Midday Macro - Bi-weekly Color – 3/24/2022
Overnight and Morning Market Recap:
Price Action and Headlines:
Equities are higher, and now look to be consolidating near recent highs after a multi-day rally finally fizzled yesterday, with the VIX falling back closer to 20
Treasuries are lower, although also consolidating after recent losses have now safely sent yields to above pre-pandemic levels, with the curve continuing to flatten while yesterday 20yr supply was well received
WTI is lower, as Russia claimed the shutdown of one of its pipelines was technical, not intentional, while hopes for an Iranian deal live on and the U.S. readies an energy deal with Europe
Narrative Analysis:
Equities are higher after a selloff yesterday reversed six days of gains. Tech/growth continues to generally outperform, although gains across sectors do not indicate a strong factor-orientated theme today. Initial claims hit the lowest level since 1969, while durable goods declined more broadly. S&P’s PMI survey showed a further increase in demand in March with reduced supply-side impairments, helping production capacity increase across both service and manufacturing sectors. Treasuries are taking a break from their two-week selloff, with much of the curve now flat to inverted. Oil is lower, although still around the middle of its post-invasion range. The dollar is stronger, with the $DXY approaching 99 again.
The Nasdaq is outperforming the S&P and Russell with Growth, Momentum, and High Dividend Yield factors, and Technology, Materials, and Communication sectors are outperforming.
S&P optionality strike levels have the Zero-Gamma Level lower to 4475 while the Call Wall increased to 4600. Dealer resistance increases as the S&P moves over 4500, which means the market needs a catalyst to push higher. With gamma near zero and vanna drained off due to the decline in implied volatility that has occurred, the market seems to have run out of steam.
S&P technical levels have support at 4460 (200 dma), then 4425-35, and resistance is at 4500, then 4545. After six straight days of setting higher highs, in which each of the green days was >1% (a very rare occurrence historically), bulls ran out of steam yesterday/overnight. The market will need to consolidate above the 200 dma at 4460 area to keep its gains as an overbought condition further cools.
Treasuries are lower, but little changed and consolidating in a two-day range after a 20yr auction was well received yesterday. The 10yr yield is now at 2.34%, higher by around 5bps on the session but off morning highs, while the 5s30s curve is lower by 2 bps to 14.5bps.
Deeper Dive:
On Tuesday, we laid out our belief that the second half of this year would see weaker growth than expected as the consumer's disposable income became increasingly taxed by higher energy and food costs, causing a further decline in sentiment that would ultimately reduce demand more broadly just as firms were operating at full capacity and sitting on restocked inventories. However, in an attempt to play devil's advocate today, we will highlight the positives that may prove the Fed is right in their belief they can move policy above neutral quickly and still orchestrate a soft landing without hurting employment and “crushing” inflation. Below we lay out some of the positive pulses that may allow this.
Monetary Policy and the Money Supply is Still Highly Accommodative: The growth in M2 may be slowing, but the level is 40% higher than two years ago. Cash holdings by individuals and firms either through traditional checking/savings accounts or money market funds remain near record highs. The level of lending/borrowing activity is increasing, with bank loans, revolving credit, and home equity borrowing activity all rising. The bottom line is there is a lot of cash in the system (and it is still growing) and credit access is abundant, so even as the Fed expediates the rise in short-term financing costs and reduces excess liquidity, there is a long way to go before it becomes restrictive.
*Declines in the Fed’s RRP facility usage will be a good indication that excess liquidity in the system is falling back to more normal levels
The Labor Market is Strong: Employment gains, as seen through the NFP Jobs Report, will likely average around +550 thousand a month in the first quarter. Initial claims fell to the lowest level since 1969 today, when the nation's population was significantly lower. There is a near-record amount of job openings, and the unemployment rate based on the household survey will likely fall further even as more workers enter the market, increasing the participation rate level. Wage growth is also at a multi-decade high. Consumer confidence surveys show job security is high and is expected to stay that way, helping consumption/demand remain positive.
*The high level of job openings likely means the impressive streak of monthly gains will continue
*Wage increases continue to rise, with many business surveys indicating expectations for further rises for some time
Business Surveys and Activity Shows Increasing Demand: Today’s S&P Flash PMI survey encompassed the general tone seen in other regional Fed and ISM manufacturing and service industry surveys; demand remains strong with firms able to pass on cost increases without losing business. Materials and labor shortages seem to be stabilizing, allowing for production capacity increases. With profit margins being defended and now greater output capacity, revenues/earnings are set to grow further.
*Although off recent expansionary highs, both sides of the economy continue to show increasing demand, with other business surveys supporting that nationally
Housing Activity is Strong: Although higher prices and rising mortgage rates are further weighing on affordability, the housing market is expanding with the “Spring Season” off to a strong start. Housing starts and building permits, when combined, made new record highs in February, showing inventory shortages should slowly start to improve. Ths increase in supply should reverse the recent decline in first-time buyers' intentions and improve affordability. Investors and secondary home buyers also continue to be very active.
*Homebuilders will be busy for some time as shortages have limited completions (but this is improving) while permits and starts continue to rise
The Consumer is Strong: Although consumer confidence continues to fall due to worries around inflation, the U.S. household’s net worth has never been higher. That wealth effect, increased job security coupled with rising wages, as well as further comfort in engaging in activities due to the ending of the pandemic, will keep retail sales and spending on services strong. If inflation is peaking, consumption should rise further as the future outlook improves and disposable income is less taxed by energy and food.
*Although primarily concentrated in the top 20%, the U.S. consumer has never had this high a checking count balance to continue shopping with
*As a percent of total consumption, U.S. consumers still spend a small proportion of their disposable income on energy costs
Again, we continue to remain cautious regarding the fundamental economic backdrop moving into the second half of the year. However, we wanted to highlight some of the more positive narratives markets could further latch onto if inflation started to subside meaningfully and the geopolitical backdrop improved. In summary, there was a lot of fiscal and monetary support put into the system during the pandemic, and as a result, the balance sheets of firms and households are now in a stronger position than they were going into the pandemic. Inflation is clearly weighing on sentiment, but if it meaningfully subsides, the tax it has on consumption and where policy/rates are going could quickly change, allowing for more positive “animal spirits” at the business and consumer levels to materialize and improve the outlook for risk assets.
*All bets are off until inflation peaks given the hawkish pivot the Fed and other central banks are now making to reign in demand
Econ Data:
The S&P Global U.S. Composite PMI rose to 58.5 in March, from 55.9 in the previous month. The Service PMI index rose to 58.9 from 56.5, while the Manufacturing PMI index increased to 58.9 from 57.3. On the demand side, new orders rose to a 9-month high, including increases in new export orders. Companies responded to higher demand by raising staffing levels at the fastest pace in almost a year. Despite reports of greater output capacity and easing supply chain woes, the backlog of work grew steeply due to the strong increase in New Orders. Costs went up at one of the strongest paces recorded in the series, driven by energy, fuel, and raw material prices. The higher costs were passed onto clients, although the rate of inflation moderated slightly. Finally, the outlook was the least positive in five months, mostly weighed down by concerns over soaring costs and the war in Ukraine.
Why it Matters: It was the fastest growth in the American private sector since July, as both goods producers and service providers saw higher output levels due to supply-side constraints (material and labor shortages) abating. Capacity continued to be stretched, with March seeing a large build in uncompleted orders as firms struggled to keep up with new demand, furthering hiring. With demand still outpacing supply, prices continued to rise, although slightly cooling from February outside energy and commodities. The outlook generally remained positive but did fall to a five-month low. This was mainly due to less robust expectations from the service sector, where firms highlighted the potential negative impact of reduced disposable incomes as living costs increased.
*Both sides of the overall composite, manufacturing and services, rose in the initial flash PMI survey, with increases in new orders showing demand continues to be strong despite rising prices
*Shortages of labor and materials are improving, increasing manufacturing capacity/output
New orders for durable goods fell -2.2% in February, the most since April of 2020, following a 1.6 percent gain in January and surpassing market expectations of -0.5%. The headline number was primarily driven by decreases in new orders for transportation equipment. Excluding transportation, new orders fell by a -0.6%, compared to the 0.8% rise last month. The biggest declines there are due to declines in new machinery orders (-2.6% vs. 3% in January) and primary metals (-0.9% vs. -0.3%). Meanwhile, orders for non-defense capital goods excluding aircraft, a closely watched proxy for business spending plans, decreased by -0.3%, after a 1.3 percent increase in January. Unfilled orders increased by 0.4% MoM while Inventories rose by 0.6% MoM.
Why it Matters: There was a decrease of -5.6% in new orders for transportation equipment, primarily driven by a decrease of -30.4% in aircraft orders on the month, driving down the headline number. However, the more core measures all saw declines.
New home sales decreased by -2% from a month earlier to a seasonally adjusted annual rate of 772 thousand in February, following a revised -8.4% drop in the previous month and below market expectations of 810 thousand. Declines were seen in home sales in the West (-13%) and South (-1.7%), while sales rose in the Northeast (59.3%) and the Midwest (6.3%). The median sales price of new houses sold last month was $400.6K, much higher than $362K a year earlier, while the average sales price was $511K, up from $407.5K a year earlier.
Why it Matters: A weaker than expected reading, but new home sales are among the most poorly measured and volatile government data series. This data also pre-dated the surge in yields, which has pushed the MBA 30-year national mortgage rate to 4.5%, almost 25 basis points higher than last week. As a result, mortgage applications are dropping, falling -8.1% on the week alone, although this too is a volatile data series with much seasonality. Finally, the median home price over the last 12 months is up 10.7%, but the mean price is significantly more, rising 25.4% on the same comparison, which suggests a skew in home sales to high-end homes. Affordability is increasingly becoming an issue that will ultimately find its way to the debate floors of D.C. as Wall St. cash buyers are blamed for destroying the American dream. As a result, we see the housing market likely near peak price appreciation and activity more generally given higher financing costs, increasing inventory (under construction or permit at highs), and investment/secondary-home driven buying potentially facing increasing headwinds.
*Activity in new home sales cooled with both drop-in units sold (seasonally adjusted) and a fall in median price
*Affordability continues to worsen, now back to levels seen during the height of the housing bubble
Policy Talk:
San Francisco Fed President Mary Daly said: "everything is on the table" in a recent interview with Bloomberg. She noted that the next few weeks of data would determine whether a 50 basis point hike and a beginning to shrink the balance sheet would be warranted in the next FOMC meeting. Daly wants to move rates to around 2.5% and then reassess, indicating she favors front-loading rate increases. Although she further explained that she did not want to be too disruptive by moving too quickly on tightening, indicating her support of rate hikes will be conditional on financial conditions. She highlighted that the Ukraine invasion poses an upside risk to inflation and is a modest drag to growth. She continues to believe that inflation is too high because of shocks related to the pandemic and that there is little chance of a U.S. recession. This tells us that she doesn’t believe there has been a structural change to inflation or a de-anchoring of inflation expectations, likely leaving her views on the appropriate level of r* unchanged.
* “If we need to do 50, that is what we’ll do,” Daly said Wednesday in an interview with Michael McKee during the Bloomberg Equality Summit.
Cleveland Fed President Loretta Mester gave views on the economy and policy at the John Carroll University on Tuesday. She supports front-loading interest-rate increases this year, likely including potentially more than one 50 basis point hike. “I don’t want to presuppose every meeting from here to July, but I do think we need to be more aggressive earlier rather than later.” Mester, who votes on monetary policy this year. She noted her forecast is conditional on the Russia-Ukraine conflict not escalating a lot, and she said that the war would have to be considered when thinking about policy in the second half of the year but currently, getting inflation under control was rightly the committee's number one priority. She did acknowledge the Fed can’t affect the resilience of supply chains, something she believes will improve, but “reducing the level of monetary accommodation will better align demand and constrained supply.” At this point, Fed officials are still split on tightening policy to create outright demand destruction, so this was an interesting tilt that she was open to that. She highlights that she wants to reduce the balance sheet in a predictable manner, but given the larger size and the higher level of inflation, it is appropriate to move faster than the 2017-19 period. She ends her prepared remarks by highlighting that the ultimate pace of both rate hikes and balance sheet reduction will depend on how fast inflation falls and that the Fed could slow the rate of hikes in the second half of the year.
*The fact that Fed officials have so quickly changed their views between now and December does not bode well for general forecasting abilities given where inflation already was then and the fact Omicron indicated limited improvements in supply-side inflationary forces
Technical and Charts:
Four Key Macro House Charts:
Growth/Value Ratio: Growth is higher on the day and week. 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 lower on the week as other metals, such as nickel, are seeing repeating limit up days while property developers are again under pressure
5yr-30yr Treasury Spread: The curve is flatter on the day and week, as the long-end continues to outperform as growth outlook downgrades increase rate cut expectations in 2024
EUR/JPY FX Cross: The Euro is higher on the day and the week, blowing through its recent down channel with the Yen as policy further diverges between the two nations
Other Charts:
The 2yr-10yr slope has had a mixed record in predicting downturns in stocks, with the 3month-10yr being better.
Uncertainty over the supply and demand of commodities due to the war in Ukraine and economic growth more generally have cross-asset volatility at high levels, although off highs seen at the outbreak of the conflict
"Total household wealth has increased by more than $24 trillion dollars from the end of 2019 through the end of 2021, driven primarily by rising asset prices and only secondarily by excess saving out of income" – Brookings
The four-week for gas demand/supplied was little changed, marking a departure from the rising trend seen in the past six years with the exception of 2020 as rising prices look to be starting to hurt demand
The Case Freight Shipment Index is now negative on an annual basis, rolling over significantly as logistical demand and supply have normalized, indicating inflationary pressure may follow
The number of container ships waiting off the ports of L.A. and Long Beach continues to decline
After rising since July, trucking volumes stabilized in February. Volumes were up 2.4% YoY, but off from March 2020 as post-holiday demand is reduced while driver and equipment shortages persist
The Middle East and South America have much higher inflation than others with average rates of 25% and 43%, respectively
Articles by Macro Theme:
Medium-term Themes:
Real Supply-Side Improvements:
Not an Improvement: European and American terminals brace for whiplash effect from latest China Covid outages – Splash247
Terminals in Europe and North America have been told to brace for another whiplash effect from delayed shipments out of southern China. Bloomberg data today shows that the queue of ships outside Hong Kong and Shenzhen is the highest in five months, with 174 ships anchored or loading off south China and queues also growing off Shanghai. Shenzhen has just come out of a seven-day lockdown, while the rampant number of Covid cases to the south in Hong Kong has severely impacted trucker availability. Ports elsewhere (Yantian and Shekou) are also experiencing fewer port calls due to lockdowns.
Why it Matters:
Otto Schact, executive vice president of sea logistics at Kuehne+Nagel, warned via LinkedIn yesterday that these delayed vessels in China will cause problems at their destination ports in the coming weeks. As a result, as much as we want the logistical side of our supply-side improvements theme to be better, there is clearly a further delay due to Omicron’s rise in China. However, we do take some comfort in falling shipping costs, and significantly fewer ships docked off the ports of L.A.
Longer-term Themes:
National Security Assets in a Multipolar World:
Energy Assets: U.S., Europe Closing In on Deal to Cut Demand for Russian Energy – Bloomberg
The Biden administration and European Union are close to a deal aimed at slashing Europe’s dependence on Russian energy sources. Biden’s national security adviser, Jake Sullivan, said that an agreement would be announced as soon as Friday. “This has been the subject of intense back-and-forth over the course of the past few days and weeks,” Sullivan said, “and we will have more to say on this subject, specifically on Friday.”
Why it Matters:
It’s unlikely the U.S. will guarantee specific amounts of gas supplies to the EU, the official familiar with the plan said, and it’s unclear how the arrangement would work or whether it would include an agreement on pricing. Ahead of Biden’s trip, Treasury Secretary Janet Yellen, Sullivan, and National Economic Council Director Brian Deese met with energy industry executives and leaders of other major corporations this week. The group discussed how to increase production/exports of fossil fuels and reduce development time for renewable energy production.
Electrification and Digitalization Policy:
Sides: Chinese companies weigh business and politics in Russia after war - FT
Russian troops “are using DJI (Chinese drone firm) products in Ukraine to navigate their missiles to kill civilians,” Mykhailo Fedorov, Ukraine’s vice prime minister, wrote in an open letter posted on Twitter. He demanded that DJI take a series of measures, including sharing more product information and blocking the potential use of its drones by Russian forces. The company tweeted in response to Fedorov that its products did not meet “military specifications” and his other requests were either impractical or required a formal order from the Ukrainian government. “We remain available to discuss these issues at your convenience,” DJI said.
Why it Matters:
A Beijing-based lawyer who advises Chinese companies on their Russian operations said many were struggling to balance commerce and allegations that they were keeping Russia’s economy afloat after western governments imposed wide-ranging sanctions on Moscow. “Chinese companies are finding it increasingly difficult to walk a fine line between conducting normal business activities in Russia and bankrolling its war against Ukraine,” the person said. We see the Ukraine conflict as providing a further need for an international electrication/digitalization human rights policy regarding international hardware/software used in war.
Commodity Super Cycle Green.0:
Mobilize: Dimon Pushed White House for ‘Marshall Plan’ on Domestic Gas – Bloomberg
The White House needs a “Marshall Plan” for developing domestic natural gas, J.P. Morgan CEO Jamie Dimon told President Biden during a private meeting this week. When Biden briefly stopped by the meeting between administration officials and fossil fuel and other industry executives, Dimon urged the administration to increase domestic natural gas production and reduce the time needed to obtain permits for renewable energy projects such as wind farms. Dimon also spoke bluntly about the need for more investment in oil and gas in the short term, despite the longer-term climate and clean energy goals.
Why it Matters:
A major challenge in permitting all energy projects on federal lands, including renewable wind farms and solar arrays, is clearing requirements in federal law for environmental analysis. The Biden administration has moved to reverse a Trump-era initiative to shrink those reviews under the National Environmental Policy Act. At this point, it looks like Biden will have to capitulate in his position over fossil fuels more generally, given the current level of inflation and national security priorities. We expect to increasingly see a rollback of regulations or at least a continued change in tone towards the industry and its financing.
ESG Monetary and Fiscal Policy Expansion:
Not so E: U.S. states slash fuel taxes after spike in prices – Argus
Governors across the U.S. have started tapping surplus state funds to provide drivers relief from gasoline prices that for regular grade hit a record national weekly high of $4.32/USG earlier this month, according to data from the US Energy Information Administration. California is considering a proposal to give residents a refund of $400 per vehicle in response to record-high fuel prices, while Maryland and Georgia last week temporarily suspended state taxes on fuel purchased in those states.
Why it Matters:
Some Democratic lawmakers have proposed suspending the federal 18.4¢/USG tax on gasoline for the rest of the year. But critics say lifting fuel taxes will eat into needed funding for road work and stimulate the economy when inflation is already at 40-year highs. In the end, a suspension of the tax or a direct stimulus to compensate consumers for the added costs will have a minimal effect on the price, given the more important variables at play.
Current Macro Theme Summaries:
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