MIDDAY MACRO - DAILY COLOR – 3/16/2022
OVERNIGHT-MORNING RECAP / MARKET WRAP
Price Action and Headlines:
Equities are higher, with potential improvements in peace talks surrounding Ukraine and a more supportive policy shift in China helping risk assets globally as markets now await the Fed
Treasuries are mixed, but little changed with the curve further flattening to levels not seen since 2018 as Fed tightening expectations weigh heavier on the front-end and belly
WTI is lower, as reduced demand expectation due to rising Covid cases in China and renewed hopes for an Iranian deal have oil back to pre-Ukrainian invasion levels
Narrative Analysis:
Things continue to move fast, with today currently being a more positive toned session due to headlines that there could be a potential ceasefire in Ukraine and China signaling a more positive policy shift overnight. Equities are, however, off morning highs as all eyes now turn to the Fed, and where its projections for raising rates will fall. Treasuries are pricing in further rate hikes from the Fed as well a slowing growth environment causing the curve to continue to flatten to near inversion levels. Oil has effectively done a $60 dollar round robbin in a week and is now back at pre-war levels with worries over demand and expectation for Iranian supply being more in focus than further energy sanctions against Russia. The dollar is off recent highs as the Euro and other EM currencies are better bid on Ukraianin and Chinese developments.
The Russell is outperforming the Nasdaq and S&P with Momentum, Growth, and Small-Cap factors, and Financials, Consumer Discretionary, and Technology sectors are all outperforming.
S&P optionality strike levels have the Zero-Gamma Level lower to 4481 while the Call Wall increased to 4600. If Fed is perceived to be more dovish than expected, a lot of short-covering could occur. With such a large put position tied to Friday’s expiration, this type of rally significantly hurt those put values given the limited time to expiration. If the market moves above 4400, increased positive gamma and declining implied volatility (i.e., Vanna flows) would start to suppress actual realized volatility.
S&P technical levels have support at 4285-90, then 4230, and resistance is at 4335, then 4370. The triangle pattern continues to hold, with support being tested yesterday and the 4375 area being near its top downtrend. The longer we consolidate in this pattern, the stronger the breakout is likely to be (either higher or lower).
Treasuries are mixed, with the long-end better bid. The 10yr yield is now at 2.18%, higher by 3.2bps on the session, while the 5s30s curve is flatter by 4bps to 33.5bps.
Deeper Dive:
There has been a significant improvement in the “perception” of the macro backdrop over the last 24hrs as indicated by the rally risk assets globally. There is increased optimism over the potential end of the invasion of Ukraine, with both sides signaling progress in peace talks. Meanwhile, Beijing announced a reversal in policy, indicating a more market-friendly stance moving forward. Finally, markets await the Fed, which may signal a more dovish stance than expected, furthering the rally underway. However, although positive, these developments will have limited effects given the severity of the underlying problems that now exist due to the increases in inflation and increased bifurcation of the world.
To start off, we still have a macro backdrop of slowing global growth due to growing uncertainty primarily coming from rising inflation, specifically in food and energy costs. This trend, already underway due to the effects of the pandemic, was exacerbated by Russia’s invasion of Ukraine. Further, Xi’s Zero-Covid and Common Prosperity policies have effectively derailed growth in the second-largest economy. Even if the war ended today and China further easied its restrictive policies, increasing inflation and its negative effects on consumer activity would still weigh on earnings growth for a long time.
*Sell-side economists continue to raise their inflation forecasts. Will they or central banks, which have a lower forecast, be right?
The Fed will undoubtedly increase its inflation and rate hike forecasts for ’22 and ’23 while slightly decreasing its growth expectations. However, given the high level of tightening already priced in by markets and our belief that core-Fed committee members still believe the majority of the current inflation shock is supply-side driven, and hence will fall over the year, as well as the significant amount of tightening already occurring from changes in financial conditions, both of which reduce the urgency to act, leads us to believe a higher probability that the Fed’s SEP projections underwhelm, particularly in 2023.
As a result, that leaves markets likely to tactically rally further as optionality and technicals become more supportive following the positive developments discussed. We, however, still caution against chasing any rallies given the high level of uncertainty over Ukraine and Chinese growth that still remain. This coupled with the fact that even if the Fed does move more cautiously, the level of financial condition tightening that has occurred and the coming reduction in excess liquidity on top of an increasingly deterred/taxed consumer does not bode well for earnings growth or multiple expansions, the two things needed for a sustained rally in equities to materialize.
*Financial conditions have tightened sharply this year. According to Morgan Stanley, that’s equivalent to 140 basis points of Fed rate hikes.
Equities and other risk assets across China have stagged a significant rebound overnight as China’s State Council pledged to stabilize financial markets, promising to ease a regulatory crackdown, support property and technology companies, and stimulate the economy after stock markets there have erased close to $1.5 trillion in value over the last year.
Beijing has pledged to “actively introduce policies that benefit markets,” according to statements following a meeting of China’s Financial Stability and Development Committee led by Vice Premier Liu He, adding there is a need to “boost the economy” in the first quarter and promised investors relief on several regulatory fronts. Monetary policy will be proactive in this quarter, and new loans will grow appropriately, it added.
*There will need to be an increase in new loan creation and hence the money supply to properly stimulate the economy and ensure risk assets are supported by both improvements in the fundamentals but also liquidity conditions
China’s banking and insurance regulator said in a statement following the meeting that it would guide trust, wealth management, and insurance companies to stabilize capital markets through increased purchases of stocks and bonds.
*A recovery is underway today with numerous firms up double digits, but given the weakness over the last year, indexes are still down close to -75%
The statement also mentioned that regulators in both China and the U.S. had achieved positive progress on the issue of Chinese stocks listed in U.S. markets. Markets took that as a sign Beijing now intends to allow overseas stock listings to go unabated and that dialogue regarding the auditing of firms with listed ADRs between the SEC and Beijing is coming to a positive conclusion. Separately, regulators will be more aggressive in cracking down on "institutions engaged in malicious short selling” in domestic markets.
*Timing is everything in markets with a number of sell-side price cuts occurring over the last week, as well as J.P. Morgan calling Chinese ADRs uninvestable yesterday. Although FDI from the U.S. is at high levels, there is still room for investments in publically traded equities to increase.
The Financial Stability and Development Committee also promised to handle risks surrounding property developers more proactively, increasingly pushing for struggling firms in the sector to sell projects to stronger state-owned/backed firms. Markets also expect further official and “back door” credit easing measures with reductions on regulatory limits for debt ratios as well as increased pressure from municipalities on lenders to maintain existing relationships and increase flexibility with repayment extensions.
*Prior to yesterday’s FSDC announcement, property developer's equities and debt were tumbling, with many attempting to alter debt terms and negotiating with auditors on liability levels and cash availability
Wednesday’s announcement was also a clear statement that Beijing is loosening its grip on internet platforms, saying that efforts to “rectify” internet platform companies should be completed “as soon as possible.” This indicated a greater level of policy stability moving forward after a year of often chaotic and sudden surprises. “Any policy that has a significant impact on capital markets should be coordinated with financial management departments in advance to maintain the stability and consistency of policy expectations,” the finance committee meeting stated.
*Weakness seen in the Hang Seng Enterprise Index over the last year best captured the effects of XI’s “Common Prosperity” purge of Shanghai tech elites, with the index reaching decade lows
In summary, Beijing is moving away from its “Common Prosperity” crackdowns to a more supportive markets/economy stance as tighter financial conditions and the increasing drag from growing Covid cases has Xi worried about how he will look at the Communist Party National Congress set for this fall. In the end, the full decoupling Xi wants from the West, known as “Dual-Circulation,” is his highest priority, and its best achieved with health financial markets that bolster real growth increasingly driven by domestic consumer demand. He also needs cover for the mishandlings of the virus with the failure of domestic vaccines and the zero-Covid policy increasingly leaving China behind improvements in the West.
*Xi is waking up to the fact that his crackdown and further power grab over other factions within China has limits and that if he wants to be revered as Mao and Deng were and create a domestic consumer base that insulates the economy from external threats, financial markets can’t be in free fall.
Econ Data:
Retail sales increased by 0.3% in February, easing from an upwardly revised 4.9% jump in January and below market forecasts of a 0.4% gain. Sales at gasoline stations recorded the biggest increase (5.3%) as gasoline prices soared nearly 7% last month, but excluding gas stations, retail sales fell -0.2%. Other increases were also seen in sales at food services and drinking places (2.5%), miscellaneous store retailers (1.9%), and sporting goods, hobby, musical and book stores (1.7). Sales activity by auto dealers increased by 0.8%. On the other hand, retail sales fell at nonstore retailers (-3.7%), health and personal care stores (-1.8%), and furniture stores (-1%).
Why it Matters: There was a significant upwards revision to January’s number, buffering the weaker February activity. However, retail sales on a three-month average, excluding the now volatile gasoline station spending, show only an increase of 1.4%. This means real retail sales are essentially flat as increases in CPI excluding energy increased 1.7% over the same period. February also saw a slowdown in auto sales. According to the Commerce Department, Americans bought cars and trucks at an annualized pace of 14.5 million in February, down from 15.5 million in January, as dealers continued to struggle with inventories and demand is beginning to fall. This is supported by consumer intentions to purchase “big ticket” items continuing to weaken, as seen in the University of Michigan's Consumer Survey report. The bottom line, as we reiterate below when reviewing the NY Fed’s consumer survey results, is the realization that inflation is longer lasting is increasingly altering consumer behavior while increases in food and energy costs are reducing disposable income for other goods and services.
*The majority of the weakness came from online sales falling -3.7% on the month nut when excluding gasoline and auto, sales were -0.4% showing a broader slowing of activity
Producer prices increased 0.8% in February, less than an upwardly revised 1.2% rise in January, and slightly below market forecasts of 0.9%. Core PPI (less food and energy) increased 0.2% in February, slowing from an upwardly revised increase of 1% in January and below market expectations of 0.6%. Prices for final demand goods jumped 2.4%, the largest advance since data were first calculated in December 2009, mainly due to a 14.8% rise in gasoline costs, which added 40% of the gains. Meanwhile, prices for final demand for services were unchanged as a 1.9% rise in the cost of transportation and warehousing services and a 0.2% advance in margins for final demand trade services offset a -0.4% decrease in the index for final demand services less trade, transportation, and warehousing. Within intermediate demand in February, prices for processed goods rose 1.6%, the index for unprocessed goods jumped 14.6% due to unprocessed energy materials, and prices for services were unchanged. The annual increase in producer price inflation was unchanged at 10%.
Why it Matters: Well, it stopped going up on an annual basis for at least one month, which at this point we will take. Around 40% of gains came from energy-related inputs, which may cool as the initial spike in oil and gasoline prices following the Ukraine invasion has reversed. However, to be clear, the report still indicates a broad level of inflationary pressures. It is also too early to tell what the full effects of the disruption in trade of commodities and reduction in supply due to sanctions and the war will ultimately be in the long run. The significant increase in final demand costs for food and energy (increasing 1.9% and 8.2%, respectively) on the month may cool in the velocity of monthly increases. Still, prices there will likely stay at elevated levels, given the uncertainty. As we have continually discussed here, this will act as a tax on the consumer and reduce disposable income for other goods and services. We do take some comfort that the final demand for services was flat while the final demand for construction was notably lower (0.6% vs. 3.6% in January).
*Increases in core PPI barely increased, with final demand for services being flat. However, inflationary pressures are still very strong due to increase in energy and food costs
The Empire State Manufacturing Survey declined to -11.8 in March, falling -14.9 from 3.1 in February and missing market expectations of 7. New Orders (-11.2 vs. 1.4 in Feb) and Shipments (-7.4 vs. 2.9) all contracted significantly. Delivery Times (32.7 vs. 21.6) continued to lengthen while the rate of Inventory (21.5 vs. 11.7) expansion continued. Labor market indicators pointed to a slowing in employment (14.5 vs. 23.1) and a shorter average workweek (3.5 vs. 10.9). Plans for capital and technology spending remained positive but fell from February’s intentions. Looking ahead, firms were slightly more optimistic than last month that conditions would improve over the next six months.
Why it Matters: March’s report was not a very encouraging business survey out of the NY region. Large decreases in New Orders and Shipments showed significant declines in demand, although Unfilled Orders remained stable. Delivery Times were again higher after dropping over the winter as logistical issues persisted. The restocking of inventories increased, a familiar theme seen in other manufacturing data nationwide. We would expect this to continue, given future expectations for demand remained high. There was no meaningful decrease in price pressures, with firms continuing to have success passing on increases to end consumers. Finally, employment indicators cooled, both current and future, something we will be watching closely. We worry the economy may be cooling faster than many expect, and a reversal in labor market strength may start to reverse in the second half of the year.
*The current indicators for demand weakened significantly while supply-side ones worsened in March while future expectations were better
The NY Fed's short- and medium-term inflation expectations both increased in February to 6.0% and 3.8%, respectively, reversing some of January's sharp declines. All the commodity price change expectations increased, namely for food (9.2%), gas (8.8%), medical care (9.6%), college education (9%), and rents (10.1%). Median home price expectations, on the other hand, declined by -5.7%. Meanwhile, earnings growth expectations remained unchanged, while expectations about unemployment, perceived job loss, and job finding all improved. Expectations for spending growth reached a new series high.
Why it Matters: The survey showed consumers increased their expectations for future inflation while remaining positive on their labor situations. However, expectations are for real compensation to decrease at the same time spending growth/needs is increasing, and increasingly, as a share of disposable income, going to energy and food purchases, showing that inflation will increasingly be weighing on perceptions about households current financial situations. This development leads us to be less optimistic on the U.S. consumer moving forward as the reality of purchasing power loss and prioritization of food and energy spending due to persistent inflation begins to sink in and reduce demand. Initially, we thought inflation would be decreasing enough at this point in the cycle to reduce inflation expectations from rising this aggressively.
*Earnings growth is expected to be half of inflation in one year ahead period, showing a significant loss of real purchasing power
TECHNICALS / CHARTS
Four Key Macro House Charts:
Growth/Value Ratio: Growth is higher on the day and week. Small-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 lower on the week with increased pressure on speculation weighing on the week while the more risk-on tone is helping it today following the policy pivot
5yr-30yr Treasury Spread: The curve is flatter on the day and week, as growth outlook and Fed tightening expectations all work to move the curve to its flattest level since 2018
EUR/JPY FX Cross: The Euro is higher on the day and the week, as positive developments in peace talks are benefitting European assets and the Euro
Other Charts:
Credit spreads have risen notably but are still somewhat contained given other risk metrics
Household net worth surged in the fourth quarter of 2021 and is now 826% of disposable personal income
February's New York Fed Survey of Consumer Expectations showed one-year inflation expectations continued to increase while household one-year ahead spending growth expectations hit a record high. The mean probability of losing a job in the next 12 months falls to a record low of 10.75%.
We continue to believe that supply-side disruptions are improving and when coupled with now weakening demand from consumer behavioral changes will lead to lower “goods” inflation
In what is the first evidence of the impacts of the Ukrainian invasion in official data, Germany's ZEW business survey outlook collapsed while inflation expectations surged
After accounting for a lag between infection & death, 1 in 20 cases in Hong Kong currently ends in death.
Articles by Macro Themes:
Medium-term Themes
Real Supply-Side Improvements:
For Now: Southern California's Ports Are Catching Their Breath During Import Lull - WSJ
With about 1,000 trucks due to pick up cargo before the terminal closed for the weekend, it was the busiest that the Port of Los Angeles’s container yard on a Friday in more than a year. The hum of activity was one sign that the gridlock that has made Southern California’s ports the center for U.S. supply-chain congestion may finally be easing, at least for now. Terminal operators there and at the neighboring ports say the imported containers have been moving more quickly through the ports and on to inland destinations recently.
Why it Matters:
The terminals are catching their breath during a seasonal lull in imports that occurs when factories in Asia slow or stop production during the Lunar New Year. Terminal operators say a sharp decline in the number of workers calling in sick with Covid-19 has also helped. The volume of inbound shipments handled at Los Angeles and Long Beach dipped to the lowest level in 18 months in December and then rose just 1.8% in January compared with the year before. Measures such as the time boxes wait for handling have also slipped from historic highs.
China Macroprudential and Political Loosening:
China's factory output unexpectedly picked up pace in the first two months of the year while retail sales beat expectations, even though the country is grappling with a surge in COVID-19 cases, a property market downturn, and heightened global uncertainties.
Industrial output rose 7.5% in January-February from a year earlier, the fastest pace since June 2021 and up from a 4.3% increase seen in December.
Retail sales in January-February grew 6.7% YoY amid rising demand during the Lunar New Year holidays, having increased 1.7% in December.
Fixed asset investment rose 12.2% YoY compared with the 5.0% increase tipped by the Reuters poll and 4.9% growth in 2021.
Why it Matters:
Last Friday, Premier Li pledged that Beijing would offer up a variety of "oxygen-supplying" measures to help counter risks to economic growth in 2022. This is in light of the worsening coronavirus situation that has been casting a shadow on the better than expected January and February economic data. It is also likely in response to the significant weakness their markets are currently experiencing. The PBOC recently resumed injecting some additional liquidity into markets but produced no further rate cuts. Meanwhile, M2 money growth slowed in February to 9.2% on the year, vs. the expected 9.5% and previous 9.8% in January.
Longer-term Themes:
National Security Assets in a Multipolar World:
Weaponized FX: Yuan Jumps After Report on Saudis Weighing Its Use in Oil Deals - Bloomberg
The Chinese yuan appreciated following a report by Dow Jones that Saudi Arabia is in active talks with Beijing to price some of its oil sales to China in the currency. The bump for the yuan comes at a time when Chinese assets more broadly have been under some strain. The renminbi has come under tremendous selling pressure over the past couple of days amid a rout in the country’s stocks.
Why it Matters:
While the U.S. dollar is the preeminent currency of exchange in global trade and oil markets, as the yuan has been making headway in cross-border transactions. The outbreak of the Ukraine war and the swath of sanctions imposed on Russia, as a result, has brought to the fore questions about alternatives to U.S. currency-based markets, and the yuan is one in particular focus in light of China’s relationship with Russia. This move away from the dollar system, as a result of the increasing weaponization of the dollar, will clearly reduce America’s ability to use its currency as a national security asset/weapon.
Electrification and Digitalization Policy:
ESG Crypto: Proposal Limiting Proof-of-Work Is Rejected in EU Parliament Committee Vote - CoinDesk
The European Parliament’s economic and monetary affairs committee voted 30-23 on Monday to keep the provision out of a draft of the proposed Markets in Crypto Assets (MiCA) framework, the EU’s comprehensive regulatory package for governing digital assets. Six committee members abstained. The provision, which was added to the draft last week, sought to limit the use of cryptocurrencies powered by an energy-intensive computing process known as proof-of-work across the EU’s 27 member states.
Why it Matters:
For popular proof-of-work cryptocurrencies like bitcoin and ether, which are already traded in the EU, the rule proposed a phase-out plan to shift their consensus mechanism from proof-of-work to other methods that use less energy, like proof-of-stake. Proof-of-work has come under heavy criticism from some regulators and politicians around the world over energy concerns. Some EU leaders are concerned that renewable energy may be channeled into sustaining cryptocurrencies like bitcoin instead of national use.
ESG Monetary and Fiscal Policy Expansion:
Too Damn High: Rent-Control Measures Are Back as Home Rents Reach New Highs – WSJ
Numerous lawmakers across the U.S. are looking to enact rent controls to curb the country's surge in home rental prices. These proposals, which would generally allow landlords to boost monthly rents by no more than 2% to 10%, are on the legislative agenda in more than a dozen states. Rental prices are up about 18% on average over the past two years, according to real-estate broker Redfin Corp., hitting record levels across the U.S.
Why it Matters:
Rent-control measures in the U.S. date to the years following the first and second World Wars, but the concept saw a major resurgence in the 1970s, a period marked by high inflation. Its resurgence was somewhat short-lived, and many lawmakers adopted the view that rent controls hurt housing markets more than they helped tenants by discouraging new development and disincentivizing apartment maintenance. More recently, some economists and politicians have reconsidered that thinking, pointing to rent control as one of the few ways to protect low-income renters, who often face the greatest hardships. We expect many of these proposed rent control bills to be enacted, and this, as well as other developments, could limit the pace of any further increases in shelter costs.
Current Macro Theme Summaries:
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