Midday Macro - Semi-weekly Color – 6/16/2022
Overnight and Morning Market Recap:
Price Action and Headlines:
Equities are lower, with yesterday’s FOMC-driven rally reversing overnight and accelerating at the NY-open as recession fears grow, helped by weaker economic data today
Treasuries are higher, back to levels seen immediately following yesterday’s FOMC meeting results and reversing overnight weakness thanks to the more risk-off tone
WTI is higher, but also highly volatile as prices dropped from over $10 in three sessions before recovering halfway as traders grabble with various supply and demand concerns/uncertainties
Narrative Analysis:
Equities are having another historically weak day, with indexes down around -4%, more than reversing any post-FOMC gains. The perceived risk of a recession grew significantly with the Fed changing their tune yesterday, not only with the more aggressive 75 bp rate hike but also increasing their 2022 inflation projections and subsequent level Fed funds will reach while downgrading their growth outlook over the next three years in the June SEPs. Elsewhere the Bank of England and Swiss National bank both raised rates overnight, with the SNB surprising markets with a 50bp hike. Economic data today showed manufacturing activity in the Richmond region was contracting while housing starts fell sharply, all be it off high levels of current activity. The economic data this week has undoubtedly been weakening and along with the more hawkish Fed, giving good reason for the drop in risk assets. Oil fell sharply over the last two days but is now recovering much of those losses, with WTI at $117. A similar story is playing out in RBOB and natural gas futures. Copper continues to trend lower while the agg complex is better bid but mixed. Finally, the dollar is falling as both the Euro and Yen are higher, with the $DXY at 103.7.
The S&P is outperforming the Nasdaq and Russell with Low Volatility, Momentum, and High Dividend factors, and Consumer Staples, Health Care, and Real Estate sectors are outperforming on the day.
@KoyfinCharts
S&P optionality strike levels have the Zero-Gamma Level at 4098 while the Call Wall is 4200. Key gamma levels have shifted sharply lower. There was sharp calling selling yesterday around the 3850 level, killing the rally. The size of the put position expiring tomorrow is still very large, and many ITM puts will be exchanged for OTM puts, creating a short delta hedge imbalance for dealers (i.e., they need to cover short futures). This is what may drive an OPEX-related rally, but markets will be a lot of volatility until then.
@spotgamma
S&P technical levels have support at 3625-35, then 3600, and resistance at 3665, then 3720. The 3625-35 is final support likely until ~3500. The 50% retrace of the entire 2020-2022 bull market is occurring before our eyes. Bulls need to get above 3670 to squeeze now.
@AdamMancini4
Treasuries are lower, with the 10yr yield at 3.30%, higher by around 1.8 bps on the session, while the 5s30s curve is steeper by 3.2 bps, sitting at 0
Deeper Dive:
With continued high inflation becoming perceived as more entrenched, eroding the consumer's future real income further, the probability of a more protracted economic slowdown is increasingly being priced into risk assets. To make matters worse for the markets, the Fed (and central banks more generally) is becoming increasingly hawkish (rightly so but too late), raising rates 150 bps since May and likely further hiking another 275 bps into next year before hitting a still rising “terminal rate” level. These higher rates, coupled with balance sheet runoff, are further tightening financial conditions into restrictive territory, which through negative wealth effects and higher financing costs, will increasingly weigh on consumer activity. Coupled with an unchanged negative international macro backdrop, that is showing little meaningful inflationary relief (from energy and food cost increases), the Fed is facing one of the most challenging central bank policy environments in some time. We go further into this in the “Policy Talk” sections below, recapping the main takeaways from the June FOMC meeting. However, we still believe there is an overly pessimistic outlook priced into risk assets given our belief that inflation will fall in the second half of the year more than expected, and a soft-landing is possible and are adding some risk to our mock portfolio (discussed below). First, we finish our three-part series with “the Ugly” macro themes below.
The Ugly: The war in Ukraine is leading to higher food and energy prices which has kept inflation growth going longer than expected. This is increasingly scaring global central bankers who can do little but tighten policy to slow overall aggregate demand in hopes the supply-side driven cost-push inflation will eventually subside on its own. There were already poor supply/demand imbalances in the food and energy markets, but now things are increasingly ugly due to the war. Secondly, the consistent/continual deterioration in the relationship between the two largest global growth drivers, the U.S. and China, shows little signs of improvement. In an ideal world, these two would have fought Covid together (meaning China would have its population properly vaccinated and hence no zero-Covid policy needed) and be coordinating policy to fight inflation while still supporting growth. We are far from that world with a very confrontational “strategic rivalry” relationship continuing, although there are some tepid positive signs the relationship may be stabilizing tactically.
The War in Ukraine: At this point in the conflict, given the losses of equipment and personnel already incurred, Russia’s military probably isn’t strong enough to take complete control of Ukraine, and Ukrainian forces lack the muscle to oust Russian forces entirely from Ukrainian territory. With that said, Russia has made recent gains in the eastern regions, given the huge concentration of their forces there, with the tide of war turning against Ukraine currently. However, the inability of Russia to push on multi-fronts and the growing arsenal Ukraine is receiving to fight back means current gains are far from assured. This leads to the development of a “frozen conflict” that has the potential to continue for a long time.
*Since the first week of April, when they shifted away from districts north of Kyiv, Russian forces made gradual advances in the eastern Donetsk and Luhansk regions, the two main districts comprising the Donbas. Western officials have said it would potentially take until August or into September for them to take all of the Donbas.
Each day the conflict continues, more damage is done, not only to Ukraine and its people who have seen the world they knew destroyed but also to the global supply of food and energy. Worse, Russia's actions clearly show an intent to increasingly extract a cost on the world through these commodity channels in hopes of helping them win. This means if things worsen for them on the battlefield, they may increasingly target energy and food sources and infrastructure, something they are already doing. This leaves a general uncertainty over where commodity prices are going and whether the conflict escalates outside of Ukraine. As a result, it is no surprise that global consumer/business sentiment has fallen further since the beginning of the conflict, altering real economic activity negatively.
*Global food prices are near record highs, with millions of tons of grain and vegetable oil stuck in Ukraine. Efforts to reopen the ports are stumbling, with no sign of progress on a deal, while removing sea mines could take months, according to a UN agency.
As is well known by now, Ukraine urgently needs long-range weapons and better air defense that can directly attack Russia’s artillery and air advantage, but this also increases the chances of a spillover/escalation given Russia’s threat to punish those who are supplying these weapons. New additions to NATO and an increasingly worse economic situation at home will likely also lead to more erratic behavior on Putin's part. The bottom line, there are still no “off-ramps” to end the conflict, and the longer it goes on, the higher the price that is paid and the greater chance for escalation to occur. We see this conflict ultimately ending with either regime change in Moscow or Kyiv, likely the first as authoritarian leaders like Putin can not look weak, something the Russian military is increasingly looking like. However, as history shows, these “strong men” figures can hang around a lot longer than expected.
*Despite energy (and food) revenue still coming into Russia every day, the war is costing more than Putin expected, with the largely unified response against him and failure to quickly capture Kyiv showing he miscalculated and is now in much worse shape than expected
The U.S. and China Relations: Whether it’s bi-partisan anti-China bills or Chinese military officials asserting the Taiwan Strait isn’t international waters, there is no shortage of things to point to currently that show relations between the two countries are ugly. This is, of course, for good reasons, with a long history of events that have gotten us here. However, stepping back and looking at it strictly from an economic perspective, the confrontation is increasingly weighing on global growth, and the chances of a further escalation/deterioration due to nationalistic fervors are very real.
*Despite increased open conflict on the international stage, trade between the two nations continues to grow, although actions are being taken by both sides to change this
Keeping things relatively high level, Xi is using “Wolf Warrior” nationalism to remove western/foreign cultural influences that could challenge the CCP’s legitimacy to rule. Further, he is increasingly trying to shield the Chinese economy from outside economic pressures/needs through the “Dual Circulation" policy, something that is being prioritized after how united the West became against Russia, quickly increasing sanctions and cutting them out of global financial markets and trade. China is still reliant on commodity imports for fuel and food but is increasingly becoming more self-reliant on the technology front. As a result, and we believe they are not there yet, Beijing is building a nation that could, in the face of united Western opposition, operate at some level alone.
*Anti-foreign sentiment has increasingly grown, and even with faith in the government weaker due to lockdowns, there are few signs that Xi and his Beijing tribe will not maintain power and exert increasing control/influence on the people of China
On the other side, anti-China sentiment is one of the few areas of bipartisan agreement in Congress today. There is a long list of legislation approved or coming that, either due to security or human rights concerns, look to diminish the U.S.’s economic reliance/relationship with China and/or counter China’s growing international ambitions. Higher inflation seems to be forcing the Biden administration to reconsider some of their current stances, with talks of tariff relief being the most important de-escalation signal. Further current talks between senior defense officials as well as a scheduled call between Biden and Xi may indicate that despite a wide disparity on numerous topics, Taiwan being the most prevalent, the two nations are taking a break at saber-rattling due to economic (for China) and inflation (for the U.S) hardships. We don’t see this slight de-escalation as likely to last and hence have the relationship as an “ugly” macro factor given the tail risks that exist (invasion of Taiwan being number one).
*U.S. and Chinese defense officials said they planned further talks after Defense Secretary Lloyd Austin and his counterpart sparred over Taiwan and other regional security issues
*China continues to expand its military capacities, especially regarding securing the seas, while the U.S. increasingly sees this as a threat to their military hegemony
In summary, there is greater long-term uncertainty in markets due to the War in Ukraine and U.S. and China relations. The potential adverse tail risk that could occur is why we categorize these two things as “ugly” macro factors. The end state of where/when inflation settles to a more normal level and hence when central banks can normalize policy and hence how tight financial conditions get will remain unclear with energy and food prices higher and volatile. This price pressure was exacerbated by the war in Ukraine and the sanctions placed on Russia. Some stabilization or hopefully an end to the conflict is needed before those price pressures meaningfully reverse. At the same time, global growth over the last few decades has been driven by China’s export-driven model that relies on U.S. (and European) consumers. Although China has certainly grown its own domestic consumer base, we see that growth engine as currently impaired, meaning it will increasingly rely on exports and fixed asset investment again in the short term. This will play a key role in providing the capacity/inventory to reduce inflation, specifically through the consumer goods channel, while also supporting the global growth picture. The bottom line is that any de-escalation in either situation will reduce inflation and improve sentiment globally, but both have highly uncertain outcomes.
*It's all about inflation, and in our opinion, we are at the point in the cycle where demand destruction will cap how much further things can rise while supply-side impairments are increasingly normalizing
Finally, we are sticking our neck out, given it's halfway through the year (and the knife is still falling), and we think the second half will see an improvement in risk sentiment as inflation finally begins to fall, reducing policy tightening uncertainty, and hence, the ultimate level of that financial condition will tighten too. We are increasing the size of our Copper and China Long to 15% each. We are adding a 10% Yen long (again) through the $FXY ETF and entering a 10% S&P long through the $SPY ETF. At this point, you need to either go entirely into cash cause the world is ending or start buying because things are not that bad. We see stocks near the bottom of their pullback and will be looking to add to the S&P long if there is a further drop, with the 3500 level being our next area of interest. We think the BoJ can no longer sit this global rate rising episode out, and the dollar will generally maintain strength but ease back slightly, helping the Yen bounce. China is reaccelerating, and we expect that to support copper and domestic equity performance. This leaves the portfolio 45% in cash with a growing desire to put more to work given our outlook but maintaining a patient stance due to the knife still falling. The point of the mock portfolio is to express views, and our main view currently being enough is enough, with expectations for greed regaining the edge over fear in the second half of the year.
*Things can certainly drop more, but we feel the fundamentals and current price action are wrong and want to start positioning the portfolio for somewhat of a second-half recovery
*Although there are still shortages and logistical issues, Gavin is right, and things are improving quicker than expected in many areas. Will the same occur for energy and food?
Econ Data:
Retail sales fell by -0.3% in May, following a downwardly revised 0.7% increase in April and missing market expectations of a 0.2% rise. Excluding autos, retail sales were up 0.5%, and excluding gas and autos were only higher by 0.1%. Auto sales recorded the biggest decline (-4%) followed by sales at electronics & appliance stores (-1.3%), miscellaneous store retailers (-1.1%), nonstore retailers (-1%). On the other hand, retail sales rose at gasoline stations notably increased (4%) amid a surge in gas prices, followed by food and beverage stores (1.2%), food services and drinking places (0.7%).
Why it Matters: May brought a weaker retail sales report than expected, especially when including the downward revisions to March and April core retail sales, implying downward revisions to positive real PCE for March and April, and a decline in May. Several economists downgraded their forecasts for real spending and gross domestic product following the report. Six of the thirteen retail categories showed declines last month, and the ones that increased, such as grocery store sales, likely reflect price increases, not increased purchase volumes. Further, the increased use of revolving credit and reduced savings levels show that future retail sales will be increasingly under pressure as real income levels fail to keep up with the persistently high level of inflation.
*Not a particularly surprising report, and when adjusted for inflation, every category likely saw reduced purchase volumes as the consumer is increasingly pulling back due to rising prices
*Retail sales are effectively back t their longer-term pre-pandemic trend
The New York Empire State Manufacturing Index rose to -1.2 in June from -11.6 in May, missing market forecasts of 3. The General Business Conditions (-1.2 vs. -11.6) improved but remained slightly negative. New Orders (5.3 vs. -8.8) and Shipments (4.0 vs. -15.4) rose back into positive territory, while Unfilled Orders (-4.3 vs. 2.6) declined into negative territory for the first time in over a year. Delivery Times (14.5 vs. 20.2) fell further, confirming reduced demand for shipping as seen elsewhere. Inventories (17.1 vs. 7.9) grew significantly. Labor market indicators showed an increase in Employment (19 vs. 14) but a shorter Average Workweek (6.4 vs. 11.9). The Prices Paid (78.6 vs. 73.7) moved higher, and the Prices Received (43.6 vs. 45.6) edged lower, but both remained elevated. Changes in the six-month outlook mirrored many of the changes in the current condition sub-indexes. Firms still expect general conditions and demand to stay positive while price pressures remain but expected Unfilled Orders and Delivery Times fell sharply. Capex and technology spending intentions are still historically high.
Why it Matters: Despite staying negative, the report was generally a positive bounce back after last month’s negative surprise. There was a return to more neutral levels for activity and demand measures. As expected, price pressures remain persistent from a material perspective, with margin pressures increasing. However, drops in delivery times, unfilled orders, and workweek show a reduced urgency/mismatch in supply/demand. Employment intentions coupled with commentary/data seen elsewhere show there is yet to be a meaningful contraction in hiring activity. Six-month-ahead outlooks were relatively stable besides future Unfilled Orders and Delivery Times heavily dropping, which in our opinion, is a good thing as it reduces inflationary pressures and shows firms expect to be in a better supply/demand balance.
*The overall index is back to a more neutral level as increases in General Activity, New Orders, and Shipments drove the gains
The Philadelphia Fed Manufacturing Index dropped to -3.3 in June, well below forecasts of 5.5, signaling the first contraction in factory activity since May of 2020. Declines were seen in New Orders (-12.4 vs. 22.1 in May), Unfilled Orders (-7 vs. 17.9), and Inventories (-2.2 vs. 3.2). At the same time, Price pressures eased slightly but remained elevated for both Prices Paid (59.4 vs. 78.9) and Prices Received (49.2 vs. 51.7). Delivery Times (9.9 vs. 17.5) and Inventories (-2.2 vs. 3.2) also fell. On the other hand, the Number of Employees moved higher (29.2 vs. 25.5). The Six Months Ahead outlook for General Business Activity (-6.8 vs. 2.5) also fell with every category dropping, except for Capital Expenditure intentions, which rose slightly. Future New Orders (-7.4 vs. 16.1) and Shipments (3.6 vs. 32.1) had notable drops.
Why it Matters: This was a very negative Philly manufacturing report with every sub-index dropping except the Number of Employees and Future Capital Expenditures. There were significant declines in demand. On the supply-side front, delivery times improved, and price pressure eased while firms sourced more workers. The urgency to produce is dropping, also seen in the NY Fed’s survey, as unfilled orders and the average work week fell. This indicates pricing pressures will continue to fall as increasing capacity (paying up for materials and workers) is no longer a priority.
*A lot of decreasing sub-indexes, driving the overall index to low level not seen since the beginning of the pandemic.
The NFIB Small Business Optimism Index fell to 93.1 in May, the lowest since April of 2020, and compared to 93.2 in April.
Owners expecting better business conditions over the next six months decreased four points to a net negative 54%, the lowest level recorded in the 48-year-old survey.
28% of owners reported inflation was their single most important problem in operating their business, a decrease of four points from April.
The net percent of owners raising average selling prices increased two points to a net 72%, back to the highest reading in the 48-year-history of the survey.
51% of owners reported job openings that could not be filled, up four points from April.
The net percent of owners who expect real sales to be higher decreased three points from April to a net negative 15%.
A net 46% of owners reported raising compensation, down three points from April, with a net 25% planning to raise compensation in the next three months, down two points from April.
36% of owners report that supply chain disruptions have had a significant impact on their business, up three points.
Why it Matters: Certainly a further negative turn in the small business outlook as reported by the NFIB report. "Small-business owners remain very pessimistic about the second half of the year as supply-chain disruptions, inflation, and the labor shortage are not easing," NFIB Chief Economist Bill Dunkelberg said. General Business Conditions, Sales Expectations, and general Uncertainty all worsened. Firms reported confidence in their ability to continue to pass cost increases on to customers with 3-month ahead “Price Plans” rising and showed they still expect to need more workers as hiring plans and current compensation plans increased. However, the report's overall tone remained increasingly negative, with supply-side shortages again worsening and inflation weighing on confidence and outlook.
*The overall index was little changed but trending lower with some conflicting messages given expectations for sales fell, but the ability to pass on costs increased
*The outlook is materially worsening with firms increasingly worried about inflation and now renewed supply-chain pressures and labor shortages
*Currently, small businesses continue to signal they intend to hire and still can not find the needed qualified workers
*Looking forward, small business are reducing their expectations to have to raise compensation although currently, they plan to raise wages/compensation, supported by their rising hiring intentions and skilled labor still be hard to find
Housing starts fell by -14.4% MoM to an annualized 1.549 million units in May, the lowest reading since April last year and compared to market forecasts of 1.701 million. Still, figures for April were revised higher to 1.81 million starts, the strongest reading since May of 2006. Single-family housing starts dropped by -9.2% and starts of multi-unit buildings plunged by -26.8%. Starts dropped the most in the South (-20.7%) and the West (-17.8%) but rose in the Northeast (14.6%) and the Midwest (1.9%). Building permits fell by -7% MoM to an annualized rate of 1.695 million, the lowest level since September last year and well below forecasts of 1.785 million. Single-family authorizations dropped by - 5.5%, while new multi-unit permits fell -10%. Building permits declined in all four regions: Northeast (-20.2%), West (-7.1%), Midwest (-7.6%) and South (-4.7%).
Why it Matters: There was a significant drop in new starts and permits, but the level of housing units under construction are at very high levels so it shouldn’t be surprising given the pressures homebuyers are facing that new activity is slowing. Currently, there are 822 thousand single-family units under construction (SA). This matches last month as the highest level since November 2006. Furthermore, there are 843 thousand multi-family units under construction. This is the highest level since April 1974! For multi-family, construction delays are probably also a factor. The completion of these units should help with rent pressure.
*Housing starts and permits have been in a relatively well-defined range since the GFC; however, the coming slowdown in buying activity should change that despite persistent low inventory levels
*Houses under construction, whether single or multi, are at multi-decade highs and will reduce price pressures over the next few years as supply and demand return to a more normal relationship
The NAHB Housing Market Index fell for a 6th straight month to 67 in June, the lowest since June 2020, from 69 in May and below forecasts of 68. The Current Sales subindex dropped 1 point to 77, the Buyer Traffic subindex fell to 48 from 53, while the Sales Expectations in the Next Six Months subindex declined 2 points to 61.
Why it Matters: Same old story we have been highlighting for some time now in housing; higher prices and financing costs continue to hurt affordability, and big drops in prospective buyer traffic are forecasting generally weaker purchasing activity moving forward, weighing on builders' sentiment. "The entry-level market has been particularly affected by declines in housing affordability, and builders are adopting a more cautious stance as demand softens with higher mortgage rates. Government officials need to enact policies that will support the supply-side of the housing market as costs continue to climb", said NAHB Chairman Jerry Konter.
*Big drops in prospective buyers continue, driving overall sentiment lower as buying activity is slowing much faster than anticipated a few months earlier
Import prices increased 0.6% from a month earlier in May, following an upwardly revised 0.4% rise in April and below market expectations of 1.1%. On a yearly basis, U.S. import prices are now 11.7%. Fuel prices rose 7.5 %, driven by soaring petroleum and natural gas prices. Meanwhile, prices for nonfuel imports declined by -0.3%, marking the first decline since November 2020. Export prices jumped by 2.8% in May, picking up from the upwardly revised 0.8% increase in April and well above market expectations of 1.3%. Exports excluding agriculture jumped 2.9% from a 0.7% increase in the prior month, led by industrial supplies and materials, capital goods, and autos. Prices for agricultural exports rose by 2.1%, lifted by soybeans, corn, and wheat. On a yearly basis, export prices rose by a record-high 18.9%.
Why it Matters: It's all about energy, and each new inflationary data point reaffirms a growing theme; the latest inflationary pressures are coming from rises in fuel costs while the consumer is increasingly turning away from discretionary goods, which are now beginning to decline in price.
*Worth highlighting that nonfuel price pressures are falling as the demand for goods continues to drop and the cost to ship them is no longer as high
Policy Talk:
The Federal Reserve increased its policy rate level by 75bp to a 1.5%-1.75% range yesterday and signaled a willingness to maintain this pace of tightening at the July FOMC meeting. This means the Fed funds rate will likely end the year well above 3%, although longer-term terminal rate expectations fell due to the higher probability growth will now decline sooner/faster. Powell made the point that headline inflation is what determines peoples' expectations, which makes the policy environment more challenging. He noted that it is "becoming more clear that many factors" the Fed doesn't control will determine if avoiding a recession is possible. He reasserted he still believes that a soft-landing was possible, but his conviction was significantly diminished as he did not convey a high level of confidence in the presser. Below are some notable comments from his prepared remarks and the press conference:
“Clearly, today’s 75 basis point increase is an unusually large one, and I do not expect moves of this size to be common. From the perspective of today, either a 50 or 75 basis point increase seems most likely at our next meeting.”
“So if you take a step back, what we're looking for is compelling evidence that inflationary pressures are abating and that inflation is moving back down, and we'd like to see that in the form of a series of declining monthly inflation ratings, that's what we're looking for.”
“Just talking about the SEP for a second; what it really says is that Committee participants widely would like to see policy at a modestly restricted, restrictive level at the end of this year, and that's six months from now, and so much data and so much can happen.”
“One of the factors in our deciding to move ahead with 75 basis points today was what we saw in inflation expectations. We're absolutely determined to keep them anchored at 2 percent. That was one of the reasons, the other was just the CPI rating.”
“I mean, the labor market we had before the pandemic was, and that's what we want to get back to. And you see disparities between various groups at historic lows. We'd love to get back to that place. But to get there, it's not going to happen with the levels of inflation we have. So we have to restore that, and it really is in service in the medium and longer-term of the kind of labor market we want and hope to achieve.”
“The consumer’s in really good shape financially, and they're spending. There's no sign of a broader slowdown that I can see in the economy. People are talking about it a lot, consumer confidence is very low. That's probably related to gas prices and also just stock prices to some extent for other people. But that's what we're seeing. We're not seeing a broad slowdown.”
*Notable changes in the June FOMC statement with the removal of stronger growth rhetoric and a downgrade in certainty over the path of inflation
Despite conveying a continued positive outlook on the economy, the Fed notably downgraded its GDP economic projections. It also marginally increased its unemployment expectations. Interestingly the inflation outlook for the end of ’23 and ’24 fell despite a near one percent increase in expected PCE inflation at the end of this year.
*Big changes in the FOMC’s SEPs, with a more negative tone clearly coming forth
The dot plot of individual forecasts now predicts the year-end Fed funds rate at 3.4% versus 1.9% in March and 2023 at 3.8% (2.8% previous) with 2024 at 3.4% (2.8% previous) and long-run at 2.5% versus 2.4%. Even the least hawkish FOMC members have the Fed funds rate ending this year above 3%.
*Policy makers and the market are becoming more closely aligned in their expected future path of Fed funds, with the market still questioning the ability (or necessity) to raise rates to 3.75% in 2023 and 2024 given growing recessionary fear
In summary, Fed is in a bind. The inflationary forces they are fighting are still primarily driven by cost-push due to factors outside of their control. However, Powell is being disingenuous when he says this is out of his hands and will affect the ability to orchestrate a soft landing. This is because the Fed is increasingly concerned about inflation expectations becoming unanchored, which are being driven by rising energy and food prices, something that the Fed has historically looked through but is now being controlled by. We continue to see inflation falling faster than expected, primarily driven by sharp drops in discretionary spending and peaking in energy prices due to demand destruction already occurring. Gas and diesel at these levels represent a $200+ price of oil, not the current $120ish one reflected in markets, and this is unsustainable. The bottom line is that things are breaking/slowing both in financial markets and increasingly in real economic activity. The Fed will likely not need to reach the expected terminal level of around 3.5% by Q1 next year because the increasing slowing of demand will weigh meaningfully enough on inflation before then.
*Goldman sees the Fed funds range as between 3.25-3.50% by year-end, with inflation cooling enough to allow 25 bp hikes in November and December
Technicals and Charts:
Four Key Macro House Charts:
Growth/Value Ratio: Value is higher on the day and lower on the week. Large-Cap Value is the best performing size/factor on the day
Chinese Iron Ore Future Price: Iron Ore futures are higher on the day and lower on the week, with the Chinese economy showing signs of recovery in May, but pressure on the labor market persisted, and overall growth remained fragile
5yr-30yr Treasury Spread: The curve is flatter on the day and steeper on the week, with a lot of volatility in Treasuries (everywhere, really) as last week's flattening has reversed some following the June FOMC meeting
EUR/JPY FX Cross: The Yen is higher on the day and on the week as speculation is growing the BoJ will have to act or the bond market will break while FX intervention is becoming too rampant
Other Charts:
Analysts continue to estimate earnings growth of about 10% this year and next for S&P 500 companies. However, the market is pricing a much lower expected growth level.
Real yields have shot up, with the 5-year point (many Fed officials’ favorite point of the curve) rising over 60 basis points since the hotter-than-expected CPI print last week.
“Before inflation peaks, expect 10yr yields to peak. Historically, the 10-year yields peak 6 to 8 weeks prior to peak inflation data for the cycle. 10-yr at cycle high 3.487% (+.127%) today in front of Fed.” - @RenMacLLC
A recent BofA Fund Manager Survey showed asset managers have a more negative outlook on global growth than any period before
“US demand has slowed down, but this is not yet enough to affect overall price pressure, as indicated by the widening gap between the ISM price and new order components.” - @Gavekal
As seen in flat real retail sales when adjusted for inflation this week, consumer spending levels are increasingly becoming negative according to higher frequency credit card data when also adjusted for the effects of inflation
The price action following the announcement that the Freeport LNG export facility would be closed longer than expected tells you everything you need to know about natural gas markets, with Europe not having enough and America eagerly trying to make up for losses from Russia
Just a quick reminder that some important stuff is up in price a lot this year so far. When do price levels start meaningfully destroying demand?
Clarida’s favorite inflation policy index, the Common Inflation Expectation Index, has risen but is not yet alarming. However, GS’s estimates have it moving even higher, and inflation expectations surveys seen elsewhere are also increasingly rising.
There is much more policy tightening, except for the BoJ, with major central banks now openly scrambling to raise rates
“Delivery times are easing, according to the NY Empire Index. At -13.7, the six-month outlook is the lowest since October 2013. Current delivery times slipped to 14.5, the lowest since March 2021. Factories are getting products out the door faster, taking the pressure off the price.” - @RenMacLLC
Shanghai is reopening despite recent headlines of more lockdowns with the road clearly plagued by new Covid outbreaks, but things look to be still improving.
Regular driving activity is also returning to more normal levels in China, according to the Gaode road mobility index
China has a long way to go with the bounce back in May still showing an uneven restarting of activity, although things did improve off severally low levels in April
Article by Macro Themes:
Medium-term Themes:
Real Supply-Side Situation:
Too Much Stuff: Samsung temporarily reduces procurement amid inventory pressure - NikkeiAsia
Samsung Electronics is temporarily halting new procurement orders and asking multiple suppliers to delay or reduce shipments of components and parts for several weeks due to swelling inventories. The move by Samsung, the world's largest smartphone and TV maker and one of the leading home appliance providers, is the latest sign that electronics makers are pessimistic about the economic outlook amid global inflation risks.
Why it Matters:
Samsung told suppliers that the company needs to closely review its inventory levels of both components and final products to ensure the stock on hand is manageable. The South Korean tech giant's notice to suppliers comes in stark contrast to its previous plan last month when it told suppliers that it had a relatively healthy view of the year ahead and that it still planned to ship at least 270 million smartphones in 2022, a similar level as last year. It is increasingly looking like discretionary goods will be an increasing deflationary force in the second half of this year as high inventory levels and falling demand force price cuts to move stock.
That Was Quick:South Korean trucker strike ends after eight days – Argus
South Korean truck drivers have ended an eight-day strike that had caused severe disruption to movements of petrochemicals, steel, and other products. The strike was linked to the South Korean government's plans to remove coverage for truck drivers working in the container and bulk cement sectors under the country's "safe rates" system by the end of the year. The system, which offers truck drivers minimum wages derived from operating costs, has helped cushion the impact of soaring fuel prices and living costs on such drivers.
Why it Matters:
The prolonged strike has strained the nation's logistical network, with major domestic industries such as the automobile, steel, and cement sectors have been affected by issues like reduced shipments. We want to highlight the end of the strike to simply point out that what could have been a longer-lasting additional supply-chain impairment has now been resolved. We will now be closely watching how labor negotiations on the West Coast of the U.S. go with the Long Shoremen.
Longer-term Themes:
National Security Assets in a Multipolar World:
Critical Green: U.S. and partners enter a pact to secure critical minerals like lithium – Reuters
The United States, Canada, Australia, Finland, France, Germany, Japan, South Korea, Sweden, the United Kingdom, and the European Commission have established a new partnership aimed at securing the supply of critical minerals, which are essential for clean energy and other technologies, as global demand for them rises, the State Department said on Tuesday. The Minerals Security Partnership will aim to help "catalyze investment from governments and the private sector for strategic opportunities ... that adhere to the highest environmental, social, and governance standards," the State Department said in a statement.
Why it Matters:
Demand for the minerals such as nickel, lithium, and cobalt is projected to expand significantly in the coming decades. The nations with access to these critical minerals will be able to diversify their energy portfolio faster and become less subject to the prices of fossil fuels, which are still controlled by “hostile” or ideologically different nations/actors. As a result, it's not surprising due to the current energy crisis that “Western” nations are uniting to secure supplies of materials needed for their clean energy goals. Eventually, these minerals may be more valuable than fossil fuels, but that’s likely 50+ years away, and as we are seeing, getting from here to there will be a volatile story.
Electrification and Digitalization Policy:
Foul Play You Say: SEC Launches Inquiry Into Insider Trading at Crypto Exchanges – Coin Desk
The U.S. Securities and Exchange Commission (SEC) has begun an investigation into whether crypto exchanges have sufficient protections against insider trading, according to Fox Business, which cited a source with direct knowledge of the inquiry. The source said the SEC had sent a letter to a major crypto exchange asking about the kinds of protections it has in place against insider trading. The inquiry is meant to cover additional exchanges as well, according to the source. The letter was sent after the collapse last month of Terra’s UST stablecoin and the associated LUNA token, according to the report.
Why it Matters:
As the crypto world further implodes, it is becoming clear a large swath of this unregulated landscape was little more than a Ponzi scheme, with insiders reaping the vast majority of gains. Of course, blockchain technology and the subsequent crypto ecosystems that support it will have a future, but likely only after the vast majority of “tokens” and protocols go bust due to a lack of real utility. Further, crypto insiders eagerly welcome more regulations in the hope of legitimization and protection from bad actors. We are not crypto experts, and clearly, we are skeptical of the value various parts of this world really have, but by no means are these the last days either. Instead, we will simply say the pullback has been impressive and is not yet likely over as excess liquidity is further removed from the system and speculative investments suffer the most.
Commodity Super Cycle Green.0:
Rare Bankroll: Pentagon bankrolls rare earths plant as U.S. plays catch-up to China - FT
The US Department of Defense has signed a $120mn deal with Australia’s Lynas Rare Earths to build one of the first US domestic heavy rare earths separation facilities, part of Washington’s push to counter China’s dominance of critical minerals supply chains. According to the International Energy Agency, China is responsible for almost 90% of global refining of rare earths and more than 50% of rare earths mining.
Why it Matters:
Rare earth elements are vital to making magnets used in military equipment such as lasers and guidance systems, as well as components in electric vehicles, wind turbines, fiber optic cables, and consumer electronics. Basically, they are the future. The U.S. has no operating commercial-scale processing facilities, raising concerns in Washington that the country could be cut off from these critical minerals in the future if relations with China deteriorate further. As a result, along with
Green Oil: Taiwan buys 'carbon neutral' crude from Azerbaijan - Argus
Taiwan's state-owned refiner CPC said it took delivery of approximately 1.05 million barrels of Azeri crude from Azerbaijan's state-owned oil marketer Socar, with cradle-to-gate greenhouse gas (GHG) emissions being offset with carbon credits certified by the Verified Carbon Standard. According to CPC, the entire trade, including GHG emissions calculations, offset quality, and retirement was independently certified as carbon neutral by certification company Intertek, as well as commodity certification specialist Climate Neutral Commodity.
Why it Matters:
It was reported that Azerbaijan’s State Oil Company had received a profit of $1.7 million from the sale of carbon emissions related to the oil purchase. As another environmental achievement, for the first time, SOCAR has certified emissions generated during oil and gas production within the Upstream Emission Reduction (UER) project. The certification and sale of the specified volume of carbon emissions were made possible as a result of the implementation of a project together with the Norwegian company Carbon Limits. We don’t fully know where this is going but want to highlight it as it seems important given it blends ESG goals with fossil fuel needs.
ESG Monetary and Fiscal Policy Expansion:
Helping the Little Guys: ECB to design new bond-buying plan to tackle market turmoil - FT
The European Central Bank has pledged to accelerate work on a “new anti-fragmentation instrument” to tackle surging borrowing costs in weaker eurozone economies after an emergency meeting of its rate-setters on Wednesday. The pandemic has left lasting vulnerabilities in the euro area economy, which are indeed contributing to the uneven transmission of the normalization of our monetary policy across jurisdictions,” the central bank said in a statement after its meeting. The central bank also said it would “apply flexibility” in the way it reinvests the proceeds of the bonds that will mature in the €1.7tn portfolio of assets bought to counter the impact of the coronavirus pandemic. Analysts have estimated the ECB could muster €200bn of extra firepower to buy bonds of vulnerable governments through these reinvestments.
Why it Matters:
The eurozone central bank disappointed investors last Thursday with a lack of detail over when or how it would intervene in government bond markets to tackle so-called financial fragmentation, which had raised the costs of borrowing for vulnerable southern European countries more than for their northern neighbors. Silvia Merler, of Algebris Investments, said the announcement “buys time” for the ECB, adding that it was “probably the best one could expect out of today’s emergency meeting, but does not take them out of the corner yet.”
Fair Seas: Biden to Sign Ocean Shipping Bill Into Law Amid Inflation Fight – Bloomberg
The Ocean Shipping Reform Act is intended to alleviate supply-chain bottlenecks at sea that were exacerbated by a spike in demand during the pandemic. It directs the Federal Maritime Commission to launch probes of ocean common carriers' business practices and to apply enforcement measures, requiring ocean common carriers to report to the FMC "total import/export tonnage" each calendar quarter. It would also bar ocean carriers from unreasonably declining opportunities for U.S. exports under new rules to be determined by the FMC.
Why it Matters:
This bill includes numerous provisions intended to help reduce ocean shipping costs and address supply chain issues. Senator Maria Cantwell said the bill gives the FMC "the tools it needs to cut down on extraneous shipping costs and stop shipping carriers from leaving American products like apples, hay, milk, and potatoes behind." The American Trucking Associations President Chris Spear said the "bill provides important tools to address unjustified and illegal fees collected from American truckers by the ocean shipping cartel."
Current Macro Theme Summaries:
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