 5s30s curve is steeper by 11bps to 55bps as the amount and size of expected Fed hikes are being reduced.
Deeper Dive:
We are increasing our position in copper through the $JJC ETF from 5% to 10% in our mock portfolio. We have also reduced our stops in a few positions. Although we continue to see a severe downside risk growing to risk assets if energy sanctions are imposed on Russia, we are not yet convinced that things have escalated that far and Europe is willing to take the pain. Hence it is not time to abandon long positions at these current levels (but we are getting close and highly advise anyone reading this to beware of the unprecident situation we are in and the risk of significant further loses to global risk assets)
Copper has been lagging other commodities, especially energy-related ones, and we believe it will now catch up. Not only is the increased long-term demand for “electrification” metal/materials benefitting from the current conflict, but the availability of supply from Russia should be reduced, although they only supply 3% of the market. Further, we see a slowly recovering Chinese property market as being further supportive. There is significantly more to be said and it is our hope to provide more detailed coverage on copper in the coming weeks, especially now that there will be a greater urgency to move away from fossil fuels.
*Copper has been relatively range-bound this year so far, consolidating in a triangle formation but now looks poised to break out to the upside.
If energy sanctions are imposed against Russia, likely due to a significant increase in civilian casualties, the S&P could easily drop a further -5% to -10% quickly, breaking its head-and-shoulders neckline around 4200-50ish and likely eventually settling somewhere around 3600. We see this as an increasing risk but are not yet convinced this is the highest probability outcome. As a result, we are willing to sit in our long positions and take the pain a little longer.
*Painful year so far, with the market continuing to be headline-driven as there seems to be no clear path to de-escalation in Ukraine while inflationary pressures seem to be only growing
Econ Data:
The ISM Manufacturing PMI rose to 58.6 in February from 57.6 in January, with market forecasts predicting 58. New Orders rose an impressive +3.8 points to 61.7. Other demand measures increased too, with New Export Orders and Backlog of Orders both increasing, despite the stronger dollar and worries about inflation's effects on demand. Employment and Price sub-indexes both decreased.
Why it Matters: This was a relatively upbeat report in that not only did it show demand increasing but also showed somewhat reduced inflationary pressures. Decreases in employment and price measures showed firms now look to be emerging from the worse of the supply-side impairments that kept materials and labor hard to find. Respondent comments indicated demand remained strong than normal seasonals would have predicted. There are also indications that supply-side problems have peaked but are still far from ideal. This is best seen in the list of commodities either “up in price” or “in short supply” not materially improving.
*The ISM Manufacturing PMI showed what we are seeing elsewhere, overall economy continuing to expand at a faster rate after a winter slowdown due to Omicron
*The majority of sub-indexes increased with Backlog of Orders, New Orders, and Export Orders seeing the most notable increases
The Dallas Fed’s Manufacturing Index rose to 14 points in February, up from a year and a half low of 2 in January. The Production came in at 14.5, down two points from January. The New Orders rose +3.1 to 23.1 while the Growth Rate of Orders held steady at 12.6. Both readings are significantly above average. Capacity Utilization was unchanged at 11.5, and Shipments rebounded +15 points to 23.5 after its January drop. Delivery Time, Prices Paid, and Prices Received all increased, showing logistical and inflationary forces worsened from January. All three employment measures (Wages and Benefits, Employment, and Hours Worked) weakened while Capital Expenditures increased. Future indicators were mixed with Company Outlook slightly decreasing while General Business Activity increased for six months ahead. There were also decreased expectations for price increases and employment, although Wage and Benefit expectations rose notably.
Why it Matters: Although the headline index number increased, it was mainly due to more inflationary related areas, with Shipments and Prices Paid/Received all higher. However, in a sign that the pricing pressure may subside slightly, Unfilled Orders fell while Shipments increased, meaning the backlog of work and delays from lack of transportation availability is cleaning up. Finally finished Inventories also increased as the restocking continues. Of note also was a sizeable decrease in “Outlook Uncertainty” as the further drop in Omicron has likely given firms greater confidence in their ability to predict future business conditions.
*The increase in the headline index hid weaker production activity
*Inflationary pressure measures all picked up in the “Current” indicators while expectation for Wage and Benefit increases six-month ahead rose +19.9
Wholesale inventories increased 0.8% to $798.2 billion in January, slowing from an upwardly revised 2.3% increase in December. It was the 18th straight month of expansion, amid increases in inventories of both durable goods (1.0% vs. 2.8% in December) and nondurable ones (0.5% vs. 1.6%). On an annual basis, wholesale inventories advanced 17.8% in January. Retail inventories for January were up 1.9% MoM and up 6.0% from January 2021.
Why it Matters: At this point, we welcome a modest slowing in inventory builds due to the inflationary pressure that the frantic holiday builds created. As we move away from that and the urgency of having products available for sale diminishes, and the demand sensitivity to cost rises increases (demand is now more elastic), whether for input goods/material or logistical services. The bottom line is we expect firms to increasingly push back on suppliers and shippers/logistic services despite continued success passing on these costs increases. We have started to see this with drops in shipping costs already occurring, but shortages (and hence price increases) remain for certain products and commodities.
*Inventory builds are expected to continue for most of the year given where stock is, but the urgency will likely continue to fall as end demand becomes more challenged by the inflationary backdrop
*The Inventory to Sales Ratio is still well below historical levels but recovering. There is likely to be a structural change to a higher level as just-in-time failed during the pandemic, but first wholesalers and retail have a lot of restocking to do
Policy Talk:
The NY Fed’s Liberty Street Economics blog just posted “Drivers of Inflation: The New York Fed DSGE Model’s Perspective.” The researchers highlight that when looking through the “lens” of the New York Fed’s DSGE model, the main driver of inflation is mostly accounted for by a large cost-push shock that occurred in the second quarter of 2021 and whose inflationary pressures persist today. The model’s “reading of historical data” shows that the shock is expected to gradually fade throughout 2022, returning inflation to close to 2% by mid-2023.
Why it Matters: We usually wouldn't highlight a blog post, but we wanted to highlight it given the topic and its finding. However, there are a few important takeaways. First, the NY Fed researchers/economists believe that the bulk of inflation is not coming through changes to productivity, real wages, and the cost of capital, something they see, if to happen, as more structural. Instead, increases in energy or other inputs, including those caused by supply chain problems, would be classified as a cost-push shock. Secondly, the model found that transitory factors dominated the movement of inflation early in the pandemic. However, now more persistent cost-push shocks are the dominant factor. This is why the model only sees inflation falling to a more historically normal level by mid-2023. This should not surprise anyone watching the evolution of inflation over the last two years; however, it is important to see that the Fed has now modeled it out (publicly). It means they believe that the end of inflation is in sight, all be it further out than expected.
*“Persistent cost-push shocks are an important source of inflation variation in the model, as also shown by the bars in the period up to 2019. But they are far from able to explain all its fluctuations.”
TECHNICALS / CHARTS
Four Key Macro House Charts:
Growth/Value Ratio: Growth is higher on the day and the week as stagflationary fears grow. Large-Cap Growth is the best performing size/factor on the day.
Chinese Iron Ore Future Price: Iron Ore futures are higher on the day and week as despite Beijing continuing to talk down commodity price appreciation, traders have a more favorable view on growth following more positive PMIs and property sector developments
5yr-30yr Treasury Spread: The curve is steeper on the day and week, seeing a significant move today as the front and belly prices out rate hikes
EUR/JPY FX Cross: The Euro is lower on the day and the week, as increased fighting and worries over energy sanctions are pressuring growth and capital account outlooks for the eurozone
Other Charts:
Multiple compression due to worries of tighter financial conditions have been the primary driver of losses in the S&P so far this year
Not surprisingly, equity positioning levels continue to fall as asset managers continue to wait till there is more clarity regarding Ukraine and the Fed
The volume of puts trading continues to see a parabolic rise
The ISM Prices Paid and some of the regional Fed business surveys have shown signs that inflation is cooling. Variant Perception’s Short-term Leading Inflation Index is rolling
over.
5yr5yr, the Fed’s go-to market-implied rate for gauging inflation expectations is still well within its longer-term range, helping to push back on any belief that there has been a structural change to inflation
The demand for oil in the U.S. was at 20.8 mbpd in December, an annual increase of 9.4% or 1.6% higher than December 2019 and the highest level in December since 2006 (EIA)
ARTICLES BY MACRO THEMES
LONGER-TERM THEMES:
National Security Assets in a Multipolar World:
Knowledge Transfer: MIT severs ties with Russian school after Ukraine invasion – ABC News
The Massachusetts Institute of Technology is severing ties with Skolkovo Institute of Science and Technology in Moscow, a research university it helped establish more than a decade ago, citing the country's “unacceptable military actions” in invading Ukraine. MIT partnered with the nonprofit Skolkovo Foundation in 2011 to establish the research university as part of a Russian government effort to create a science and technology hub akin to California's Silicon Valley or Massachusetts' Kendall Square.
Why it Matters:
Federal law enforcement officials and foreign policy experts have long voiced concerns about the potential for espionage and technology theft arising from MIT's partnership with the school, which has close ties to Russian President Vladimir Putin’s government. The Ukrainian invasion, though, proved to be the line too far. The loss of access to western universities and research will increasingly leave Russia disadvantaged in the global tech race.
Electrification and Digitalization Policy:
SpyWare Wars: The U.S. Crackdown on Spyware Vendors Is Only Beginning - Vice
On Tuesday, the Department of Justice announced that a Mexican businessman had pleaded guilty to conspiring to sell surveillance and hacking tools made by Hacking Team, a notorious spyware vendor that is now defunct. In the plea agreement, Carlos Guerrero, who was the head of a company that distributed surveillance technology called Elite by Carga, admitted that he sold Hacking Team spyware knowing that the Mexican authorities who were purchasing it "could and likely would" use it for "political purposes, not just for law enforcement purposes."
Why it Matters:
Guerrero's case comes months after the U.S. government announced that it had added NSO to a list of companies that are restricted from purchasing products and services from U.S. companies, effectively making it hard for them to procure crucial equipment and technology. More recently, a European watchdog suggested that European governments should halt the development and purchase of any technology like the spyware developed by NSO. There will be more to come here as the West clamps down on this technology and exposes its use elsewhere.
Fracturing: Big Tech caught in information war between west and Russia – FT
Meta-owned Facebook and Chinese short-form video platform TikTok on Monday announced they would block access to Russia Today and Sputnik in the EU following a request from the bloc designed to throttle pro-Russia propaganda. YouTube put a similar ban in place on Tuesday morning. On the opposite side, Russia has increasingly wielded the threat of penalties such as fines and slowing or shutting access to the platforms to get them to restore or restrict content.
Why it Matters:
Western governments are pushing for social media companies to remove Russian state-backed media from their platforms, as Big Tech is dragged into the information war. The claims and counterclaims over the war in Ukraine have placed Silicon Valley companies in the middle of a geopolitical battle for influence, given their position as gatekeepers to information seen by billions of consumers. The potential removal of state media would mark a new frontier for the social media platforms, which have tended to focus on removing covert operations rather than any domestic propaganda apparatus.
Commodity Super Cycle Green.0:
Odd Couple: Chevron raises clean energy bet with $3 billion Renewable Energy Group deal - Reuters
Chevron, the second-largest U.S. oil and gas producer, plans to pay $61.5 in cash for each share of Renewable Energy, a premium of over 40% to the company's Friday closing market value. Iowa-based Renewable Energy Group produces both biodiesel and renewable diesel. Chevron has set a target to cut operational emissions to net-zero by 2050. In September, it pledged to invest $10 billion to reduce its carbon emissions through 2028, with about $3 billion earmarked for renewable fuels.
Why it Matters:
The deal is expected to accelerate progress toward Chevron's goal to grow renewable fuels production capacity to 100,000 barrels per day by 2030 and brings additional feedstock supplies and pre-treatment facilities, the company said in a statement. The Energy Information Administration estimates renewable diesel production capacity in the United States may increase fivefold by 2024 from 1 billion gallons currently to more than 5 billion gallons per year.
Sooner: Germany Brings Forward Goal of 100% Renewable Power to 2035 – Bloomberg
Germany plans to rapidly accelerate the expansion of wind and solar power, bringing forward a target to generate almost all the country’s electricity from renewable sources by 15 years to 2035. The Economy Ministry, which also oversees energy and climate policy, proposed new legislation on Monday that aims to roughly triple the annual additions from onshore wind and solar facilities. Offshore wind capacity is set to more than double.
Why it Matters:
To bridge the gap until there’s sufficient renewable power capacity, Germany is also getting ready to prolong the use of coal beyond 2030. To create alternatives to Russian gas, Germany is seeking to revive plans to build liquefied natural gas terminals. A new law focused on national gas reserves will require owners of storage facilities to have them 65% filled by August, 80% filled by October, and 90% filled by December. The Germans are moving fast as the realities of Russia set in.
ESG Monetary and Fiscal Policy Expansion:
Limits: Supreme Court Hears Arguments on Limits of EPA’s Powers – WSJ
A case over federal authority to limit greenhouse-gas emissions drew out sharply different principles at Supreme Court arguments Monday. West Virginia, leading a coalition of Republican-leaning states and small coal producers, brought its case to the Supreme Court after a lower-court opinion approved the EPA’s authority to regulate the overall amount of emissions by considering strategies that look beyond the property lines of specific power plants. The plaintiffs argue that ruling amounts to administrative overreach that could pave the way for tougher new rules under the Biden administration.
Why it Matters:
Conservative justices posed questions around the limits of regulatory authority for federal agencies. The so-called major-questions doctrine presumes that agencies can’t adopt rules that affect large swaths of the economy without explicit direction from Congress. Such a ruling on climate regulations could be devastating to President Biden’s agenda. He is poised to rely more on EPA rules as a divided Congress hasn’t passed his $2 trillion social- and climate-spending proposal. We will continue to keep an eye on developments here as they may have broader social-focused policy precedent-setting effects besides the EPA and environmental regulation.
Current Macro Theme Summaries:
VIEWS EXPRESSED IN "CONTENT" ON THIS WEBSITE OR POSTED IN SOCIAL MEDIA AND OTHER PLATFORMS (COLLECTIVELY, "CONTENT DISTRIBUTION OUTLETS") ARE MY OWN. THE POSTS ARE NOT DIRECTED TO ANY INVESTORS OR POTENTIAL INVESTORS, AND DO NOT CONSTITUTE AN OFFER TO SELL -- OR A SOLICITATION OF AN OFFER TO BUY -- ANY SECURITIES, AND MAY NOT BE USED OR RELIED UPON IN EVALUATING THE MERITS OF ANY INVESTMENT.
THE CONTENT SHOULD NOT BE CONSTRUED AS OR RELIED UPON IN ANY MANNER AS INVESTMENT, LEGAL, TAX, OR OTHER ADVICE. YOU SHOULD CONSULT YOUR OWN ADVISERS AS TO LEGAL, BUSINESS, TAX, AND OTHER RELATED MATTERS CONCERNING ANY INVESTMENT. ANY PROJECTIONS, ESTIMATES, FORECASTS, TARGETS, PROSPECTS AND/OR OPINIONS EXPRESSED IN THESE MATERIALS ARE SUBJECT TO CHANGE WITHOUT NOTICE AND MAY DIFFER OR BE CONTRARY TO OPINIONS EXPRESSED BY OTHERS. ANY CHARTS PROVIDED HERE ARE FOR INFORMATIONAL PURPOSES ONLY, AND SHOULD NOT BE RELIED UPON WHEN MAKING ANY INVESTMENT DECISION. CERTAIN INFORMATION CONTAINED IN HERE HAS BEEN OBTAINED FROM THIRD-PARTY SOURCES. WHILE TAKEN FROM SOURCES BELIEVED TO BE RELIABLE, I HAVE NOT INDEPENDENTLY VERIFIED SUCH INFORMATION AND MAKES NO REPRESENTATIONS ABOUT THE ENDURING ACCURACY OF THE INFORMATION OR ITS APPROPRIATENESS FOR A GIVEN SITUATION.