Midday Macro - Bi-weekly Color – 4/28/2022
Overnight and Morning Market Recap:
Price Action and Headlines:
Equities are higher, with Facebook, we mean Meta’s earnings, surprisingly being a catalyst for Tech and Growth to get a relief bounce as traders shrugged off the GDP miss and started to see earnings more positively
Treasuries are lower, with the curve flattening as the front-end underperformed following the GDP data release, while today’s 7yr auction will be the highest when-issued yield since November 2018
WTI is higher, with Germany signaling it will not oppose a Russian oil embargo while traders continue to focus on low inventories, especially in distillates, causing NY harbor diesel prices to soar and crack spreads to hit multi-decade highs
Narrative Analysis:
Equities are higher, with the morning sell-off reversing and overnight highs now being eclipsed as traders refocused on positive earnings releases and saw the GDP miss as a positive due to the increase in imports and strong consumer spending. There is also a high level of optionality, exacerbating moves in a lighter volume session. Treasuries are weaker but given recent volatility only marginally lower today as risk sentiment is still weak. The general risk-aversion is also keeping the dollar near multi-year highs, with the $DXY at 103.5 as the Yen is again falling, following no indication from the BoJ that they are close to changing policy. Oil is higher as energy sanctions against Russia by the EZ look increasingly likely, while domestic demand in the U.S. is expected to increase due to low inventories of distillates. There are reports that lockdowns in China may be easing, although risk assets there are only marginally higher.
The Nasdaq is outperforming the S&P and Russell with Growth, Low Volatility, and High Dividend Yield factors, and Communication, Technology, and Energy sectors are all outperforming.
S&P optionality strike levels have the Zero-Gamma Level at 4497 while the Call Wall is 4750. The VIX is currently holding near 30. Support is around 4200 with resistance at 4300. There is a meaningful level of in-the-money puts, indicating a “maximum put threshold” is near similar to what was seen in early March. This indicates an elevated level of volatility is likely to occur until May 4th, when the next FOMC meeting and a potential Russian debt default are occurring
@spotgamma
S&P technical levels have support at 4200, then 4175, and resistance at 4255-65, then 4285 area. The 4200 area continues to be critical support as it is the support of the rising trendline connecting the February and March lows this year and, in turn, is the support of a 10-month “triangle pattern.” The defense of it over the last few days is a positive technical sign. The 4365 zone (50 dma) is now the next key resistance area, and a move above would likely lead to a squeeze back to March highs.
@AdamMancini4
Treasuries are lower with the 10yr yield at 2.86%, higher by around 2bps on the session, while the 5s30s curve is flatter by 4bps to 6bps.
Deeper Dive:
After a week away, we come back to a market that increasingly doubts the Fed’s ability to orchestrate a soft landing given the degree of policy tightening expected. As a result, rising Treasury yields are pushing risk assets and increasingly the real economy as bond markets try and find the highest yields before a significant slowdown in growth becomes inevitable and Fed tightening expectations are reduced. Although pockets of the market are now becoming "cheaper,” we feel risk assets are still not correctly reflecting the coming slowing of growth and earnings and caution against chasing any rallies. This continues to be a choppy/volatile environment that favors tactical trading verse new structural long positions.
The S&P is near the lows of its 2022 range while credit spreads are widening and Treasury yields are rising after a short tactical dip back to near recent highs. The dollar is now at multi-year highs. Energy and agricultural commodities continue to be generally well bid, although oil is off war-driven highs, while Dr. Copper has been hurt by weakness in China. In summary, price levels indicate a high level of defensiveness/uncertainty with no place to hide (and hence increased flows into money markets/cash) due to the combination of increased market, credit, and duration risk as well as reduced levels of liquidity.
*April saw a large outflow of funds from U.S. stocks, with equity markets globally also generally under increased pressure
*Demand for T-bills is growing with large flows into money markets needing to be put to work and usage of the Fed Reverse Repo again near highs after a short-lived dip
*Real yields continue to rise, pressuring risk assets more generally and P/E multiples more specifically
*The dollar is increasingly becoming a negative headwind for corporations with international exposure, and its appreciation has done little to thwart inflationary pressures yet
The prevalent narrative in the market is now a growing fear that the economy will not be able to withstand the level of tightening that we are going to be getting from the Fed without going into recession. When coupled with the demand destruction already occurring from inflation, it's not surprising to see the future outlook from investors, businesses, and consumers weaken. These growing concerns are best seen in consumer and business survey-based metrics, which are leading economic indicators and, when decreasing, are a good predictor of slowdowns in future activity.
*Expected new orders, a gauge of demand generally six-month ahead, are starting to approach contractionary area in several regional Fed manufacturing surveys
*The two most prevalent consumer confidence surveys both have consumer expectations trending lower, although there was a bounce in the University of Michigan recently from extreme lows
*Small businesses are increasingly signaling a more defensive posture with the overall NFIB indexes dropping largely due to falls in sales expectations while plans to hire, expand, or invest have stalled
Things are not looking much better outside the U.S., with the war in Ukraine showing no signs of easing, increasing expectations for a recession in the Eurozone due to increased energy costs. At the same time, China’s lockdowns continue to reduce economic activity there and are re-stressing supply chains. Emerging markets, more generally, are bracing for the effects of rising food and fuel costs on aggregate demand and general societal stability. Rising levels of unrest in certain countries already are foretelling of the difficulties that many countries will increasingly be facing.
*Although high levels of energy and food costs are detrimental to growth, the exponential level of the rise in both is shocking the global consumer and increasingly going to cause social unrest
*The recent severe weakness in the renminbi has spooked investors, and all eyes look to how Beijing will counter the drag to growth that lockdowns have created
Although fear is currently in the driver's seat, all is not lost, and as risk assets continue to cheapen, we believe greed will once again return to control the market narrative in the second half of the year. We just aren’t there yet, and our expectation is for equities to remain around these current levels, with a bias lower, until inflation finally begins to fall meaningfully into year-end. Although weakening, the economy is not in immediate danger of a recession. Financial conditions are still historically easy (although the pace of change may be more critical and what we are watching). All of which should provide a floor to how much further risk assets can fall, and given what is already priced in, we believe that floor is not too far away. This assumes several things, most notably that the labor market keeps aggregate demand from free-falling and inflation approaches 3-4% into year-end, allowing the Fed to reduce its tightening plans in 2023.
*Supply-side impairment driven inflationary pressures are easing, slowly, as seen by a reduction in shipping/trucking demand and drops in costs there, but the longer than expected persistence and stickiness of price increases and new developments globally have the path to normalization growing longer
*Expectations for future Fed Fund rate cuts in ’23 and ’24 are increasing, with the market increasingly expecting a rapid overshoot to eventually warrant a round of cuts back to the longer-run terminal r* level
In summary, the current negative macro backdrop and our views that inflation will finally begin to meaningfully decelerate into Q4 leave a lot of time for tactical trading, but there is still a less compelling backdrop to take a more structural long view. As drops in core inflation materialize, Fed officials will increasingly signal that they believe their policy is working, and fears over peak Fed hawkishness (likely currently occurring) should finally meaningfully fall as markets reduce the ultimate level of overshoot needed (and whether there could be increases in long-run r* or a further reduction in bs*). Basically, right now, the Fed is overly jawboning financial conditions tighter but still believes inflation will fall fast enough to potentially not need to reach their (current quickly overshooting r*) projected rate path, staving off a recession. This is made apparent in their unemployment projections being little changed over the forecast period. We believe this is still the highest probability outcome given the weakening demand coming and normalization of goods/service demand. Things are slowing but a crash into prolonged quarters of negative growth will not materialize. We also, as often stated here, do not believe there is a structural change to inflation occurring, driven by a wage spiral cycle, hence long-run r* is not in danger of rising.
*After bouncing back in March thanks to the notable short-covering rally and drop in volatility, financial conditions are significantly tightening again in April
*We were once told forecasts more than six months out are pretty worthless in the world of economics (and believe it), but it is important to note that model-driven recession estimates are increasing
Finally, we want to highlight some developments in the mock portfolio. We have been stopped out of our Yen ($FXY) long, Lithium Miners and Battery Producers ($LIT) long and hit the target on our Transports Index ($IYT) short. This leaves our portfolio down -3.4%, and now only 35% invested. We moved the stop on our Chinese Large-Cap ($FXI) long lower as we continue to believe that Chinese equities are the best value proposition out there. The current growth deceleration occurring is overly priced in, and further/continued stimulus out of Beijing will improve sentiment and ultimately real growth there and increase inflows into equities. Given all that we continue to discuss, we are not in a hurry to enter longs or shorts at current levels, given this exercise is supposed to be a more thematic long-term orientated investment exercise. However, with that said, we will be continually looking for additions to the portfolio that make sense.
Econ Data:
New orders for durable goods increased 0.8% in March, recovering from a downwardly revised -1.7% drop in the previous month but below market expectations of a 1% gain. Excluding transportation, new orders rose 1.1% (vs -0.5 percent in February); and excluding defense, new orders advanced 1.2% (vs. -2.1 percent). Computers and electronic products led the increase, rising by 2.6%, followed by electrical equipment, appliances, and components. Transportation equipment also bounced back, rising 0.2% after falling by -4.4% in the previous month, thanks to a large bounce in motor vehicles and parts (5%). Meanwhile, orders for non-defense capital goods excluding aircraft, a closely watched proxy for business spending plans, rose by 1%, rebounding from a -0.3% decrease in February and surpassing market expectations of a 0.5% increase. New orders for Capital Goods decreased by -1.1%. Overall Shipments increased by 1.2% after only rising 0.1% in February.
Why it Matters: The report suggests a pick-up in activity in March as companies increased capital expenditures while overall new orders and shipments rebounded. The gains in new orders came from notably stronger bookings in communication equipment, motor vehicles, machinery, and electrical equipment. The increase in core orders indicated that firms are still increasing Capex despite growing uncertainty due to persistent inflation and rising uncertainty over future demand.
*New Orders for durable goods bounced back in March after a significant drop in February as firms signaled current demand and Capex intentions remain intact.
The S&P CoreLogic Case-Shiller 20-city home price index rose 2.4% in February, raising the annual increase to 20.2%, the most on record and above market expectations of 19%. Price growth in all 20 cities accelerated relative to January’s report. Phoenix’s 32.9% price increase led all cities for the 33rd consecutive month, with Tampa (32.6%) and Miami (29.7%) close behind. Prices were strongest in the South (28.1%) and Southeast (27.9%), but every region continued to show impressive gains.
Why it Matters: Overall, the national annual increase in home prices is currently 19.8%, the third-highest rate in 35 years. Demand for homes remains strong, but the composition of buyers is changing as rising prices, higher mortgage rates, and tight inventory for starter homes are increasingly pricing out first-time home buyers. Existing home sales contracted by -2.7% in March, despite the median price continuing to increase. “The housing market is starting to feel the impact of sharply rising mortgage rates and higher inflation taking a hit on purchasing power,” said Lawrence Yun, NAR’s chief economist.
*Expectations are for price pressures to moderate as affordability reduces demand while new supply comes available, it just hasn’t happened yet
The Conference Board Consumer Confidence Index decreased to 107.3 in April from 107.6 in March. The Present Situation Index fell to 152.6 from 153.8 last month, while the Expectations Index, based on consumers’ short-term outlook for income, business, and labor market conditions, ticked up to 77.2 from 76.7. Regarding their present situation, consumers' appraisal of current business conditions increased slightly while views on their views on the current labor market deteriorated. Six-month-ahead expectations saw slight declines in business conditions and labor market outlook while financial prospects improved.
Why it Matters: Despite the slew of negativity that should be further weighing on sentiment, the Conference Board’s measure held in well due to improvements in future outlook. “The Present Situation Index declined but remains quite high, suggesting the economy continued to expand in early Q2. Expectations, while still weak, did not deteriorate further amid high prices, especially at the gas pump and the war in Ukraine. Vacation intentions cooled but intentions to buy big-ticket items like automobiles, and many appliances rose somewhat,” said Lynn Franco, Senior Director of Economic Indicators at the Conference Board. Finally, concerns over inflation retreated from all-time highs seen in March but remained elevated.
*Not much change in April from March, with a slight decrease in the Present Situation Index and increase in the Expectations Index
*The gap between the Conference Board and the University of Michigan surveys has come in slightly due to the most recent positive bounce seen in the U of Mich survey.
The number of signed contracts to buy existing homes or pending home sales declined by -1.2% in March, following a revised -4.1% drop in February but missing the market consensus of a -1.6 % decline. It was the fifth straight monthly decline and pushing contracts to the lowest level since May 2020. Pending home sales declined in the South, Midwest, and West but rose in the Northeast. Pending home sales are now down -8.2% YoY.
Why it Matters: Demand is still strong, but affordability continues to worsen, reducing the pool of potential buyers. Expectations are for a deceleration in housing price appreciation, but there is still enough of a supply-demand mismatch to ensure no declines in residential property values. "The falling contract signings are implying that multiple offers will soon dissipate and be replaced by much calmer and normalized market conditions," said Lawrence Yun, NAR's chief economist. "As it stands, the sudden large gains in mortgage rates have reduced the pool of eligible homebuyers, and that has consequently lowered buying activity.”
*Five consecutive months of declining pending sales have the overall annual level back at pre-pandemic levels
The Dallas Fed’s Manufacturing Survey’s General Business Activity fell to 1.1 in April from 8.7 in March, while the Richmond Fed’s Manufacturing Index increased to 14 in April from 13 in March. The Dallas survey saw modest increases in New Orders (+12.1 vs. 10.5 in March), while Production (10.8 vs. 13.2) and Capacity Utilization (14.3 vs. 15.1) fell. Further, the Growth Rate of Orders (13 vs. 13.7) and the Amount of Unfilled Orders (10.5 vs. 12.4) also fell. The majority of the drag to the headling index number came from supply-side orientated sub-indexes with Prices Paid (61.5 vs. 74), Prices Received (43.5 vs. 47.8), and Wages and Benefits (50.9 vs. 55.2) falling as well as Delivery Times (21.2 vs. 23.2). Finally, future expected Company Outlook (7.6 vs. 10.4) and General Business Activity (1.8 vs. 8.2) both dropped notably. Turning to the Richmond district, current New Orders (6 vs. 10 in March) fell while Shipments (17 vs. 9) significantly increased. Capacity Utilization (17 vs. 9) jumped higher, and the Backlog of Orders (6 vs. 7) was little changed. There was some improvement in supply-side orientated sub-indexes with Vendor Lead Times (36 vs. 44) dropping and Prices Received (8.93 vs. 9.16) falling slightly; however, Prices Paid (11.83 vs. 11.05) did increase. Firms generally remained negative on future outlook.
Why it Matters: The two April manufacturing surveys varied in their message. The Dallas survey saw a stronger level of activity than suggested by the headline number, which was driven lower by notable decreases in prices, wages, and delivery times. However, the future outlook material worsened for New Orders (-23.4) and Growth Rate of Orders (-18) as well as the majority of other sub-indexes. Richmond’s headline index slightly improved despite the fact that demand-orientated sub-indexes worsened as improvements in inventory sentiment and capacity utilization were the primary positive drivers verse the majority of negative sub-index developments. A commonality between the two was the drop in current and future Capex expenditures, contrasting the improvement in new orders for capital goods seen this week in the Durable Goods report.
*Decreases in Prices, Delivery Times, Inventories, and Wages all drove the Dallas Fed’s Manufacturing Headline Index lower, although these are somewhat positive developments regarding the inflation front
*Outlook material worsened in the Dallas District with demand expectation weakening while expectations for supply-side pressures also dissipated.
*Stepping back, there was little change this month in the current conditions in the fifth district, while, contrasting Dallas, Richmond manufacturers expect future demand to increase
Technicals and Charts:
Four Key Macro House Charts:
Growth/Value Ratio: Growth is higher on the day, but Value is higher on the 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 the week as lockdowns weigh on demand due to plant closures despite expectations for increased fiscal driven fixed-asset investment
5yr-30yr Treasury Spread: The curve is flatter on the day but steeper on the week, with Treasuries little changed on the session following an imports driven GDP miss.
EUR/JPY FX Cross: The Euro is higher on the day and the week as the BoJ refuses to budge its accommodative policy stance, sending the Yen to multi-year lows
Other Charts:
Goldman’s sentiment indicator remains extremely negative, which is seen as a contrarian bullish sign
The April pullback following the March bounce has finally resulted in more put buying as investors seek protection or speculate on further drops
The growing hawkishness of the Fed due to persistent and rising inflation has implied volatility in the rates markets at very high levels.
Eventually, higher prices will lead to lower demand, something we may be starting to see, and as a result, commodity prices will need to come down
To add to the already tight global grain situation, bad winter/spring weather in the U.S. has been hurting the on the ground conditions and planting progress
Weaker levels of imports due to slower growth in China have yet to meaningfully put downward pressure on commodity prices. Do markets expect growth/imports to quickly rebound, or is supply that impaired that the Chinese demand's loss is not material?
Although inflation is high everywhere, the reasons why are much more energy driven across the pond
Article by Macro Themes:
Longer-term Themes:
National Security Assets in a Multipolar World:
Dom: Taiwan's rise as chip design hub threatens U.S. dominance - NikkeiAsia
Taiwanese research company TrendForce's ranking of the top 10 chip design companies by revenue in 2021 put Taiwan's MediaTek at No. 4, with compatriots Novatek Microelectronics coming in sixth and Realtek Semiconductor at No. 8. Himax Technologies joined the list for the first time, in 10th place. While U.S. companies held on to the other six spots, this marked the largest Taiwanese presence on the list to date.
Why it Matters:
The trend of Taiwanese Company’s growth in importance regarding R&D is starting to raise concerns about the world's growing reliance on a single market for vital components for a vast array of products, from smartphones to cars to rice cookers. Advanced design capabilities are a must for developing high-performance chips, and America has enjoyed a reputation as a semiconductor superpower because of its overwhelming advantage on this front, with a roster that includes Qualcomm, Broadcom, Nvidia and Advanced Micro Devices. With worries over China’s intentions towards the island growing, Taiwan is increasingly becoming a critical national security asset to the western powers.
Dual Use No More: China's DJI halts Russia, Ukraine sales to prevent use of its drones in combat – Reuters
Drone giant DJI Technology said it would temporarily suspend business in Russia and Ukraine to ensure its products are not used in combat, making it the first major Chinese firm to cite the conflict in halting sales in Russia. A DJI spokesperson said its suspension of business in Russia and Ukraine currently was "not to make a statement about any country, but to make a statement about our principles."
Why it Matters:
A company representative said last month DJI was aware of footage online that suggested the Russian military was using its products, but it had not been able to confirm this, and the company had no control over the use of its products. The conflict has put Chinese companies in a bind. Continuing to operate in Russia has drawn international criticism, but withdrawing would risk a backlash from the Chinese public. This is an interesting development as it shows pressure from the West may be influencing Chinese businesses despite Beijing's defiance, while separately, firms in China are allowed to have “principles” of their own, a chapter we missed in the little red book.
Electrification and Digitalization Policy:
Must Moderate: EU approves groundbreaking rules to police Big Tech platforms - FT
The EU will force Big Tech companies to police content online more aggressively after approving a major piece of legislation that sets the rules for the first time on how companies should keep users safe on the internet. The Digital Services Act, agreed in Brussels between member states, the European Commission, and the European Parliament, is part of a push in Brussels to lead the way on how the internet should be regulated. Earlier this year, the EU approved a separate piece of legislation, the Digital Markets Act, which aims to tackle the market power of Silicon Valley firms.
Why it Matters:
The DSA aims to make the internet safer for consumers. Internet companies will have to offer terms and conditions that are understandable even to children. Targeting users online based on their religion, gender, or sexual preferences are among the practices to be banned. Those who breach the rules face heavy fines and bans from operating within the EU.
Critical: Pentagon hires first chief digital and AI officer from Lyft – FedScoop
Craig Martell has left his role as head of machine learning for Silicon Valley rideshare company Lyft to be the Pentagon’s first chief digital and artificial intelligence officer, the Department of Defense announced Monday. Martell has also held machine learning and AI roles at Dropbox and Linkedin. His professional experience with the U.S. military is limited to his service as a tenured computer science professor at the Naval Postgraduate School, specializing in natural language processing.
Why it Matters:
The Department of Defense announced the creation of the Chief Digital and AI Office last December to centralize oversight of data and AI initiatives under one official at the highest levels of the Pentagon. The CDAO reports directly to the deputy secretary of Defense. The CDAO launched with initial operational capability in February and planned to reach full operational capability by June. The Pentagon office of the Chief Information Officer transferred the Joint AI Center to the CDAO’s leadership. The new office will also oversee the Pentagon’s Defense Digital Service and the chief data officer units.
ESG Monetary and Fiscal Policy Expansion:
Complications: Pandemic Border Policy Could Complicate Covid Relief, Ukraine Bills – WSJ
A pandemic-era immigration policy could complicate efforts to pass further coronavirus relief legislation and possibly another Ukraine aid measure if centrist Democrats side with Republicans in opposing the Biden administration’s repeal of the border rules. Republicans are trying to amend a $10 billion coronavirus relief bill that is being considered in the Senate to reinstate the border policy and hope enough Democrats will side with them. There may also be consequences for the passage of further Ukrainian aid in a separate bill.
Why it Matters:
Earlier this month, the Biden Administration said that it would end its use of Title 42 in May, a controversial policy dating to the Trump administration that allows Border Patrol agents to turn away migrants at the southern border quickly. The administration has previously said it expects that revoking Title 42 could lead to a marked rise in both the numbers of migrants seeking asylum at the border and those released into the U.S. to pursue their requests. The “situation” at the border is high on voters' minds in many contested congressional districts, and hence any change in policy there would affect election outcomes in November.
Cereal?: Biden Seriously Considering Student-Loan Forgiveness, Officials Say – WSJ
President Biden signaled to House Democrats this week that he is seriously considering taking action to forgive student-loan debt on a large scale, according to congressional aides and others familiar with the discussions. Mr. Biden didn’t detail his plans but responded positively when lawmakers pushed him to forgive $10,000 in student debt, the people said, suggesting they would be happy with his final decision. He also indicated he is open to further extending the current pause on student-loan payments, which is set to expire on Aug. 31.
Why it Matters:
What is clearly a politically motivated decision, given the current strong job market and passage of the pandemic, does not warrant such fiscal stimulus. However, stepping back and looking at it through purely an economic eye, about 40 million people owe around $1.6 trillion in federal student debt, which makes up around 90% of student debt outstanding. Any reduction in debt payments there would clearly boost aggregate demand elsewhere. As a result, any meaningful forgiveness would be marginally inflationary, likely boosting demand for services over goods. We highlight this development with that in mind.
Current Macro Theme Summaries:
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