Midday Macro - Bi-weekly Color – 5/24/2022
Overnight and Morning Market Recap:
Price Action and Headlines:
Equities are lower, as yesterday’s rally surprisingly reversed (joking) at the overnight open due to (check notes) Snapchat reducing outlook as the now-familiar theme that profit margins will be falling is again driving sentiment
Treasuries are higher, helped by weaker U.S. PMIs and housing data, while global PMIs didn’t fare much better as persistent inflation is finally starting to break the camel's back
WTI is flat, hovering around $110 for the last few sessions as shortages of distillates have slightly stabilized, and traders watch for a stronger policy response (specific to diesel) while gauging the demand outlook from a slowly reopening China
Narrative Analysis:
Equities are lower, effectively unchanged on the week as yesterday’s rally quickly reversed after the close as new earnings reports furthered worries that persistent increases in costs will increasingly pressure profit margins while demand weakens. Coupled with declines in the ISM service and manufacturing PMIs, a significant drop in the Richmond Fed Manufacturing Survey, a big negative miss in new housing starts, and voila, an existing risk-off tone was emboldened after the NY open. Treasuries subsequently are better bid, with a bull steepening of the curve as higher inflationary pressures were again evident in the econ data, leaving traders balancing a slowing growth environment with potentially tighter Fed policy. Oil is little changed, consolidating in a tighter range over the last few sessions with no new catalysts to move it meaningfully. Elsewhere commodities are weaker with the agg complex under some pressure today as supply worries are marginally reduced while industrial metals are also slightly weaker. The dollar is continuing its multi-day drop as the Euro has moved back above 1.07 on more hawkish ECB expectations, while the Yen is also bouncing.
The S&P is outperforming the Russell and Nasdaq with Low Volatility, High Dividend Yield, and Value factors, and Utilities, Consumer Staples, and Real Estate sectors are outperforming.
@KoyfinCharts
S&P optionality strike levels have the Zero-Gamma Level at 4201 while the Call Wall is 4500. Trading below 4,000 on the S&P invokes “capitulation” risk down to 3,700, wherein gamma then turns supportive of the market. 4300 is the upside area wherein negative dealer gamma declines toward zero and is the “best case” upside level into June OPEX, but any rallies should be seen as a short-covering bounce.
@spotgamma
S&P technical levels have support at 3890, then 3860, and resistance at 3925, then 3945. Every bounce is still being sold with a multi-day rally, then a dramatic drop cycle still in place. The 4025-35 is the major resistance, and for a sustained rally to take hold, this must break and then hold. However, as it stands, the momentum is again down, with 3890 being critical support that needs to be defended, or new lows are coming.
@AdamMancini4
Treasuries are higher, with the 10yr yield at 2.75%, lower by around 10bps on the session, while the 5s30s curve is steeper by 3.5bps to 22bps.
Deeper Dive:
Bears continue to be in charge of price action, with a profit warning from Snapchat last night reversing yesterday’s Bostic fueled rally and reaffirming the most important current truth; profit margins will increasingly be under pressure as consumers push back on price increases. Unfortunately, there are still no clear signs showing that inflation is materially going to fall in the next few months, with today’s data showing instead that renewed supply-side constraints are again pushing prices higher and pressuring margins. As a result, despite a belief that parts of the market are becoming more reasonably priced/valued, given our view that growth will not fall as much as feared, we are increasingly viewing the likelihood of a reduced Fed tightening pace in the fourth quarter as not yet supported by the data. As a result of the continued real policy tightening, financial conditions have yet to bottom (fully tighten) and will continue pushing risk assets to remain in their negative bear-market down-channel.
Last week numerous Fed officials noted that substantial tightening in financial conditions had occurred, with the recent weakness in financial markets now clearly catching the Fed’s attention. Along these lines, Atlanta Fed’s President Bostic shared his view yesterday that after two additional 50 bps rate hikes, it may be prudent to pause and reassess inflationary conditions in September given the lagged effects policy (and tighter financial conditions) have on the real economy. He also continues to have a rosier outlook on inflation decreasing (to a 3%-handle by year-end) than many of his fellow committee members.
*One of the main channels financial conditions impact the real economy is through the wealth effect, where consumers change their behavior based on changes to their net worth (with a lag). Currently, losses in the market should increasingly weigh on discretionary spending moving forward
Although Bostic’s views on pausing in September helped fuel yesterday’s rally in risk assets, it is still not the consensus FOMC view. Instead, Chairman Powell’s need to see “clear and convincing evidence” that inflation is moderating before stopping the current tightening push is the best mantra to follow. Unfortunately, the reported input/output price increases in today's ISM PMI and Richmond Fed Manufacturing Survey show we are not moving in the right direction as supply-side constraints are again worsening, giving us little conviction that the Fed will see a meaningful improvement in core inflation by September.
*Hard to say pricing pressures, as seen in the most recent regional Fed manufacturing surveys, are rolling over meaningfully, although there is a lag on core CPI/PCE here as well as a difference between paid and received
As highlighted last week, the ultimate Fed Funds level the Fed will need to reach (to bring inflation back down to target) is plateauing as increased worries over whether the U.S. economy will enter a recession (sooner than expected) has the front-end and the Treasuries curve more generally better bid recently while the dollar continues to weaken. However, Value (factor) continues to outperform Growth due to increased sector/company-specific stories still weighing on earnings growth expectations and hence the appropriate P/E multiples to accept (given other macro inputs are now favoring a reversal in trend here). If markets expect a sustained period of negative growth (recession), we would increasingly expect the current trend of value outperforming growth to begin to reverse even with the current valuations for growth factor firms/stocks on the higher side.
*Market estimates of where the ultimate level of Fed Funds will peak continue to be near 2.7%
The bottom line is we see a muddied market-derived outlook, again reaffirming our current more patient stance in allocating capital back into (any) positions until a clearer picture on inflation and hence Fed policy is obtained. Today’s quick reversal of yesterday’s gains, as well as new economic data pointing to continued inflationary pressure, continue to favor defensive positioning as fundamentals, technicals, and market optionality positioning remain negative.
*The outlook for inflation is still highly uncertain. As a result, worries over Fed policy and profit margins have most thinking a further leg down in the S&P is coming
SHORTER “DEEPER DIVE” TODAY AS NOT MUCH HAS CHANGED. THERE WILL BE NO MIDDAY MACRO UNTIL NEXT WEEK. BE PATIENT WITH ENTRY LEVELS FOR LONGS AND SHORTS.
ENJOY THE LONG WEEKEND!
*Leo’s first game, GO RANGERS!
Econ Data:
The S&P Global Flash U.S. Composite PMI registered 53.8 in May, down from 57.7 in March, signaling the weakest rate of expansion of output across private sector firms in four months, preliminary estimates showed. The Manufacturing PMI fell to 57.5 from 59.2 in April, pointing to the slowest growth in factory activity in three months and in line with expectations. The Services PMI fell to 53.5 from 55.6 in the previous month, the lowest in four months and below the market consensus of 55.2. New orders continued to increase, primarily driven by the manufacturing side, which saw a sharp uptick but overall, it was at the softest pace since August 2020 due to the service side. Input prices soared higher, with the pace of increase edging up to a new series high as firms reported a substantial uptick in cost burdens, primarily driven by a record-breaking rise in service sector input prices. Firms continued to raise employment levels at the fastest pace in 13 months. Manufacturers registered a steeper upturn in job creation, with service providers noting another sharp rise in workforce numbers just shy of April’s one-year peak.
Why it Matters: There are no real surprises in the weaker report. Demand continues to be positive but is slowing due to higher prices. At the same time, firms are again becoming increasingly capacity constrained by shortages of materials again while they continue to hire at a robust pace. There was a further deterioration in supplier delivery times, confirming what we have seen elsewhere, some stabilization in logistics. The surge in input prices was linked by companies to supplier-driven price hikes for a wide variety of goods and services as demand often continued to outstrip supply, as well as higher interest rates, wage bills, fuel costs, and higher transportation fees. Still, business confidence across the private sector remained upbeat, with firms recording a stronger degree of optimism in the outlook for output over the coming year in May.
*The overall PMI composite moved down to a four-month low as new sales growth slowed in the service sector while input prices increased to new record highs
*S&P’s Chris Williamson painted a more cautionary tone, noting that PMI implied GDP growth was returning to a more historically normal level
New home sales fell by -16.6% MoM to a seasonally adjusted annual rate of 591K in April, the lowest since April of 2020 and well below forecasts of 750K. March and February’s sales data were revised lower to 709K from 763K and 792K from 835K, respectively. Sales fell in all regions: the South (-19.8%), the Midwest (-15.1%), the West (-13.8%), and the Northeast (-5.9%). The median sales price of new houses sold last month was $450.6K, significantly higher than $376.6 a year earlier, while the average sales price was $570.3K, up from $434,8K. There are now 8.3 months of supply in inventory, almost twice the 4.3 months a year earlier.
Why it Matters: The country's housing activity is getting worse, although new home sales are a notoriously noisy data series. Building material and worker supply constraints are continuing to lead to price increases (the price of a new home rose 3.6% in April and was up 19.7% from April 2021), and higher financing costs appear to be weighing on new construction activity in mid-level housing as builders are increasingly moving up the value chain to higher-priced homes.
*Housing is starting to bifurcate as worsening affordability has builders now increasingly adding new supply to higher-end buyers, but overall pipeline activity is still strong, and the inventory situation is improving, potentially reducing future price pressures
The Richmond Fed Manufacturing Index fell to -9 in May from 14 in the previous month and missing the market forecast of 10. It was the first negative reading since September ‘21 and the lowest since May ‘20. The shipments fell to -14 from 17, while the volume of new orders was at -16 compared to 6 in the prior month. Manufacturers reported a lower number of employees, even though wage levels were steady from the previous month. Also, firms noted a significant increase in prices paid, while prices received rose to a lower extent. Survey participants expect business conditions to deteriorate in the next six months, the fourth time in survey history that the expectations index was negative.
Why it Matters: This report brought us another very severe drop in a regional Fed’s manufacturing survey. This time the declines were more broad-based at the sub-index level than what was seen in the recent NY and Philly surveys, with a notable decline in future expectations. The large drop in Capacity Utilization echoes what we saw in today’s PMI report and other surveys; shortages of materials are back while the labor situation has only marginally improved. Looking further at labor, the drop in the number of employees contrasted the other labor data as the availability of skilled labor worsened. Price increases were notable, with “profit margins” contracting as Prices Paid jumped by much more than Prices Received. Searching for some positive news, Capital Expenditures and Equipment & Software Spending improved. Vendor Lead Times also fell, showing some improvement in logistical delays.
*A broad deterioration in current ant outlook sub0indexes showed that manufacturers are increasingly becoming less optimistic about business conditions
Chicago Fed National Activity Index increased to 0.47 points in April from a 3-month low of 0.36 points in March. Production-related indicators contributed +0.26, up slightly from +0.20 in March; the contribution of the sales, orders, and inventories category rebounded to +0.04 from -0.01; and the contribution of the personal consumption and housing category moved up to +0.08 from +0.01. On the other hand, employment-related indicators contributed +0.10, down from +0.17 in March. The index’s three-month moving average ticked down to +0.48 in April from +0.49.
Why it Matters: Labor market contributions to the overall index cooled in April while the three other areas improved. This index, which summarizes 85 existing monthly economic indicators, does not signal an imminent recession is coming. Instead, there was a rebound in the “sales, orders, and inventories,” as well as “consumption and housing” categories after both were effectively flat in March. The initial shock of the Ukraine war looked to have weighed on activity in March due to the increased uncertainty and may now have a reduced effect.
*Personal consumption and housing’s as well as Sales, orders, and inventories contribution to the overall activity index all rebounded after going flat to slightly negative in March
Policy Talk:
Atlanta Fed President Raphael Bostic gave a speech at the Rotary Club of Atlanta outlining his views on the economy and path of policy Monday. Of note, he said there could be a potential pause in rate hikes increases in September after hiking by 50 bps at each of the next two meetings. He said he would be open to being more aggressive if inflation starts moving in a different direction than it is right now, giving a clear sign he believes it has peaked. Bostic is forecasting inflation to be in the “high 3%” range at year’s end but has a lot of uncertainty around his forecasts. He believes the Fed has been successful in using forward guidance given the financial tightening that has already occurred, but he noted there are still no signs of the real economy slowing.
“I have got a baseline view, where for me, I think a pause in September might make sense… After we get through the summer and we think about where we are in terms of policy, I think a lot of it will depend on the on-the-ground dynamics that we are starting to see. My motto is observe and adapt.”
“It’s hard to know exactly how far or how hard we are going to push, but I think getting us somewhere in the 2% to 2.5% range by year’s end would be a good place for us to get to.”
Kansas City Fed President Esther George gave prepared remarks yesterday at the KC Fed’s Agriculture Symposium, highlighting the challenges the current supply-side impaired economy is having on monetary policy. The speech reiterated how inflation developed over the last two years. George believes that the supply constraints we are all so familiar with now continue to keep the economy in an unfamiliar place due to their persistent ability to cap production capacity. In a nutshell, the manufacturing and service sectors’ “production” was constrained and unable to meet quickly rebounding demand. She goes on to highlight how the labor market dynamics also capped capacity and have structurally changed. All of which contributed to the high level of inflation. She finishes by saying a move to 2% for the Fed Funds rate by the end of summer with balance sheet reduction looks to be the clear path right now before reassessing then. Separately, The Kansas City Fed’s annual Jackson Hole symposium is scheduled for Aug 25-27, with the subject of the program being "Reassessing Constraints on the Economy and Policy."
“However, another possibility is that the pandemic has resulted in persistent, perhaps even permanent, damage to the productive capacity of the economy. This damage could be manifested along with a number of dimensions. I’ll highlight three: persistent damage to global supply chains, the quick destruction of capacity in the services sector, and long-lasting damage to workforce engagement and labor force participation.”
“On the demand side, if, as appears increasingly likely, the war proves a major drag on global growth, or if Covid lockdowns substantially dent growth in China, then lower demand might take some of the heat out of inflation.”
Technicals and Charts:
Four Key Macro House Charts:
Growth/Value Ratio: Value is higher on the day and 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 week as India has hiked its export tariffs, helping reduce supply, while Beijing continues to posture for further economic support measures
5yr-30yr Treasury Spread: The curve is steeper on the day and the week, with a bull steepener occurring after weaker economic data this AM
EUR/JPY FX Cross: The Euro is higher on the day and the week as expectations are growing for the ECB to tighten policy faster while the BoJ is still on a cigarette break
Other Charts:
IIA’s sentiment gauge is now more bearish than during the initial outbreak of the pandemic
The seven weeks of selling have left very few areas of the market unhurt, with correlations between sectors breaking higher towards levels seen during the initial phase of the pandemic
Both investment grade and high yield spread indexes continue to move higher, contributing to the tightening in financial conditions
Despite the slew of recent negative earnings forecasts m from many major retailers and tech companies, net profit margins are still expected to grow over the rest of the year
Flight search activity is showing no signs of weakening despite the higher prices indicating there is still strong demand for discretionary services
More generally, mobility continues to recover as the consumer activity is not reacting negatively to the current increases in Covid cases
May often sees increases in housing inventory as completion occurs, with an 8% jump or an additional 26K coming to market last week, bringing the total unsold single-family home inventory to 344K
Goldman expects supply-constrained categories to reverse the role they have played in the current inflationary pulse, although recently renewed supply chain problems have reduced the future drag expected
Either due to port congestion in China or a real reduction in demand, shipping capacity is improving
Although it will take a while, likely coming in waves over a multi-decade time frame, corporations are beginning to talk more about bringing supply chains closer to home
Article by Macro Themes:
Medium-term Themes:
Real Supply-Side Situation:
No End?: Companies Cut Orders, Build Up Inventory as Supply Disruptions Continue - WSJ
Ongoing supply-chain issues are forcing finance teams to rethink how they are managing customer demand, from increasing inventory to cutting the number of orders taken or canceling those that cannot be filled. About 11% of shipments from Asia arrived on time in North America this month, down from 18% in May 2021 and 59% for the same month in 2020, according to data from eeSea, a supply-chain advisory firm. The figure is up from 9% of shipments that landed on time in April, eeSea said. Improvements in global supply chains have taken a step back since the war in Ukraine and Covid lockdowns, forcing companies to continue to change their behavior.
Why it Matters:
Executives said they don’t anticipate much relief in the foreseeable future. “We don’t expect to see a change in the availability or cost of supply,” said David Bullwinkle, the chief financial officer of Rochester, N.Y. based Kodak. “We expect that will continue for the remainder of the year.” Still, Kodak has largely been able to keep up with orders despite across-the-board cost increases for materials, labor, and logistics, in part because the company decided to carry more inventory on its balance sheet, Mr. Bullwinkle said. We don’t want to generalize, but if firms have more inventory and demand is falling, then price pressures will be reduced through this channel over the rest of the year.
China Macroprudential and Political Loosening:
Additional: China Plans Tax Relief of Over $21 Billion to Lift Economy – WSJ
China will offer additional tax relief mainly aimed at businesses, including additional tax rebates to companies and cuts on passenger car purchase taxes, according to a decision from a State Council meeting chaired by Premier Li Keqiang. Beijing will also extend an existing delay on companies’ social-insurance contributions to the end of the year and expand the measure to more sectors. The meeting also said that a quota for loans aimed at small and medium-sized enterprises would be doubled.
Why it Matters:
The policies are intended to “stabilize” the economy, the meeting declared. It also said that China would improve measures to help supply chains function, ensure domestic cargo transport runs smoothly and increase the number of domestic flights. With regards to the slump in China’s property market, the meeting said it would be up to cities to set their own support measures. The country will also launch a series of energy security projects, the meeting said, without giving details. China’s financial support for lockdown-stricken areas has mostly gone to companies rather than households. The meeting chaired by Li offered no new direct household support beyond stating that social insurance payments will be raised in line with consumer price increases.
Longer-term Themes:
National Security Assets in a Multipolar World:
TPP-2.0: Biden to Begin New Asia-Pacific Economic Bloc With a Dozen Allies - NYT
President Biden has enlisted a dozen Asia-Pacific nations to join a new loosely defined economic bloc meant to counter China’s dominance and reassert American influence in the region five years after his predecessor withdrew the United States from a sweeping trade accord that it had negotiated itself. The framework will focus on four main goals: harmonizing efforts to secure supply chains, expanding clean energy, fighting corruption, and paving the way for greater digital trade. The new Biden initiative comes less than five months after the China-led Regional Comprehensive Economic Partnership officially went into force, linking 15 Asia-Pacific economies in the world’s largest trade bloc.
Why it Matters:
For the U.S., the new framework effectively replaces the more expansive Trans-Pacific Partnership as the main vehicle to shape the flow of goods and services in the region. Rather than simply rejoin the partnership, Mr. Biden essentially kept Trump’s abandonment of T.P.P. due to positions against it in his party. To assuage his liberal base, the new framework, unlike T.P.P. and other traditional free-trade pacts, will not reduce tariffs. Furthermore, even before Trump left T.P.P., it was very unpopular on both sides of the aisle, which is why the current agreements envisioned, some binding and some not, could be accomplished through executive agreements. More to come here as the initial release was more conceptual, and the devil will be in the detail.
Electrification and Digitalization Policy:
Goodfaith: Justice Department pledges not to charge security researchers with hacking crimes - Verge
The US Department of Justice says it won’t subject “good-faith security research” to charges under anti-hacking laws, acknowledging long-standing concerns around the Computer Fraud and Abuse Act (CFAA). Prosecutors must also avoid charging people for simply violating a website’s terms of service, including minor rule-breaking like embellishing a dating profile, or using a work-related computer for personal tasks.
Why it Matters:
The new DOJ policy attempts to allay fears about the CFAA’s broad and ambiguous scope following a 2021 Supreme Court ruling that encouraged reading the law more narrowly. The ruling warned that government prosecutors’ earlier interpretation risked criminalizing a “breathtaking amount of commonplace computer activity,” laying out several hypothetical examples that the DOJ now promises it won’t prosecute. That change is paired with a safe harbor for researchers carrying out “good-faith testing, investigation, and/or correction of a security flaw or vulnerability.”
ESG Monetary and Fiscal Policy Expansion:
Talk About It: Biden Says He’ll Review Trump’s China Tariffs, Fueling Yuan Rally – Bloomberg
President Biden said he’ll review Trump-era tariffs imposed on imports from China amid growing calls from businesses to remove the levies, fueling a rally in the offshore yuan. Biden said earlier this month that he and his advisers are weighing whether to cut US tariffs on foreign imports to try to fight inflation. U.S. economists say lifting the tariffs would help to ease inflation, but aides within the administration don’t want to suspend tariffs and risk appearing soft on China ahead of the November congressional elections.
Why it Matters:
The Biden administration has maintained most of the tariffs imposed by his predecessor, Donald Trump. However, with inflation running at the hottest pace in four decades, the president has come under pressure from some economists and lawmakers and the US Chamber of Commerce to reduce or eliminate the tariffs. “A reduction of US-China tariffs is taken to be positive for US-China relations and that translates to yuan gains,” said Fiona Lim, a senior currency analyst at Malayan Banking Bhd. “However, we are wary that mentions of tariff reduction have surfaced time and again,” she said.
Problem Numero Uno: Biden Exploring Release of Diesel Fuel Reserves Amid High Prices – WSJ
The Biden administration is considering releasing diesel fuel from federal strategic reserves, with officials having drafted an emergency declaration as prices have soared recently. White House spokeswoman Emilie Simons said on Twitter on Monday. Such a declaration would allow for the quick release of some of the 1 million barrels of diesel in the Northeast Home Heating Oil Reserve “if necessary,” she said. Crude and gasoline prices have been on the rise, too, but diesel has outpaced them because of the refinery closings and because Russia was such a big supplier of refined fuels into Europe, causing ripple effects worldwide.
Why it Matters:
Supplies are particularly tight along the U.S. East Coast, where inventories have dropped to their lowest level since at least 1990. U.S. average retail prices for ultra-low-sulfur diesel rose more than 37% in just ten weeks after Russia’s invasion of Ukraine, setting a new nominal record of $5.62 a gallon in the week ended May 9, according to the U.S. Energy Information Administration. The Biden administration is preparing for the release in case there are shortages, but diesel inventories in the Northeast have started to rise again, and retail prices fell last week for the first time in a month, leaving administration officials optimistic for now that they might not need to intervene, the official said.
Current Macro Theme Summaries:
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