Midday Macro - Semi-weekly Color – 6/29/2022
Market Recap:
Price Action and Headlines:
Equities are lower, with the S&P now sitting at levels seen before Friday’s rally, thanks to yesterday's sharp reversal lower due to weaker data and more hawkish Fed rhetoric
Treasuries are higher, with yields across the curve lower by 5-6 basis points as the more risk-off tone is helping rates get a bid despite increased supply this week through some taily auctions
WTI is lower, reversing overnight and morning strength, now around $111 as market-derived demand continues to look strong verse a worsening overall economic backdrop as refineries are running at 97.9% of their capacity
Narrative Analysis:
Equities are lower, but the S&P is somewhat consolidating above critical levels (at 3800), as yesterday's drop reversed Friday’s rally and reminded traders that this is still very much a bear market. The combination of weaker economic data, more hawkish Fed messaging, and rising energy prices and yields derailed the rally after Tuesday’s open. Traders now await PCE inflationary data and month/quarter-end flows tomorrow, as well as the ISM Manufacturing PMI reports Friday to either reestablish a positive narrative or not. Treasuries are enjoying a flight to safety bid today, with this week’s poor auction results not materially mattering. Oil lost some momentum today with gasoline and natural gas also under pressure. Copper continues to be punished, down significantly in Chinese markets due to low demand expectations there but flat in the U.S. Agg markets are mixed and more muted given recent price action, with the focus continuing to remain on global weather conditions. Finally, the dollar is higher, with the $DXY moving above 105 thanks to weakness in the Euro following comments made by Lagarde at today’s notable central bank panel.
The Nasdaq is outperforming the S&P and Russell with Low Volatility, Growth, and Momentum factors, and Health Care, Consumer Staples, and Technology sectors are outperforming on the day.
@KoyfinCharts
S&P optionality strike levels have the Zero-Gamma Level at 4011 while the Call Wall is 4300. Volatility is expected to remain elevated as long as markets are below 4000. There was a pick-up in activity for downside puts yesterday, with some chunky positions added to 3700 & 3600 levels. Zooming out, post-June OPEX has seen very few new call positions initiated. This indicates that the “rally” has been mainly about the sale of puts (both shorting and selling/closing out longs) and not traders positioning for an extended rally with call positons.
@spotgamma
S&P technical levels have support at 3800, then 3775, and resistance at 3855, then 3890. Since the June 17th low, we have rallied almost daily, and yesterday was the first pullback. Pullbacks are healthy, but they must hold the levels that triggered the breakout originally (and/or critical retracements like the 50% fib retrace or 61.8% fib retrace). Hence, the touch on the 3800 level was a back-test of last Friday's breakout and must hold if the rally is to regain momentum.
@AdamMancini4
Treasuries are higher, with the 10yr yield at 3.11%, lower by around 6 bps on the session, while the 5s30s curve is steeper by 1.4 bps, moving to 6 bps
Deeper Dive:
Hopes the economy was slowing enough to move inflation back towards the Fed’s target but not crashing too much to hurt labor markets significantly, destroying future earnings growth, and hence require a repricing of risk assets lower were dashed with this week’s weaker economic data and more hawkish Fed commentary. Hence the “bad news is good” theme, which helped create last week's rally, came crashing down, as seen in yesterday's price action. Policymakers continue to insist ample evidence inflation is falling will be needed (despite weaker data predicting it) before a change in their tightening course can occur. Further, with oil and other energy prices back on the rise, recent drops in yields reversed (until today), increasing market volatility expectations, capping bullish sentiment, participation, and ultimately how far things could rally. Coupled with negative technicals and new bearish optionality positioning, the short squeeze rally last week effectively hit a wall. With expectations for a high level of month-end rebalancing flows into stocks, it is possible to see bullish momentum into the end of the week resume. However, there is still a long way to go before a more risk-on backdrop can help sustain a meaningful rally.
Markets have lowered their expected peak Fed funds rate and are now surprisingly aligned with what Fed officials are saying they would like to see and what the June FOMC projections showed. This is due to the recent weaker economic data increasingly pointing to a quicker slowdown than initially expected. Further, there are signs that discretionary goods (and potentially services) will be increasingly discounted in the second half of the year, reducing inflationary pressures. Finally, household inflation expectations did not increase as much as initially reported, and market-derived ones fell further. At the same time, Fed officials reaffirmed the current Core-PCE level/trend is driving policy over inflation expectations, but clearly, worries of de-anchoring are materially impacting the discussion.
*Despite weaker data over the week, the Fed Funds curve was little changed, showing market participants are discounting the effects weaker data will have on current policy while inflation remains high. However, rate cuts are increasingly being priced into the second half of next year
*Growing inventory levels and changing consumer preferences have many expecting a deep discounting of discretionary goods in the second half of the year, with savvy consumers may pull back further in anticipation of this
*Longer-term inflation expectations as derived in the TIPs market are continuing to fall, breaking to new lows on the year and signaling reduced fear for a wage-spiral inflation
Last week’s theme of “bad news is good” is reverting back to “weak data is still hawkish,” with Fed officials increasingly pushing back on the growing future disinflationary pulses. Although we are sympathetic to the view that we have seen a peak in Treasury yields and Fed fund hiking expectations, this does not necessarily equate to a bottoming in equities. This is because the breathtaking drops currently occurring in “softer” economic data (such as regional Fed manufacturing surveys and consumer sentiment readings) have not equated to equal drops in “hard” data readings (such as retail sales and new orders for durable goods) yet. If the Fed’s policy is still solely driven by inflation, weaker (increasingly “hard”) data will not change the Fed’s reaction function meaningfully while lowering earnings growth expectations, a harmful recipe for stock prices.
*“Soft” data, which is survey-based and often prone to emotional biases, currently made worse by high inflation levels, is signaling a recession is imminent.
*However, harder data, as well as higher frequency spending and mobility data, continue to show firms investing in their capacity (through physical and digital Capex and hiring new workers) and consumers remaining active (although certainly slowing down from high levels)
*This divergence in “soft” verse “hard” data has made forecasting future earnings especially tricky, with economist downgrades in growth yet to be reflected in sell-side EPS estimates materially
Given the high level of negative emotional effects that inflation (mainly due to fuel and food inflation) is having on business and consumers verse what is actually occurring in the real economy/activity (still healthy levels of hiring and spending), forecasting the second half of the year is problematic given the uniqueness of all the variables at play, with no good historical comparisons available. Basically, we know we are getting a slowdown, but the strong starting point of the economy makes the “when” and “how long/deep” the key question. Further, the greater the resilience in the economy, the longer inflation remains, and the higher the peak in rates (Fed Funds & Treasuries) will be.
*The constant negative weight high inflation is having on consumer sentiment has removed any comfort a strong labor market might historically bring
*Bloomberg surveyed economist have notably downgraded their growth outlooks for this year and next
As a result of this higher level of uncertainty, market-implied measures of growth and inflation will be more volatile and less helpful. Instead, we are looking for actual “spot” gas and food prices to ease (inflation under control) to help signal “the bottom.” As we have highlighted, the Fed is committed to using Core PCE as their go-to gauge to determine policy. However, the core rate will be unable to fall meaningfully as long as the headline rate is elevated, something we have talked about here before with the concept of a “head-fake” occurring (slowing in core in Q3 only to rise again in Q4) if fuel and food costs don’t fall. Add in the effects rising inflation expectations are having, with the nuanced walk back recently still not materially changing the secondary derivative effects in the committee's policy debate, the path of policy is really being driven by gas and grocery prices, given what we know about the Fed’s reaction function. Put simply, the level of growth, the labor market, and how far markets may fall are secondary in determining the ultimate Fed funds level currently. Bad or good, future data results should only be viewed through the effects/narrative they have on inflation.
*Despite the negative headline and broad weakness underneath, yesterday’s Richmond Fed Manufacturing report was especially negative, given it showed no relief in price pressures
In summary, the data for June over the past week has been overly negative. Initially, markets saw this as a positive, given it reduced Fed tightening expectations. However, yesterday’s negative Richmond Fed’s Manufacturing survey reading (following a significant drop in the Dallas Fed’s Manufacturing Survey on Monday) coupled with the now close to “recessionary” reading in the Conference Board’s consumer expectations coupled with several Fed officials reaffirming a focus on inflation pressures over weakness in data was enough to reverse much of last week’s gains in risk-assets. Adding rising energy prices, which pressured yields higher, as well as an abundance of call selling and put buying and stocks fell out of bed yesterday. Currently, rate markets are recovering on the more risk-off tone while energy markets are flat, helping equities consolidate. But rallies are clearly still not sustainable until inflation has unquestionably peaked. The first signs of this may be in discretionary goods, but until gas and food prices fall, the best one can hope for is a broad choppy trading range. Stay patient with reduced risk.
*Real rates are driving equity market performance, and although nominal yields may have peaked, risk-asset will not base until Fed policy becomes more definitive and breakevens and reals settle
*Mr. Burry is looking through the next couple of months of tightening to next year's policy reversal
Econ Data:
New orders for durable goods rose by 0.7% in May, beating market forecasts of a 0.1% rise. Orders for transportation equipment led the increase (0.8%), followed by capital goods (0.8%), machinery (1.1%), and computer and electronics (0.5%). Non-defense aircraft and parts orders were down by -1.1%, while defense-related aircraft orders rose 8.1%. Excluding defense, orders of durable goods rose 0.6%. Orders for non-defense capital goods excluding aircraft, a proxy for investment in equipment, rose 0.5% after a 0.3% gain in April. Shipment levels increased 1.3%, while inventories rose by 0.6% MoM. Finally, unfilled orders rose 0.3%.
Why it Matters: There was an acceleration in the monthly rate of increases in New Orders and Shipments in aggregate. In contrast, growth in Inventories and Unfilled Orders slowed but remained positive before adjusting for the effects of inflation. The 0.5% monthly increase in non-defensive capital goods shows that firms are still expanding their capacity, although again when adjusted for inflation, the change is marginal. Still, on a sub-item level, the majority of categories saw an acceleration in new orders, showing that demand is not collapsing yet, as feared.
*Monthly increases in new orders for durable goods and capital goods specifically beat expectations but look to be flat on the month when adjusting for inflation
Pending home sales increased 0.7% in May, the first rise in seven months, beating market forecasts of a -3.7% fall. Regionally, results were mixed as the Northeast (15.4%), and South (0.2%) experienced increases while sales fell in the Midwest (-1.7%) and West (-5%). Year-on-year, pending home sales have declined by -13.6%
Why it Matters: Despite the gain in May, much higher mortgage rates and a low supply of affordable homes for the average buyer are expected to continue to weigh on housing market activity. The NAR estimates that at the median single-family home price and with a 10% down payment, the monthly mortgage payment has increased by about $800 since the beginning of the year as mortgage rates have climbed by 2.5 percentage points since January. "Despite the small gain in pending sales from the prior month, the housing market is clearly undergoing a transition. Contract signings are down sizably from a year ago because of much higher mortgage rates", said NAR Chief Economist Lawrence Yun.
*Thanks to strength seen in the Northeast, pending home sales broke a seven-month decline in monthly levels.
The Federal Reserve Bank of Dallas' general business activity index for manufacturing in Texas declined to -17.7 in June from -7.3 in May, the lowest reading since May 2020. Production (2.3 vs. 18.8 in May) fell notably while New Orders (-7.3 vs. 3.2) dropped into negative territory for the first time in two years, and the Growth Rate of Orders fell further negative (-16.2 vs. -5.3). The Capacity Utilization (3.3 vs. 19.8) and Shipments (1.2 vs. 13.1) indexes remained positive but fell markedly. Labor market measures continued to indicate positive employment growth and longer workweeks but at a decelerated rate. On the inflation front, prices and wages remained high, although there was some marginal relief. Finally, expectations regarding future manufacturing were notably less optimistic than in May. Every subindex in the six-month ahead outlook fell, with demand orientated one averaging into negative territory.
Why it Matters: This was an all-around terrible report, with drops in the future outlook being even more alarming than the deceleration in demand/activity reported through the current sub-indexes. There was little relief in price pressures, employment intentions, although still expansionary, are dropping fast, and delivery times again rose, showing a worsening in the logistical situation. The comments were overly negative, with a few signs of improving supply-side impairments, but there was a general sense of panic and despair.
*As increasingly seen in the regional fed manufacturing surveys, things are slowing fast with demand-orientated sub-indexes entering negative territory while the future outlook further worsens.
*Outlook and sentiment are falling off a cliff due to the persistence of supply-side issues, inflation, and now the Fed tightening policy, as noted in several respondent comments.
The Richmond Fed Manufacturing Index fell to -19 in June from -9 in May. The sub-indexes for Shipments (-16 vs. -14 in May) and New Orders (-38 vs. -29) fell further into negative territory. The employment picture was more upbeat, with the index notably rising (23 vs. 8), while the Wage index (10 vs. 19) also remained elevated, although cooling slightly. Lead Times were little changed, showing logistical challenges remain. The inflation picture did not improve with Prices Received (5.91 vs. 5.3) rising. The Local Business Conditions (-19 vs. -13) index fell further into negative territory. Firms are also less optimistic about conditions in the next six months as the expectations index decreased (-19 vs. -13).
Why it Matters: Although not as negative as what was seen in the Texas region, this was another significant drop in a Fed manufacturing survey with little to cheer in the underlying sub-indexes. On the more positive side, there were improvements in several of the six-month ahead sub-indexes. However, as seen elsewhere, there is still no meaningful inflationary relief with the price sub-indexes remaining near highs, little improvement in the logistical situation, and employment intentions remain strong. When coupled with the fast-dropping readings for current and expected demand, it looks like the economy is slowing, but firms are still nervous about losing needed workers.
*The overall Richmond Manufacturing Index has dropped sharply in the last three months as a real slowing of demand as well as a worsening outlook has hit respondent opinions hard
*Firms are becoming increasingly more pessimistic about the future, and as much as views on the current condition gauges are dropping, future ones are even worse
*Another regional Fed manufacturing report shows a broad cooling of activity and outlook as captured by drops across the majority of sub-indexes, with some well-defined themes now becoming established
Wholesale inventories rose 2% to $880.6 billion in May, following an upwardly revised 2.3% advance in April. Both durable goods (2.2% vs. 2.4% in April) and nondurable (1.8% vs. 2.2%) stocks increased at a slightly softer pace. There was a jump in motor vehicle & parts dealers by 2.3% after a decline in April of -2.2. On an annual basis, wholesale inventories surged 25% in May.
Why it Matters: The monthly increases in inventory accumulation fell slightly off very high levels but remained elevated. We expect to see future months showing drops here as many firms now have better sales-to-inventory ratios in a more uncertain demand environment. However, we are also entering the critical holiday restocking period, so it is unclear how much of a drag on growth in inventory building activities, given the effect longer lead times have had on the regular seasonal cycle. The bottom line is that this will be a key indicator over the next few months for gauging confidence in consumer end demand, with a continued high rate of accumulation countering the already negative sentiment many firms are reporting.
*There has been a clear trend of durable good inventory accumulation since the end of 2020 and now with consumer preferences changing, end demand is in question
The Conference Board Consumer Confidence Index decreased to 98.7 in June, down 4.5 points from 103.2 in May, and now stands at its lowest level since February 2021. The Present Situation Index declined marginally to 147.1 from 147.4 last month. The Expectations Index decreased sharply to 66.4 from 73.7 and is at its lowest level since March 2013. Consumers’ appraisal of current business conditions was less favorable in June, while their assessment of the labor market was mixed. Consumers grew more pessimistic about the short-term business conditions, labor markets, and financial prospects.
Why it Matters: The Conference Board’s index fell due to a significant drop in future expectations. While it remains more upbeat than what is seen in the University of Michigan’s survey findings, it is beginning to catch up a little. Intentions to buy large ticket items were little changed on the month, though clearly lower over the year. Intentions to “vacation” fell as price increases for services there were increasingly weighing on demand. “Consumers’ grimmer outlook was driven by increasing concerns about inflation, in particular rising gas and food prices. Expectations have now fallen well below a reading of 80, suggesting weaker growth in the second half of 2022 as well as a growing risk of recession by year-end,” said Lynn Franco, Senior Director of Economic Indicators at The Conference Board.
*There was a large drop in consumer expectations as higher fuel and food costs hit home hard
Policy Talk:
Cleveland Fed President Lorretta Mester gave prepared remarks at European Central Bank Forum on Central Banking regarding her views on how inflation expectations affect policy this morning in Portugal. She said she wants to see the Fed funds rate reach 3% to 3.5% by the end of this year and “a little bit above 4% next year” to rein in price pressures, “even if that tips the economy into a recession.” She sees growth slowing but not entering a recession as her base case. Mester said the U.S. isn’t yet suffering a “wage-price spiral,” but that it’s important for policymakers to ensure those conditions don’t bed into people’s expectations.
“Theory indicates that well-anchored inflation expectations can help to mitigate the pull of resource gaps on inflation, and therefore, the cyclical movements in interest rates that policymakers induce to maintain price stability need not be as large as when inflation expectations are not well anchored.”
“If inflation expectations are drifting up and policymakers treat them as stable, the policy will be set too loose. Inflation would then move up, and this would be reinforced by increasing inflation expectations.”
“The current challenging situation in which a sequence of supply shocks have contributed to inflation being at a 40-year high belies that view. It also calls into question the conventional view that monetary policy should always look through supply shocks. In some circumstances, such shocks could threaten the stability of inflation expectations and would require policy action.”
*Mester shared the measures of inflation expectations she uses to determine whether consumer’s views are becoming “unanchored”
New York Fed President John Williams said Tuesday in an interview on CNBC that he expects the U.S. economy to avoid a recession even as monetary policy is tightened to above neutral quickly. He believes the gross domestic product could fall to about 1% to 1.5% for the year, a far cry from the 5.7% in 2021, which was the fastest pace since 1984. Williams said it’s likely that the federal funds rate could rise to 3% - 3.5%.
“I think the economy is strong. Clearly, financial conditions have tightened, and I’m expecting growth to slow this year quite a bit relative to what we had last year.”
“My own baseline projection is we do need to get into somewhat restrictive territory next year given the high inflation, the need to bring inflation down and really to achieve our goals, but that projection is about a year from now. Of course, we need to be data-dependent.”
“I’m not seeing any signs of a taper tantrum. The markets are functioning well.”
*Williams still has an upbeat outlook on growth while also being aligned with the committee's consensus rate-hiking path view, as seen in the SEPs
Technicals and Charts:
Four Key Macro House Charts:
Growth/Value Ratio: Growth is higher on the day but lower on the week. Large-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. Excess inventory and mixed views on future demand have futures under continued pressure even though other areas of the market signal a better growth recovery story are developing.
5yr-30yr Treasury Spread: The curve is steeper on the day and little changed on the week as renewed growth scares have Treasuries better bid after last week's weakness despite several auctions this week receiving mixed/weaker support/demand
EUR/JPY FX Cross: The Euro is higher on the day and week as the Yen continues to feel the effects of higher energy and no change in BoJ policy despite the Euro being weaker against the dollar recently
Other Charts:
Nominal (and real) yields have correlated strongly with the rollover in the forward P/E ratio (and general equity weakness). If you think we have seen peak yields, valuations should improve, assuming earnings don’t fall too hard in the second half of the year.
Asset managers' sentiment is very negative, but their positioning has yet to match that, remaining still relatively high.
Energy stocks are experiencing an elevated level of volatility, as seen in the six-month implied volatility spread between the $XLE (energy ETF) and S&P. This has been driven by the uncertainty of global growth and hence future oil demand verse the fundamental shortage of oil globally which should help producers maintain profitability.
The volume of IPO so far this year is approaching lows not seen since the financial crisis, with little expectations for a pick-up in the second half of the year. Following high levels of equity supply for the last two years (from IPOs, general issuance, and SPACs), the balance is now more bullish.
74% of U.S. equity ownership is in stickier and in less leveraged hands. “Why the fear-mongering headlines that say "Hedge funds are net short" doesn't really matter that much in 2022.” - @Ksidiii
"There is a net $30 billion of US equities to buy from U.S. pensions given the moves in equities and bonds over the month and quarter. The buying imbalance ranks in the 94th percentile amongst all estimates on a net basis (-$70bn to +$150bn scale) over the past three years.” – Goldman Sachs Research
Growth in M2, aka the broad money supply, is now beginning to contract after the rapid expansion during the pandemic. Bank deposits, which were lifted by stimulus checks, QE, and low-interest rates, are reported weekly and account for 85% of M2, are stalling out as Federal outlays are declining, QT is increasing, and interest rates are rising.
Investment-grade spreads (OAS) are historically higher than what they would be given the current level of the VIX. The tightening cycle is hitting credit harder than equities, given where volatility is.
A recent survey of retailers by Evercore ISI reported that pricing power is falling fast. This bodes well for the peaking of inflation and emboldens the growing future discretionary good deflation narrative when coupled with higher inventory levels.
Although it's all about inflation, the tightness in the labor market needs to cool for the Fed to have any real conviction that inflation will materially trend lower, given the cost-push and wage spiral worries there. "Signs of worker shortages are still common, but broader indicators of US employment conditions are beginning to moderate." - @NorthernTrust
“Biden will be seeking commitments by Saudi Arabia and its Gulf allies to continue raising output through the end of the year to address high oil prices, but that would require buy-in from the rest of the OPEC+ countries -- a dicey proposition with Russia a key member. How much spare capacity Saudi Arabia and others actually hold -- and how much they would be willing to use -- is another uncertainty.” - @HermsTheWord
Putin has fully or partially cut gas to Poland, Bulgaria, Finland, Netherlands, Denmark, Germany, Italy, France, Austria, Czech Republic, and Slovakia. The reasons for shutting off the gas are clearly political. Since Russia cannot spend the money it earns, Putin’s thinking is to disconnect now while European nations restock for winter. This will make it more challenging for Europe and come back in Oct/Nov to “negotiate.”
Article by Macro Themes:
Medium-term Themes:
Real Supply-Side Situation:
Congestion: U.S. Port Backups Are Extending Into Freight Rail Supply Chains – WSJ
Some retailers are still waiting weeks to move cargo by train out of Southern California’s ports of Los Angeles and Long Beach, while others are giving up on the railroads and shifting shipments of furniture, apparel, and other consumer goods to trucks for long inland journeys on highways. The backups stretch to major freight hubs, including the key transit point at Chicago, freight executives say, where containers have been piling up at rail yards. The congestion has led BNSF Railway Co., a unit of Berkshire Hathaway Inc. and one of the main rail operators connecting the U.S. West Coast to inland points, to limit the number of boxes the railroad will carry out of the Southern California port complex.
Why it Matters:
Transportation and logistics executives say shortages of warehouse workers and truck drivers as well as of the steel trailers needed to haul containers between rail yards and warehouses are contributing to the delays. Dan Bergman, chief executive of TraPac LLC, which operates a container terminal at the Port of Los Angeles, says his yards are stuffed with 5,000 containers waiting to move by rail, about triple the usual number. The terminal has cut five shifts this month because there wasn’t enough railroad capacity to load boxes, he added. “The numbers are not improving,” he said. “At some point, we will run out of space.” We highlight this to show that even with falling demand and lead times reportedly dropping in some business surveys, there is still a significant backlog compared to historical norms.
A lot of Stuff: Manufacturing inventory hits record $1.8tn worldwide - NikkeiAsia
Inventory held by 2,349 listed global manufacturing companies hit a record $1.87 trillion at the end of March, up by $97 billion from three months earlier, according to a Nikkei analysis of information from QUICK FactSet. That was the highest level in 10 years, or since comparable data have been available. This inventory buildup can be traced to factors such as difficulty in moving products due to supply chain disruptions and some companies intentionally stocking up in case they faced shortages. Some businesses also built up stock in anticipation of an increase in consumer demand with the reopening of economies following declines in COVID cases.
Why it Matters:
The problem now is that this high level of inventory, coupled with slow consumption, could lead manufacturers to slam their brakes on production and exacerbate an economic deceleration that is already underway. Inventory increased in all 12 manufacturing sectors, but three sectors accounted for 61% of the total (electronics, autos, and machinery). On the positive side, worldwide high inventory is not expected to result in a serious cash crunch soon. The amount of cash held by the 2,349 companies stood at $2.2 trillion at the end of March, 2.3 times their monthly sales. Any number above two is considered reasonable.
China Macroprudential and Political Loosening:
China sets record local bond issuance in June to spark economy - NikkeiAsia
China is on track to issue more than 1.5 trillion yuan ($224 billion) in local government bonds during June, a monthly record underwriting infrastructure investments designed to stimulate the economy. Local governments nationwide have issued 1.41 trillion yuan in bonds this month through Sunday, Chinese media report, up nearly 80% from June 2021. This figure tops the 1.3 trillion yuan monthly record in May 2020, when China was focused on stabilizing its economy from the initial coronavirus shock.
Why it Matters:
As domestic demand from the private sector shrinks, national leadership sees local infrastructure bonds playing a leading role in revitalizing the economy. China plans to issue up to 3.65 trillion yuan in infrastructure bonds this year. The Finance Ministry has told local governments to exhaust nearly all the quota through the end of June. These governments also were told, in broad terms, to spend all the funds raised from infrastructure bonds by August. Much of this infrastructure will be targeted toward renewable energy initiatives, giving us some confidence that demand for copper is not dropping too far.
Longer-term Themes:
National Security Assets in a Multipolar World:
Green Security: China taps markets for $10bn to cement clean tech supremacy - FT
Three Chinese electric vehicle battery and material companies are tapping investors for more than $10bn in new funding. The combined fundraising by the three Chinese groups; CATL, Tianqi Lithium, and Huayou Cobalt, eclipsed the hundreds of millions of dollars being spent by Washington and U.S. allies, including Australia and South Korea, to chip away at China’s supremacy in the sector. “China is trying to position itself as the Saudi Arabia of clean tech hardware, being the lowest cost supplier and achieving the highest market share,” said Neil Beveridge, a senior analyst at Bernstein in Hong Kong. “This is a massive geostrategic competition between China and the west.”
Why it Matters:
Factories in China account for nearly three-quarters of global EV battery production and command 90 percent of the market share for processing rare earth elements — the oxides, metals, and magnets used in batteries — a level of dominance akin to its stronghold over the solar industry. According to Trafigura, more than 90 percent of the world’s battery-grade lithium is produced from refineries in China, which also processes the vast majority of cobalt and nickel, other critical battery materials. China’s EV battery capacity market share will decline marginally as the US and Europe offer generous subsidies to build plants closer to carmakers but is projected to still stand at about two-thirds by 2025. However, China’s cost advantage and inroads already made and the West's slow response means Beijing-driven dominance will likely be around for a while, and this will be a critical national asset.
Anti-BRI: G-7 rolls out global infrastructure plan: U.S. aims to contribute $200B, Biden says – ABC News
The G7 nations announced plans to create a global investment fund to counter China’s Belt and Road Initiative. “The Partnership for Global Infrastructure and Investment” plans on disbursing $600 billion by 2027 in infrastructure investments, mainly in developing nations, with President Joe Biden announcing the U.S. alone would aim to spend $200 billion in public and private partnerships. "These strategic investments are in areas critical to sustainable development and creating global stability: health and health security, digital connectivity, gender equality and equity, climate, and energy security," Biden said.
Why it Matters:
In his remarks on Sunday, Biden directly contrasted the new announcement with what China has done, emphasizing that the G-7's investments will be based on "shared values," a signal to nations that it's in their benefit to aligning with the U.S. and others compared with China. China’s BRI is not without criticism, as many nations have fallen into debt traps, but it helps create greater soft power and secure needed resources globally. The G7 nations are using the newly announced infrastructure fund to counter this and promote western liberal values.
Electrification and Digitalization Policy:
Appropriation: House panel approves major cash infusion for CISA – The Record
House appropriators on Friday voted in favor of a $2.9 billion budget for the Cybersecurity and Infrastructure Security Agency (CISA). The amount allocated for CISA is $417 million more than the Biden administration requested for the DHS cyber wing and $334 million above its fiscal year 2022 allotment. “As our economy and infrastructure continue to grow more reliant on the internet, cyberattacks and intrusions by foreign actors are of increasing concern,” Chair Rosa DeLauro (D-Conn.) said in her opening statement.
Why it Matters:
The funding will be allocated into various categories, including cybersecurity, infrastructure security, emergency communications, and risk management, among others. Over the last few years, CISA has seen an increase in funding each year as the government has expanded its investment in cybersecurity across various sectors. The war in Ukraine has also expedited investments in cybersecurity as the U.S. and other Western countries have warned against Russian cyberattacks. We highlight this to remind readers of the increased efforts/budget the government is allocating toward cyber defense.
Networks: Six government agencies launch quantum technology research consortium – Fed Scoop
The Washington Metropolitan Quantum Network Research Consortium, or DC-QNEt, will undertake research on the use of quantum-entangled particles, known as qubits, to transmit sensitive information. The six departments involved in the quantum network are the Army Combat Capabilities Development Command Army Research Laboratory, Naval Research Laboratory, Naval Observatory, National Institute of Standards and Technology, National Security Agency, and NASA.
Why it Matters:
Researchers hope the work will yield other discoveries, and the technology can also be used to distribute ultra-precise time signals. Quantum entanglement is a unique quantum mechanical property of atomic and subatomic particles, where classical physics fails to describe observed phenomena accurately. Researchers hope that research conducted by the consortium could have a range of other applications. We highlight this as part of our belief that AI and quantum computing are two of the most important areas to watch, and it is important to see a more coherent/broad government approach to critical emerging technologies.
Commodity Super Cycle Green.0:
Royalties Due: One of World’s Biggest Cobalt Mines Is at Stake in Congo Fight - Bloomberg
A dispute over one of the biggest copper and cobalt mines is escalating in the Democratic Republic of Congo, threatening to disrupt exports of essential battery materials and raising questions about the project’s future and the potential for further development in the Congo. A top executive from state mining company Gecamines said that partner CMOC Group Ltd. owes $7.6 billion in overdue payments and even accused the Chinese metals producer and trader of posing a threat to national security. CMOC said it denies the allegations, “strongly” opposes what it views as unjustified attacks, and will defend its rights and interests.
Why it Matters:
The escalating fight is important because of Congo’s outsized role in supplying the world’s cobalt, a vital part of many electric-vehicle batteries. Tenke was one of the top cobalt producers last year and is also a large supplier of copper. The spat also takes place against the backdrop of President Felix Tshisekedi’s efforts to increase scrutiny of mining deals made under his predecessor, Joseph Kabila. Its mineral riches make Congo hard to ignore for the global mining industry, but many have steered clear because of the perceived riskiness, so other international miners and potential investors will closely watch the dispute.
Cross-Border: Giant Australia-to-Singapore Solar Project Targets 2024 Build - Bloomberg
The Sun Cable project aims to export solar power from Australia’s Outback to Singapore using a 4,200-kilometer (2,600-mile) high-voltage undersea cable to export power from a giant solar and battery complex in northern Australia. The project aims to produce power for local use and enough electricity for export to meet 15% of Singapore’s demand.
Why it Matters:
At least $8 billion of investment in Australia will be needed to develop the operation, and it should provide about 800 megawatts of electricity for northern Australia, which could support the creation of new industries in the region. It also will be an interesting development for exporting renewable energy under the sea. “This brings Australia one step closer to realizing our renewables exporting potential,” Cannon-Brookes said in a statement. “We can power the world with clean energy, and Sun Cable is harnessing that at scale.”
ESG Monetary and Fiscal Policy Expansion:
Limits: Xinjiang Law Shows Reach—and Limits—of U.S. Economic Power - WSJ
The Uyghur Forced Labor Prevention Act, which was signed into law in December and came into effect last week, requires U.S. importers to show that items from Xinjiang weren’t produced with forced labor, something hard to do given the limited access western audit firms have in that region. The law is already having a marked impact on one of Xinjiang’s key industries, cotton, and has the potential to seriously damage China’s textiles industry, the world’s largest. But the lack of impact on another key Xinjiang product, polysilicon, used to make solar panels, showcases the law’s limits.
Why it Matters:
Chinese companies in Xinjiang have come to dominate the solar panel industry because of cheap and abundant coal, wind and solar power. By 2020, nearly 80% of the world’s polysilicon production was in China, but on average less than 2% of China’s yearly photovoltaic exports went to the U.S. However, the U.S. is now so desperate to secure solar panels that the Biden administration in June granted a two-year exemption from any possible tariffs levied on panels from four Southeast Asian nations, despite ongoing worries about forced labor manufacturing origins in China. As a result, the story playing out for cotton and other exports now affected by the new law is very different than solar panels.
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Current Macro Theme Summaries:
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