Midday Macro - Bi-weekly Color – 5/17/2022
Overnight and Morning Market Recap:
Price Action and Headlines:
Equities are higher, with the overnight rally fading slightly at the NY open but then recovering, helped by stronger retail sales and industrial production data as traders await Powell at 2 PM
Treasuries are lower, with the curve flattening and yields back in the middle of their recent tactical range after last week's rally faded due to improved risk sentiment
WTI is flat, after a multi-day rally cools, with Ruble purchases picking up while prices at the pump continue to show shortages of distillates
Narrative Analysis:
Equities are higher, rising for the fourth day in a row as a short-covering rally continues. The macro narrative continues to be negative, although inflationary pressures look to have stabilized slightly, as seen in last week's data, reducing Fed tightening expectations while stronger domestic data releases are emboldening the soft landing camp to add risk. Shanghai is also set to end lockdowns, relieving some supply-chain disruptions and growth drag concerns. Worries regarding shortages of critical commodities continue with the agg and energy complex well bid as protectionist pulses continue to emerge globally. Treasuries find themselves again under pressure as yield compensation, and duration risk is back in focus. The dollar has fallen from its recent highs, with the DXY moving lower to 103.3 from a 105 peak two days ago. Powell is set to speak shortly and will likely set the tone for the rest of the week for equities which will see a heavy OPEX Friday.
The Russell is outperforming the Nasdaq and S&P with Small-Cap, Momentum, and Value factors, and Materials, Financials, and Technology sectors all outperforming.
@KoyfinCharts
S&P optionality strike levels have the Zero-Gamma Level at 4297 while the Call Wall is 4800. There is no headline-driven reason for the current daily move higher, but put-heavy options positioning provided a setup for a strong market rally. The current move higher is still a short-covering rally, leaving it open to the potential for quick, violent reversals. This is because this rally is being driven by the decline in implied volatility and decay of large put positions, which leads to the buy-back of short hedges (futures and/or stocks). Markets can quickly revert once this expiration-driven flow subsides.
@spotgamma
S&P technical levels have support at 4045, then 4025, and resistance at 4110, then 4155. Today is the 4th day in a row the S&P has made a higher high, rare since March 28th, with all rallies failing on day four since then. As a result, a larger than typical relief rally is likely underway. There is also an inverse head and shoulder formation and the consolidation yesterday reset RSIs, indicating a higher move is potentially coming.
@AdamMancini4
Treasuries are lower, with the 10yr yield at 2.96%, higher by around 8bps on the session, while the 5s30s curve is flatter by 4bps to 23bps.
Deeper Dive:
A more substantial relief rally continues to occur today, with markets moving away from the Fed-induced recession narrative to a higher probability of a softer landing occurring. Recent inflationary and hard data, as well as earnings guidance, continue to show the U.S. consumer transitioning away from discretionary goods towards staples and services, as expected from the persistence of price increases, the reopening, and growing uncertainty, but demand is not yet collapsing. Turning to China, we see some stabilization in the financial markets now likely to occur as Shanghai reopens and Beijing pledges further support for the economy and markets. We are certainly far from out of the woods, given the growing tax that persistently higher energy and food costs are having on the global consumer, but we believe that recent lows in U.S. equities will hold for now as Fed policy tightening expectations stabilize, allowing for a continuation in the current tactical relief rally (based on technicals and optionality). Of course, we have numerous Fed speakers today, including Powell, that could quickly change that, leaving us still unimpressed with the macro backdrop and remaining patient with any new positioning.
After a one-day post-May FOMC meeting’s rally turned into days of methodical/systematic selling, which finally led the S&P to hit “bear market” territory, negative sentiment and defensive positioning have improved slightly. As a result of the high levels of negative gamma (much of which expires this Friday) and reduced liquidity more generally, it isn’t taking much for the dip-buying/short covering in some of the “worst performers” to start a broader relief rally at the end of last week. Unfortunately, there has yet to be a proper washout (although many individual stocks did washout), as indicated by a spike in the VIX that would give us greater confidence a longer-lasting low is in. However, the current inverse head and shoulder technical setup as well as Friday’s OPEX, along with the belief that a large amount of Fed speakers this week will come off neutral given last week's CPI, PPI, and import/export inflationary data, along with today’s Housing Sentiment data was more neutral towards the future policy path, as well as the level of financial tightening that has recently occurred coupled with stable hard data, as seen in today's Retail Sales and Industrial Production reports, will allow for a further tactical bounce higher in U.S. risk assets.
*Investor sentiment is at a historically very negative level, which is not alone enough to act on but often coincides with a bottom in stocks being near
*The increase in cross-asset volatility and breakdown of historical correlations between stocks and bonds has weighed heavy on more systematic orientated investors like risk-parity funds
Turning to China, recent economic data showed that the zero-Covid policy had a much more negative effect on growth than initially thought. Industrial output and consumer spending in the world’s second-largest economy slid to the worst levels since the pandemic began. Chinese risk assets and the CNY have largely already reflected this drop in growth expectations. However, renewed hopes that lockdowns are ending and the increased likelihood that Beijing will soften its regulatory stance while increasing fiscal and monetary support have stabilized risk assets there.
*Earnings estimates for Chinese firms continue to deteriorate given the higher than expected level of drag lockdowns have had, but given increased support from Beijing and the reopening now beginning to occur, are things too bearish?
As a recap of the recent negative economic data, we wanted to quickly highlight some of the main releases in the hope of showing the broad level of deterioration in all aspects of the Chinese economy:
Industrial production in April contracted by -2.9%, driven by declines in crude oil refinery (-10.5%), power generation (-4.3%), automobile production (-43.5%), and steel production (-5.8%).
Fixed asset investment annualized fell to 6.8% from 9.3% in the previous month. Real estate development investment fell by -2.7% in Q1, while residential housing sales are lower by -20.9% YoY.
Retail Sales fell by -11.1%, continuing a multi-month contraction. It was reported that not a single car was sold in April in Shanghai.
Finally, the “Urban Surveyed” unemployment rate ticked up slightly to 6.1%, something weighing heavily on Beijing policymakers given the need for social cohesion under a “communist” regime.
*There was a clear negative inflection point for growth this year as Omicron made its way through Hong Kong into mainland China
*Due to the very nature of what happens when you lock people in their homes, no part of the Chinese economy has been spared under zero-Covid policy, unlike other nations that remained partially open during Covid waves
Credit growth is also slowing, with both new bank loans and total social financing dropping around -80% in April from the prior month, catching analysts and economists off guard, given expectations for greater lending activity due to nudgings from Beijing. There is simply no demand from either private sector businesses or consumers due to the uncertainty that zero-Covid and its effects on the economy have had. However, the broad M2 money supply level grew by 10.5% annually, accelerating from 9.7% in March, showing the PBoC continues to ease in the background.
*Credit plays a critical role in stimulating China’s economy, and the recent slowdown coincides with the weaker data. We would need to see a significant bounce back in total social financing to give us conviction the second half of the year will be meaningfully stronger
Lockdown Update: Shanghai has restarted social activities, and a full resumption will be conducted in phases throughout June under regular epidemic preventive and control measures. Beijing has not fully locked down but has launched another round of tests for much of the city. Elsewhere, 41 Chinese cities with a population of almost 300mn are under partial or complete lockdowns. All signs indicate that Beijing is “doubling down” on dynamic zero-Covid following an essay recently released on Qiushi by the head of the National Health Commission. This means that lockdowns could quickly resume/start anywhere in the country until a homemade mRNA vaccine is rolled out at the end of the year, allowing the policy to change.
*Shanghai officially declared victory, with case counts nationwide continuing to fall. However, until a new effective mRNA vaccine can be rolled out, Xi will continue to protect the elderly by imposing zero-Covid policies when there are new flare-ups
Finally, China’s supply-chain problems intensified in April and may get worse before they get better as logistics continue to be challenged on the ground, leading port activity to drop to levels seen during the original 2020 lockdown. That blockage is leading to shortages of goods globally again and creating a new inflationary pulse.
*The hope is things can quickly resume again at the ports as Shanghai, and other production hubs begin to reopen, but the effects of the zero-Covid lockdowns will be long lasting and bring renewed shortages and price pressures
Beijing continues to “loosen” policy and change its regulatory tune with markets expecting further easing measures across the board. However, so far, there continues to be a relatively restrained approach, prioritization stopping the spread of the virus as well as not overly leveraging the economy. “The macro leverage ratio will rise, but it will remain in a reasonable range,” the PBOC recently said. Still, we take comfort in recent rhetoric that indicates a reduction in “common prosperity” regulatory crackdowns as well as fiscal initiatives directed to move forward “Dual Circulation” objectives. Finally, there is a growing effort to support the property sector end-to-end, with developers and consumers seeing initiatives to support activity and improve balance sheets.
*As a reminder, the “Dual Circulation” policy is a goal Bejing has to create a Chinese economy independent of any foreign inputs, reducing the leverage the U.S. or E.U. can have on them. Something that has likely grown in importance for Xi following the international isolation Russia is now experiencing
Putting it all together, we see the potential for a sizeable bounce in Chinese risk assets given the belief that the Covid outbreak has meaningfully stopped, valuations are attractive, and policy support for the real economy and financial markets will meaningfully increase into the winter as Xi wants to look good as he is elected by the CCP for a third term. It will also be around that time when a proper mRNA homegrown vaccination will be rolled out, finally ending the zero-Covid policy and furthering the post-pandemic global re-opening. As a result, we continue to stay long on Chinese equities through our China Large-Cap ETF ($FXI) long.
*The portfolio continues to be heavily underinvested as we see our longer-term thematic investment approaches as ill-suited for the currently more choppy tactical trading environment. Nevertheless, we closed out European Equity short expressed through $VGK after it went through our target for a nice gain.
Econ Data:
Retail sales increased 0.9% MoM in April, following an upwardly revised 1.4% in March, matching market forecasts. Excluding autos, sales increased 0.6% MoM verse whileretail sales excluding autos, building materials, and gasoline (the component of this report that feeds into the calculation of non-auto consumer goods spending within GDP) rose a stronger than expected 1.0%, both more than expected. The biggest increases were seen for sales at miscellaneous store retailers (4%), motor vehicle & parts dealers (2.2%), nonstore retailers (2.1%), and food services & drinking places (2%). In contrast, sales fell by -2.7% at gasoline stations and -0.5% at sporting goods, hobbies, musical instruments, & book stores. Year on year, retail sales increased by 8.2%.
Why it Matters: The reading showed American consumers continued to spend despite high levels of inflation, although it was the smallest gain in retail trade in four months and likely indicated spending more on less as the data is not inflation-adjusted. Revisions to the March data were significant, showing the volatility in the data series and giving pause to over-analyzing any first takes. Reduced Covid worries and restrictions helped eating and drinking establishments again, which have now seen a 50.9% annualized increase in spending over the last three months. However, with cases again rising, it will be interesting to see if this momentum can be sustained. As a result of the report and revisions, annualized real personal consumption expenditures continue to be robust despite low consumer confidence.
*A 1% rise in the control group showed the consumer has yet to materially reduce activity with the reopening theme and better availability of materials/inventory also prevalent in the data
*“So far this year, four months of data, core retail sales have advanced 18.2% at an annual rate, about twice the pace of CPI inflation. Strong real consumers' spending.” - @RenMacLLC
Industrial production rose 1.1% MoM in April. It followed a 0.9% increase in March and market expectations of a 0.5% rise. Manufacturing output advanced 0.8%, the same as in the prior month and above market expectations of 0.4%. The indexes for durable and nondurable manufacturing increased by 1.1% and 0.3%, respectively. Motor vehicle production rose 3.9%, business equipment output increased 1.1%, consumer goods production gained 0.8%, and the output of construction supplies was up 0.3%. Meanwhile, the index for utilities moved up 2.4%, and the index for mining advanced 1.6%, thanks to robust activity in oil and gas drilling. Year-on-year, industrial activity rose by 6.4%. The capacity utilization rate increased to 79.0% in April from 78.2% in March (this utilization rate was 76.3% pre-Covid in February 2020).
Why it Matters: A solid report, beating expectations across various categories. Business equipment spending was particularly strong, showing firms continue to invest in themselves after dealing with material and labor shortages that produced capacity constraints. The capacity utilization rate is now at multi-decade highs, indicating inflationary pressures are still going to materialize through this channel for some time as demand outstrips supply (however, recent business survey data seen in the Empire State Manufacturing Survey some cooling in demand as highlighted below). Spending on Computers & Electronics along with High-tech were on the weaker side, but this follows renewed supply-chain pressures out of China and strong manufacturing activity in February and March.
*After a weak January, Industrial production gains have been strong and broad-based
*Capacity utilization has improved but coupled with manufacturing survey-based data, firms still are running into capacity constraints due to material and labor shortages
The NAHB housing market index fell to 69 in May from 77 in April, below market forecasts of 75. It is the lowest level since June of 2020, hurt by rising mortgage rates and building material costs. The current sales subindex dropped 8 points to 76, buyer traffic dropped 9 points to 52, and sales expectations in the next six months sank 10 points to 63.
Why it Matters: Builder sentiment in the market for single-family homes fell sharply in May, as mortgage rates shot higher and building material costs showed no relief. "The housing market is facing growing challenges. Building material costs are up 19% from a year ago; in less than three months mortgage rates have surged to a 12-year high, and based on current affordability conditions, less than 50% of new and existing home sales are affordable for a typical family”, said NAHB chief economist Robert Dietz.
*Widespread weakness as higher mortgage rates and continued supply-side impairments/shortages weigh on optimism
Manufacturers’ and trade inventories rose 2% in March, quickening from an upwardly revised 1.8% increase in the prior month and beating market expectations of a 1.9% advance. Stocks rose the most among merchant wholesalers (2.3% vs. 2.8% in February), followed by retailers (2.3% vs. 1.6%) and manufacturers (1.3% vs. 0.9%). Motor vehicle inventories rose 1.6%, while retail inventories excluding autos, which go into the calculation of GDP, shot up 2.5%. Year-on-year, business inventories surged by 14.7% in March.
Why it Matters: Although relatively lagged, March’s data showed that although at a slower pace than Q4 ’21, inventory accumulation in Q1 this year was still respectable despite the negative overall GDP print. Moving forward, we will be watching for any deterioration in real inventory activity here as stocks begin to normalize while the future outlook for demand continues to weaken.
*Inventory to Sales ratios are still historically low, but certain areas/industries have made progress in restocking
The New York Empire State Manufacturing Index fell to -11.6 in May from 24.6 in April, missing market forecasts of 17. New Orders notably decreased (-8.8 vs. 25.1), and Shipments fell at the fastest pace since early in the pandemic (-15.4 vs. 34.5). Delivery Times (20.2 vs. 21.8) and Inventories (7.9 vs. 13.6) remained in expansionary territory. Labor market indicators pointed to a modest increase in hiring with Employment (14 vs. 7.3) and the Average Workweek (11.9 vs. 10) increasing. Both Prices Paid (73.7 vs. 86.4) and Prices Received (45.6 vs. 49.1) moved lower. Looking ahead, optimism about the General Business Conditions six-month outlook remained positive, increasing slightly on the month (18 vs. 15.2).
Why it Matters: There was certainly a deceleration in business activity in the greater New York area in May. The massive drops in New Orders and Shipments as well as Unfilled Orders, showed significant demand destruction occurred, likely due to increased uncertainty following the invasion of Ukraine and continual inflationary pressures. Supply-side pressures seemed to have marginally improved with a slight drop in Delivery Times and Prices while firms continued to fill job openings. There was a drop in inventories and when coupled with data elsewhere, furthers our belief that the restocking cycle is in its later phase. The future outlook remained somewhat upbeat, with underlying sub-indexes showing expectations that demand will remain stable. There were also signs that firms increasingly believe the worst of inflation and logistical impairments are behind them. Capex and hiring intentions also fell further, continuing a now established negative trend in both those areas.
*Current sub-indexes indicated reduced demand and some relief to supply-side impairments and inflationary pressures
Technicals and Charts:
Four Key Macro House Charts:
Growth/Value Ratio: Growth is higher on the day, but the ratio is flat on the week. Small-Cap Growth 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 but stable given recent drops as the end of Shanghai’s full lockdown as well as increased stimulus expectations have risk appetite improving
5yr-30yr Treasury Spread: The curve is flatter on the day but still steeper on the week, as the Front-end is underperforming following better than expected economic data
EUR/JPY FX Cross: The Euro is higher on the day and the week as a more risk on tone is emerging globally while ECB tightening expectations grow
Other Charts:
According to BofA's recent Global Fund Manager Survey, monetary policy has overtaken geopolitics as fund managers' identified largest risk to financial stability
The percentage of S&P 500 members hitting new 52-week lows doesn’t yet indicate capitulation
Net retail inflows amounted to just $2.4bn this month to May 10, compared to $11bn in April and $17bn in March – JPM
The S&P averages an 18.6% increase after five-month declines greater than 15%
American wholesale gasoline prices surged above $4 a gallon for the first time ever.
Despite rising fuel costs, market-implied measures of inflation continue to fall
Oxford Economic’s Supply-chain Stress Tracker Index has yet to come down despite some indication things are gradually improving
Article by Macro Themes:
Medium-term Themes:
Real Supply-Side Situation:
Slow Start: Tesla and Sony’s Problems Show Shanghai’s Big Restart is Faltering - Bloomberg
The official line coming out of Covid-hit Shanghai is that business is returning to usual despite the ongoing lockdown, yet hundreds of manufacturers in the city aren’t operating at anywhere near their full capacity if they’re up and running again at all. In a Shanghai Securities News survey of 667 companies, about half had resumed less than 30% of production as of May 7. The biggest challenges they face are disrupted supply chains and restrictions on staff movement, the newspaper said.
Why it Matters:
China has touted “closed loops,” where workers are regularly tested and shuttled between factories and accommodation on-site or nearby, as a way to keep the economy running amid Covid Zero’s punishing ordeal. But companies trying to operate these loops are facing issues from infections spreading among workers to lack of accommodation and social unrest. Tensions flared last week at a facility that makes devices for Apple Inc., as workers rushed through barriers and clashed with guards trying to keep them inside, a video shared on Twitter and YouTube shows. Even in China, eventually, people say enough.
China Macroprudential and Political Loosening:
No Go: China says it will ‘strictly limit’ citizens from going abroad – FT
Beijing said it would “strictly limit” unnecessary outbound travel by its citizens amid escalating efforts to stamp out an outbreak of coronavirus that has already prompted weeks of city lockdowns. The move reflects the government’s decision to continue with its zero-Covid policies as it battles the most severe outbreak since the pandemic emerged in Wuhan more than two years ago. Interestingly, last week, Chinese cities canceled advanced placement examinations that students take to apply to study at universities overseas, further limiting likely outbound flows over the coming year.
Why it Matters:
President Xi Jinping, who is seeking an unprecedented third term in power this year, has prioritized the Covid-19 elimination strategy but is under mounting pressure as increasing signs of economic strain emerge. He is also continuing his dual circulation goals by increasing fiscal support for critical industries. The current Covid surge gives Beijing further reason to insulate/isolate its economy from western influence. Stepping back, this is a troubling sign as a more independent and buffered Chinese economy means Beijing can further its “Wolf Warrior” ambitions.
Longer-term Themes:
National Security Assets in a Multipolar World:
Prohibited: India Bans Wheat Exports as Food Security Comes Under Threat – Bloomberg
Chicago wheat futures jumped by their 6% limit on Monday after India banned exports of the grain, citing concerns over "food security." Exports will still be allowed to countries that require wheat for food security needs, and based on the requests of their governments, India’s Directorate General of Foreign Trade said in a notification dated May 13. All other new shipments will be banned with immediate effect.
Why it Matters:
India had been helping to fill the wheat supply gap following a plentiful harvest in 2021 until it experienced a blazing heatwave in March and April. The searing temperatures prompted concerns about wheat supply and spiked domestic prices by 20%-40%. "India is not a big wheat exporter, but the fact that a big country scrambles to secure food supply left the market anxious," according to analysts at Danske Bank. There are also fears of a domino effect if other nations follow suit with their own export bans. Indonesia, which accounts for over half of global palm oil production, recently halted trade of the widely-used ingredient and feedstock.
The Thing About It: Sri Lanka meltdown exposes China loan policy: 5 things to know - NikkeiAsia
China's economic stakes in Sri Lanka are in focus as the bankrupt South Asian nation scrapes the last of its usable foreign reserves and a man regarded as China’s closest ally among the Rajapaksas, Sri Lanka's most influential political clan, Mahinda Rajapaksa, elder brother of Gotabaya and a former president himself, resigned on Monday amid daily public protests against the duo. The article highlights how Sri Lanka came to its current predicament given financing from China.
Why it Matters:
China's deep pockets enabled it to come to Sri Lanka's rescue when Colombo needed to raise commercial loans and push aside the IMF as the traditional lender of last resort in the last few years. Beijing's detractors in the West and India have scrutinized the Chinese lending that has underwritten Sri Lanka's post-conflict growth. The China-funded Hambantota Port in the south has been painted as the poster child of Beijing's "debt-trap diplomacy." Now, in capitals across Asian and elsewhere, where Chinese loans have also poured in, officials are following how China handles Sri Lanka's economic woes, given its own current problems.
Electrification and Digitalization Policy:
Tougher: EU governments, lawmakers agree on tougher cybersecurity rules for key sectors - Reuters
EU countries and lawmakers agreed to tougher cybersecurity rules for large energy, transport, financial firms, digital providers, and medical device makers. All medium and large firms in postal and courier services, waste management, chemicals, food manufacturing, medical devices, computers and electronics, machinery equipment, motor vehicles, and digital providers such as online marketplaces, online search engines, and social networking service platforms will also fall under the rules.
Why it Matters:
Companies must assess their cybersecurity risk, notify authorities, and take technical and organizational measures to counter the risks, with fines up to 2% of global turnover for non-compliance. EU countries and the EU cybersecurity agency ENISA could also assess the risks of critical supply chains under the rules. Basically, a broad-based set of new expectations/regulations for the private sector which will increase the need to combat and be transparent about cyber threats.
ESG Monetary and Fiscal Policy Expansion:
Reg it Up: Biden Administration Targets Housing Supply Shortage - WSJ
The Biden administration is using regulatory moves to address the shortage of entry-level homes, including expanding federally backed financing for affordable housing and directing grants toward localities that encourage construction. Regarding expanding financing, Fannie Mae will consider purchasing loans made to builders prior to the construction of multifamily housing. The administration also said it would consider moves aimed at boosting the availability of manufactured homes, which are constructed in factories and shipped to their destinations rather than built on a housing site.
Why it Matters:
The limited inventory of homes has pushed up housing costs, and now higher mortgage rates are further hurting affordability for lower-income households.At the end of March, there was a two-month supply of existing homes on the market at the current sales pace, near a record low. Economists consider four to six months of supply to be more balanced. “While the policies cover a wide range of issues and agencies, most are intended to do one thing: Make it easier and more economical to build affordable housing. The total effect should be considerable.” said Jim Parrott, a former Obama administration housing adviser who had reviewed the proposal.
Flashpoints: China Competitiveness Bill Faces Hurdles as Time Runs Short – WSJ
Disagreements over legislation designed to boost U.S. competitiveness against China are clouding its prospects in Congress as lawmakers enter a period of make-or-break negotiations. Many lawmakers say the sprawling, complex package remains likely to pass this year. But disputes are emerging over proposed national-security reviews of outbound U.S. foreign investments, waivers of tariffs on Chinese imports, and curbs on the sale of counterfeit goods online, among other provisions.
Why it Matters:
Among the most contentious provisions being debated is a proposed requirement that the U.S. trade representative start a new process to grant tariff waivers, a step that could result in a significant erosion of the scope of goods subject to existing tariffs on $300 billion of Chinese imports. The debate comes at the same time Biden administration officials and businesses are sharply divided over whether the Trump-era tariffs should be removed as a way to ease inflation. The passage of some form of this bill is an essential step toward onshoring and regionalization of supply chains, something that will provide greater security while also decoupling us from China.
Current Macro Theme Summaries:
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