Neutral Elections & Positive CPI Report Keeps the Rally Alive- MIDDAY MACRO - 11/11/2022
Color on Markets, Economy, Policy, and Geopolitics
Midday Macro – 11/11/2022
Overnight and Morning Recap / Market Wrap:
Price Action and Headlines:
Equities are higher, with tech and growth meaningfully adding to yesterday’s historic gains, although energy is the best-performing sector today
Treasuries are higher, with the curve continuing to steepen as an entire 25 bp rate hike was priced out of the front end yesterday, and momentum remains positive today following the CPI report and strong 30-yr auction
WTI is higher, sitting at $89 into the afternoon close with the Biden Administration unvailing tighter methane curbs as varying thoughts on the effects of price caps and China’s reopening recalibrate supply and demand projections
Narrative Analysis:
Equities are higher today, with a positive overnight follow-through after yesterday's better-than-expected CPI-driven massive one-day move higher, which saw the Nasdaq have one of its strongest intra-day moves ever and also led the S&P and Russell to break out of their recent ranges, keeping the October rally alive. Whether this was just a short-covering rally or the beginning of a move out of the year’s downtrend has yet to be determined. The CPI news was certainly a positive development but a far cry from what is needed for the Fed to change gears into the final stage of their current policy tightening cycle, reaching a terminal Fed funds level and staying there for an undetermined amount of time. With the data continuing to soften, seen in today’s larger-than-expected drop in consumer confidence, an earnings season that was in line but guided weaker, and further rate hikes to still come, communicated eagerly by a plethora of Fed officials this week, it is hard to get too excited about risk-assets yet, especially equities, which are not cheap and still face higher real rates and tighter financial conditions headwinds. The rally in Treasuries does make a little more sense, with the Fed funds future curve removing a 25 bp rate hike after yesterday’s CPI print. The steepening of the curve showed a reduced fear of policy error (overtightening). Oil caught up with the positive price action today, higher based on increased demand expectations (from China) and more regulatory headwinds for domestic supply. Copper has been on a tear due to China reopening hopes and a realization that future supply is not getting better. The agg complex has calmed a bit, with grain exports out of Ukraine continuing and the weather in South America stable, as well as yesterday’s WASDE report not materially changing the outlook domestically. Finally, the dollar has broken below its year-long up trend, with the $DXY closer to 106 due to the majority of crosses materially stronger following the CPI report, with the Yen notably outperforming.
The Nasdaq is outperforming the Russell and S&P with Growth, Small-Cap, and Value factors, and Energy, Communications, and Consumer Discretionary sectors all outperforming on the day. Factor and sector leadership on the week have completely flipped with Technology/Communication and Growth leading, although Materials and Small-caps are second, showing no clear tilt/change in leadership and instead a more knee-jerk short-covering reaction to CPI.
@KoyfinCharts
S&P optionality strike levels have the Zero-Gamma Level at 3913 while the Call Wall is 4100. Yesterday was a big day for options volumes, with an overall volume of 47 million vs. 41 million on average. More interestingly, it was one of the largest SPX call volume days this year, with 1.3 million calls trading. Volatility will likely continue to contract into the November OPEX, helped by a big drop in the MOVE index. Spotgamma sees the current rally as different from previous “put-fueled short covering” rallies and compares it to a similar setup going into August, allowing for a further melt up.
@spotgamma
S&P technical levels have support at 3975-80, then 3955, with resistance at 4020, then 4070. Following yesterday, we are now the 2nd largest rally leg of 2022, and with S&P breaking out of a major bullish triangle pattern, indicating a move higher is likely, but we’ve seen these sorts of moves fail many times this year. The 200-day moving average is around 4070 and ended up being where the August rally hit resistance (back when it was around 4300). In summary, technicals are bullish for a further move higher to the 200-DMA, but the RSI indicates extremely overbought conditions, so a period of consolidation is warranted, likely in the form of a bull flag.
@AdamMancini4
Treasuries are higher, with the 10yr yield at 3.85%, lower by 2.8 bps on the session, while the 5s30s curve is flatter by 3.7 bps, moving to 7.6 bps.
Deeper Dive:
Hard to know what to say/think after a slightly better-than-expected CPI report elicited the kind of positive cross-asset price action we saw yesterday. Clearly, positioning was caught offside, with the best-performing sectors being the least loved and most shorted ones till that point, indicating a repositioning by the systematic/macro community. With the VIX now approaching 20, an area where past rallies this year have reversed, the real question is, what are the coming catalysts that can keep things going? Unfortunately, there is no clear answer. With yesterday’s positive CPI report being only one month of data, it will take some time and a mosaic of other data points for the Fed to communicate they have begun discussions on where and when to pause rate hikes, taking us to the final stage of the current policy tightening cycle. Before yesterday's new inflation data, Fed speakers were still mainly staying on message, reiterating Powell's November FOMC presser talking points. However, a few did sound a little more concerned about over-tightening. As a result, there should be no change in tune on the aggregate from Fed officials, but dovish voices may grow as leading indicators show a slowing economy and falling inflationary pressures. Of course, expected Q4 GDP growth has only increased mainly due to the resilient consumer, while business surveys show a more neutral stance towards labor intentions, not contractionary. The bottom line is that yesterday’s CPI report was a positive development, but we still have a long way to go. As a result, patience and risk discipline are still very much warranted, and chasing this rally is not something we will be doing despite a more optimistic outlook than most.
Before delving further into inflation, the Fed, and more traditional assets, it is worth taking a moment to acknowledge the general chaos occurring in crypto. Yes, we don’t talk about
Brunocrypto because, well, we don’t know much, nor do we believe most of it (outside of some utility coins) is worth much, but negative price action in that space did spill into more traditional financial assets earlier in the week. So is FTX, one of the largest global crypto exchanges, a liquidity problem or a solvency problem, and is it systemic? The answer is yes, yes, and no. Although the size of the losses is notable, the risk of contagion outside of crypto looks minor. The fallout from FTX comes after the bankruptcies of Three Arrows Capital, Celsius, Voyager, and others earlier this year following the collapse of the UST and luna cryptocurrencies. Those failures had effects that could be seen across the industry, with crypto watchers wondering who would be next as the counterparties of these entities aren’t known. Tangled webs of counterparties and international holdings, as the ones SBF, FTX, and Alameda have, make contagion and loss predictions difficult. However, it seems unlikely to be a systemic risk event. Instead, it will likely lead to further failures of other exchanges and “projects” (Tether) within the crypto space, driving token/coin prices lower as “investors” realize they have been playing three-card monte more than owning a legitimate digital asset. It also will bring in further regulation, helping the crypto industry become a more legitimate place in the long run.
*Crypto’s Lehman moment has come and gone with a fortune whipped out in a day, and FTX clients short close to $10 billion
*It is hard to believe that the entire crypto space was worth $3 trillion a year ago and is now at $842 billion.
Turning back to reality, it's worth quickly looking at the midterm election results, which are still being tallied but have some clear takeaways. First, the red wave never materialized, with the GOP now likely to have a small majority in the House and no change in the Senate or possibly a one-seat gain by the Dems. Second, results indicated that despite record-high inflation, Americans didn’t panic vote, and the lack of real issues from the Republican side fell flat given how strong the labor market is and how healthy household balance sheets still are. To quote our political mentor, RJA of Corbu, leader McCarthy and the GOP failed to articulate a compelling alternative vision to the Democrat party agenda, whose vision was much clearer and, in the end, more welcomed by moderate voters than MAGA candidates. What does this mean for fiscal policy and markets? A thin majority in the House and no change to leadership in the Senate increases political volatility, increases support for the war in Ukraine (increasing geopolitical risk), and likely means further fiscal expansion as well as more ESG-focused policies and regulation, all of which increases inflationary pressures. Finally, the outstanding performance by DeSantis in Florida means a civil war is about to erupt in the GOP as Trump tries to burn the whole thing down rather than bow out politely. In summary, this week's midterm results on balance have a neutral effect on risk assets (at best), with greater fiscal spending (likely leading to tighter monetary policy for longer) increasing growth prospects, but increased geopolitical risk and greater regulation will weigh on investor sentiment.
*Still a number of races to call, but it looks like a 5-10 seat majority in the House, and Dem candidate wins in NV, and eventually GA will lead to a 51-49 Dem Senate
*The probability of a debt limit showdown/disruption increased following the reduced level of gains made in the House by the GOP
Turning to yesterday’s CPI report and the Fed, it's important to remember that the Fed is no longer just looking for subsequential declines in inflation data to conclude its rate hiking cycle. They also aren’t looking for higher unemployment necessarily, something we think will only materialize well after inflation is trending lower, given how reluctant employers will be to reduce “qualified” workers after it took so long to find and train them. Instead, the Fed really just wants a period of below-trend growth to allow supply and demand to better align and move inflation back towards target. The good news is that the supply side is improving despite the two steps forward, one step back progress. This is seen in cheaper logistical/shipping costs and broader Fed models, such as the NY Fed’s Global Supply Chain Pressure Index falling to more normal levels. While shortages and longer lead times are still cited in business surveys, a mosaic of improvement can be seen in recent earning calls and forward-looking business surveys. With the potential end of zero-Covid in China approaching, it is becoming safer to say the worst is behind us, and the trend is favorable into 2023. The Fed needs to see positive trends to take comfort that their policy is appropriate, and again we are simply looking for reasons for them to move to the final stage of the tightening cycle.
*Following declines in international shipping costs, trucking costs continue to fall
*The NY Fed’s GSCPI’s year-to-date movements suggest that global supply chain pressures are falling back in line with historical levels
*Other measures of supply chain stress, such as the above one by Oxford Economics, are making slower progress in normalizing but are trending lower
*The Atlanta Fed’s Labor Market Distribution Spider Graph shows no material loosening in labor market conditions, with only the EPOP and Job finding rate materially weaker
Demand, the other side of the coin, is a more mixed picture, and recent Fed speakers have given varied assessments, indicating a lack of consensus on how effective policy has been in reducing demand-pull inflationary pressures. It’s clear that rate-sensitive areas such as housing (and all the derivative goods such as electronics and appliances) and increasingly autos have seen falling demand. However, consumer spending elsewhere has remained more stable than expected, mainly due to the strong labor market and high levels of savings and net wealth households currently have. As a result, the Fed continues to target tighter financial conditions, weighing on the wealth effect channel while also signaling a willingness to slow the economy into contractionary territory, reducing business confidence and hiring intentions. But still, the stores, restaurants, and planes are generally full/busy, causing a dilemma and the need (in the eyes of policymakers) to tighten policy further into restrictive territory. It also signals that, so far, a soft landing is still possible, something we have believed this whole cycle. However, with increased rumblings from Fed officials that the end of rate hikes is in sight and increasing signs that inflation may have finally really peaked, it is our view that less demand destruction will be needed than previously feared.
*The ISM Manufacturing PMI usually leads the service side and is now indicating that demand has moved slightly into contractionary territory
*The exponential rise in mortgage rates on top of already poor affordability conditions is leading home sales to slow much faster than past episodes of weakness
*The Atlanta Fed’s GDPNow Q4 estimates are showing a 4% increase, mainly driven by PCE and reduced drags from residential construction
*Small businesses are not citing poor sales as anywhere near a top problem, showing the consumer is still out and about doing their thing
*Don’t look now, but it is increasingly looking like inflation has finally peaked, and with leading indicators and tougher yearly comparisons coming, the overall headline and core rates will continue to be under pressure
Putting it all together, we believe that ongoing improvements on the supply side and existing/growing demand destruction, which has already occurred due to higher prices and will grow further due to increased uncertainty regarding future income/job situation and net wealth levels, has finally altered the supply/demand balance to re-trend inflation back to target. We believe this is going to occur faster than expected, given the economy has yet to fully reflect the tighter Fed policy in place (and coming). Due to the strong financial position that consumers and businesses currently still have, a soft landing is still our modal outlook moving forward, with the coming below-trend periods of growth being stretched out over 2023 instead of more severely occurring in any one or two quarters. As a result, and turning specifically to equities, as long as incoming data signals softer (but not crashing) demand, stabilizing and loosening labor markets, and falling inflationary pressures, earning estimates can bottom and begin to improve off of currently very pessimistic levels, increasingly helped by cost-cutting and less top-line destruction. When coupled with more cemented Fed policy expectations, which see an end to the hiking cycle around a 4.75 – 5% terminal Fed funds range, real rates, and financial conditions can fall/loosen and allow earning multiples to expand. This is, of course, the rosiest of scenarios, but one we think can still materialize. There are many other considerations, but we will end there and dive deeper into the still many headwinds facing risk assets another day.
*The terminal Fed funds level fell back below 5%, indicating another 100 bps is all that is left in the current hiking cycle
*Historically, market expectations for the level of Fed funds have been too high, although never too far off
Econ Data:
Headline CPI rose by 0.4% in October, moving the annual rate lower to 7.7% from 8.2% in September, the lowest since January, and below forecasts of 8%. Core CPI increased by 0.3% after rising by 0.6% in September, reducing the annual rate to 6.3% from 6.6%, lower than market expectations of 6.5%. The shelter sub-index contributed over half of the monthly increase, rising by 0.8%. Both OER (0.6% vs. 0.8% in Sept) and Rents on Primary Residence (0.7% vs. 0.8%) fell slightly, while Lodging Away from Home increased by 4.9%. The energy index increased by 1.8%, with gasoline rising by 4%, while natural gas costs decreased by -4.6%. Meanwhile, food prices rose by 0.6% MoM, below 0.8% in September, with the cost of food at home rising 0.4%, the least since December. Decreases were seen in used cars and trucks (-2.4%), apparel (-0.7%), and medical care services (-0.6%), largely thanks to a quirky adjustment to medical insurance (-4%), while commodities (less food and energy) fell by -0.4%.
Why it Matter: The prices of goods are slowing down considerably, led by declines in apparel and used cars, but the service side remains sticky, mainly due to shelter. Although both headline and core came in lower than expected, the actual real progress made, or what the Fed needs to see, was far less than what market reactions suggested. Still, and as we are fond of pointing out, leading inflation indicators continue to fall broadly, indicating, especially in regard to shelter (and services more broadly), that inflation has peaked. Unfortunately, achieving lower prices will be a process. The momentum and breadth in price increase distribution were still broad, with around 50% of components rising at a 5% or faster-annualized pace, compared to 51% in September’s report. Applying Powell’s 2021 focus on the CPI that strips out food, energy, new and used vehicle prices, vehicle rentals, airfares, and hotels, the last three months have seen an increase of 7.0% when annualized compared to the actual 6.3% increase seen over the last year. Finally, the Cleveland and Atlanta Feds recalculated their underlying inflation measures after the October CPI data, and only one measure showed improvement, which was the Cleveland Fed's 16% trimmed mean. The Cleveland Fed's median CPI 12-month inflation rate was unchanged at 7.0%. The trimmed mean slipped to 7.0% in October from 7.3%. The Atlanta Fed's sticky CPI held steady at 6.5%. So again, things are slowly turning, especially for specific good categories, but at best, this report showed no acceleration when looking at the whole picture (with All Items Less Food, Shelter, and Energy falling -0.1% MoM), not yet a meaningful drop that could give the Fed comfort that they can begin to talk about the terminal level they want to reach.
*Headline and core inflation were lower than expected in October, even with shelter and energy prices rising
*Predicting where core CPI will go is really about understanding how long the currently falling house prices and rents will take to hit the official shelter sub-index
*Durable goods fell by -0.7% in October, with used cars, apparel, and household furnishings falling. Starting to be a good time to buy laundry equipment (-7.8% MoM)
*Again, when removing shelter, Core CPI is now negative
*A majority of the subindexes cooled, although the headline monthly change was unchanged
The University of Michigan consumer sentiment fell to 54.7 in its preliminary November reading, the lowest since July, from 59.9 in October and below market forecasts of 59.5. The Current Economic Conditions index fell hard to 57.8 from 65.6, and the Consumer Expectations gauge dropped to 52.7 from 56.2. Inflation expectations were little changed. The median expected year-ahead inflation rate was 5.1%, up from 5.0% last month. Long-run inflation expectations remained at 3.0%.
Why it Matters: There was a big drop this month, with the overall index falling 9% and erasing half the gains since its historic low in June. “All components of the index declined from last month, but buying conditions for durables, which had markedly improved last month, decreased most sharply in November, falling back 21% on the basis of high-interest rates and continued high prices. Overall, declines in sentiment were observed across the distribution of age, education, income, geography, and political affiliation, showing that the recent improvements in sentiment were tentative,” said Surveys of Consumers Director Joanne Hsu. Interestingly, when looking at consumer sentiment by political party affiliation, there was a slight uptick in Republican respondents (off very low levels), likely due to positive expectations for the midterm election. We expect that to reverse in the final November report, given the “Red Wave” never materialized. However, Dems and Independent respondents may see an increase. Political views continue to have weight regarding respondent outlooks.
*As gas prices have ticked back up, consumer confidence has fallen again. Is it really that simple?
*Broad decreases across categories, groups, and regions with the above showing no improvement in any contributing sub-index
*One-year-ahead inflation expectations moved slightly higher to 5.1%, while longer-term expectations remained at 3%
*When looking at responses by political affiliation, all categories were lower except for republican expectations, will the final November reading maintain this following the poor showing by the GOP in the midterm elections?
The NFIB Small Business Optimism Index declined 0.8 points in October to 91.3. Out of the ten index components, two increased, seven decreased, and one was unchanged.
Thirty-three percent of owners reported that inflation was their single most important problem in operating their business, 3 points above last month and 4 points lower than July’s highest reading since 1979 Q4.
Owners expecting better business conditions over the next six months decreased 2 points from September to a net negative 46%. The net percentage of owners who expect real sales to be higher decreased by 3 points from September to a net negative 13%.
The net percentage of owners raising average selling prices decreased by 1 point to a net 50%. Price hikes were most frequent in retail (69% higher, 6% lower), wholesale (64% higher, 12% lower), construction (61% higher, 5% lower), and services (54% higher, 5% lower).
A net zero percent of owners viewed current inventory stocks as “too low” in October, down 1 point from September. A net 2% of owners plan inventory investment in the coming months.
Owners’ plans to fill open positions remain elevated, with a net 20% planning to create new jobs in the next three months (down 3 points). Forty-six percent of owners reported job openings that were hard to fill, unchanged from September.
Fifty-four percent reported capital outlays in the last six months, down by 2 points, while Twenty-three percent of small businesses plan capital outlays in the next few months, down 1 point from September.
Why it Matters: This is the tenth consecutive month below the 49-year average of 98 and small business earnings (over the last three months) are near lows seen in the early part of the pandemic due to continued increased costs. There has been some stabilization (after an increase off summer lows) in sales expectations with actual and expected better aligned, but firms are certainly worried about a future slowdown in activity given the net negative outlook. There was a large jump in compensation plans, back to levels seen at the end of last year, while actual compensation fell. This divergence is a little puzzling but given firms continue to have net positive hiring plans and still sight the ability to find qualified workers as a critical problem, it is likely they plan to keep existing workers and adjust existing wages to compensate for increased costs of living while reducing/freezing new headcount (something we hear elsewhere) Finally, actual price changes are slowly falling while future price plans have ticked higher. This echoes what has been seen in several region business surveys and is in line with the general backdrop of demand remaining strong “enough” while cost pressures haven't eased. As always, this is our favorite survey/report, and we encourage all to read it given the importance small business play and the wealth of insight it provides
*The overall index fell in October mainly due to falling expectations for business conditions, expansion, expected sales and weaker credit conditions, and inventory satisfaction
*Hiring plans are at more normal levels, although there is still a historically high level of firms reporting job openings that are hard to fill
*There was a divergence in current compensation, which fell, and future compensation plans, which jumped higher
*Price plans rose after falling for months, while inventory levels are now at more neutral/satisfactory levels
*The Uncertainty Index was unchanged at 72 in October, well below levels seen immediately after the outbreak of the pandemic but much higher than the lower readings seen in spring, with the majority of firms seeing the current period as “Not Good Time” to expand
Wholesale inventories increased by 0.6% from a month earlier to $918.5 billion in September, below estimates of 0.8% and easing from an upwardly revised 1.4% increase in the previous month. It marked the 26th consecutive month of growth in inventories. Stocks increased at a slower pace for both durable (0.8% vs. 1.5% in August) and non-durable goods (0.1% vs. 1.2%). On an annual basis, wholesale inventories are higher by 24.1%. Sales by wholesalers rose by 0.4%, moving the annual increase to 14.4%. The September inventories/sales ratio was 1.31, compared to 1.21 a year ago.
Why it Matters: Increases in inventories are slowing but remained positive in the September report. Sales have been more uneven, with this September’s gains coming after a flat August and negative July. A further deceleration in inventory increases is likely due to the inventory/sales ratio moving back to a more historical level. Also, given the expectation for falling demand to continue into next year, it is likely that wholesaler sales will weaken further.
*Monthly increases in wholesale inventories have been methodically decreasing throughout the year as the inventory/sales ratio has normalized
*With growing concerns over weaker future demand and a preference for services over goods continuing, wholesalers are likely beginning to grow more comfortable with current inventory levels
Policy Talk:
There were a lot of Fed speakers this week, as one would expect, coming out of the November FOMC meeting blackout period. Fed officials Williams, Mester, Collins, Barkin, Daly, Logan, George, and Waller gave prepared remarks, interviews, or longer Q&A special sessions. Most stayed on message, indicating that the phase of getting policy above neutral had ended, and now the pace of tightening should be more sensitive to incoming data. Evans and Daly were more vocal about being careful not to over-tighten but generally, all acknowledged that further rate hikes were coming and the committee was not discussing the terminal level of rates yet. We highlighted a few speakers below:
Boston Fed President Susan Collins gave a speech at a virtual event hosted by the Hutchins Center on Fiscal & Monetary Policy at the Brookings Institution. Collins gave a rather rosy outlook on the economy, noting that businesses and households were in good shape for this point in the cycle.She highlighted that various indicators suggested that the policy tightening underway was already having a meaningful effect. She noted that lowering inflation required bringing supply and demand into a better balance, something occurring, but this did not necessarily need a significant economic slowdown. The terminal level she believes the Fed will need to raise the Fed funds rate to is in line with the median September SEPs. Collins is a voter this year, so her views on the economy and inflation indicate she is right in line with the step-down crowd.
“The higher interest rate environment necessary to restore price stability has challenging implications for real people. I take this, as well as the costs associated with too high inflation, very seriously. Indeed, policymakers must balance the risk that inflation remains elevated and becomes entrenched in expectations against the risk that policy actions excessively slow down economic activity.”
“Again, the path to price stability involves bringing what has been very strong demand into better balance with supply. So we need to see growth at a below-trend pace in interest-sensitive sectors of the economy and more broadly growth that is hopefully still positive but down from the rapid pace we saw last year.”
“The possibility of re-equilibrating the labor market with only a modest increase in the unemployment rate is one important reason for optimism about reducing inflation without a significant downturn.”
“…well-anchored medium- to longer-term inflation expectations, as I have noted, will reduce the extent of the slowdown in activity needed to reduce inflation.”
“It is premature to signal how high rates should go. However, I will say that the median path in September’s Summary of Economic Projections can be taken as a starting point of my current thinking, with the possibility of a higher path depending on incoming information.”
Philadelphia Fed President Patrick Harker gave prepared remarks titled “The Economy, Inflation, and Monetary Policy” in front of the Risk Management Association Philadelphia Chapter. He gave a regional-specific, more pessimistic economic assessment, noting that the re-opening boom had ended and more lackluster demand had set in. He also highlighted that businesses were still experiencing a tight labor market but would be reluctant to reduce headcount too quickly given the trouble they have had finding qualified workers. Harker reiterated the causes for the current high level of inflation and indicated he believed it would be more sticky. The speech was more balanced regarding policy implications that could be extracted. It had a greater emphasis on the economic slowdown occurring (than other Fed officials) but also a greater belief that inflation would take longer to fall.
“Credit card purchase data indicate that consumer spending, which comprises around 70 percent of economic activity in the United States, is slowing, with services and retail leading the decline. Investment in housing has weakened, and even the boom in manufacturing, which has buoyed the economy, is starting to wane.”
“The job market continues to run extremely hot. The national unemployment rate is 3.7 percent, and we still have more than 10 million unfilled jobs. All of which is to say, one economic category has certainly not suffered even as other sectors have slowed: Help Wanted signs.”
“I expect core PCE inflation to come in around 4.8 percent in 2022, around 3.5 percent next year, and 2.5 percent in 2024.”
“We’ve heard from contacts in manufacturing that, given how hard they have worked to staff up, they will be extremely reluctant to cut jobs even as the economy slows.”
“In the upcoming months, in light of the cumulative tightening we have achieved, I expect we will slow the pace of our rate hikes as we approach a sufficiently restrictive stance.”
“At some point next year, I expect we will hold at a restrictive rate for a while to let monetary policy do its work. It will take a while for the higher cost of capital to work its way through the economy… But we should let the system work itself out. And we also need to recognize that this will take time: Inflation is known to shoot up like a rocket and then come down like a feather.”
New York Fed President John Williams presented a speech titled “A Steady Anchor in a Stormy Sea” at an SNB-FRB-BIS conference on “global risk, uncertainty, and volatility” in Zurich. The speech gave a more academic take on how anchoring consumer inflation expectations helps monetary policy be more effective, reminding us that Williams is not a Tim Geithner or even Bill Dudley kind of second-in-command Fed leader. With that said, Williams believes that consumer inflation expectations have remained well anchored, which in itself is a rather dovish statement given those expectations have moved higher in light of the current inflationary pulse. He notes that increased uncertainty does not indicate an “unmoored” longer-run expectation for inflation.
“A reasonable and oft-used benchmark of longer-run inflation expectations is to look at inflation five or more years in the future. Such a forecast horizon is sufficiently long enough for typical business cycle dynamics and the effects of monetary policy on inflation to have played out...”
“The sensitivity of three-year-ahead inflation expectations is far less than that for one-year-ahead expectations. And they have been significantly less sensitive to incoming information during this period of high inflation than during the period before the pandemic. This suggests households view the run-up in inflation in 2021 as likely being less persistent than in prior episodes.”
“The importance of maintaining well-anchored inflation expectations is a bedrock principle of modern central banking, but its precise meaning and validation have been open to interpretation.
Technicals and Charts:
Four Key Macro House Charts:
Growth/Value Ratio: Growth is higher on the day and the week, and Large-Cap Growth is the best-performing size/factor on the day.
Chinese Iron Ore Future Price: Iron Ore futures are higher on the day and on the week.
5yr-30yr Treasury Spread: The curve is steeper on the day and on the week.
EUR/JPY FX Cross: The Yen is stronger on the day and the week.
Other Charts:
Yesterday’s historic daily move higher following the better-than-expected CPI report still smells like a bear market short-covering rally, with the most beaten-down names seeing the largest rallies
However, over 50% of S&P stocks are now above their 200-DMA, an important technical level of support/resistance
Both rate and equity volatility dropped significantly, as would be expected with the passage of such a critical inflation report
429 S&P 500 companies (89% of index earnings) have reported. 3Q EPS of $55.82 has come in largely in-line with expectations as of Oct 1 (+4% YoY)
The dollar has broken below its uptrend channel, with yesterday's move lower being historically very large.
Drops in the ISM Prices Paid sub-index and declines in securities at banks have both been strong leading indicators of where the 10yr yield goes, with both pointing lower currently
Moves lower in the overall ISM Manufacturing Index also indicate that 10yr Treasury yields will likely fall
The underperformance of the household survey continues.
Prime-age labor force participation declined again, keeping the labor market tight.
This year, more or less everyone has been raising rates, amid talk of “reverse currency wars” — the idea that everyone wanted to make their currency stronger to help clamp down on inflation. Dario Perkins of TS Lombard offers this illustration of how concerted 2022’s tightening has been
However, as a percent of GDP, central bank assets are not falling as fast as one would think
“We Expect 3.5% real disposable income growth in 2023, with positive real income growth for all income groups.” – Goldman Sachs Research
Expectations are for a further drop in used car prices for some time…
…as the consumer is currently over-leveraged regarding auto purchases.
Will China’s reopening be inflationary or deflationary? It's going to depend on a number of things, but current falling PPI price pressures should reduce cost pressures for end consumers.
Article by Macro Themes:
Medium-term Themes:
Real Supply-Side Situation:
Idled: Carriers consider laying-up box ships as blanking fails to prop up rates – The Load Star
The idled containership fleet has breached the 1m teu capacity milestone and is set to jump significantly higher as carriers prepare to suspend services temporarily. According to Alphaliner, as of 24 October, the number of inactive containerships either in drydock or seeking employment had reached 284, for a capacity of 1.2m teu, representing 4.6% of the global cellular fleet. At the peak of demand in February, as carriers squeezed the charter market dry in pursuit of every serviceable vessel, the consultant recorded 154 ships, for a capacity of 442,000 teu, as inactive, many in drydock, representing just 1.8% of the global fleet.
Why it Matters:
The Loadstar has seen a big uptick in the number of blank sailing advisories from Asia-Europe and transpacific carriers in the past two weeks, with, for instance, some Asia-North Europe loops being voided in consecutive weeks. “Weakening cargo demand and declining freight rates have prompted carriers to cull some sailings and even temporarily suspend a number of services on major east-west trade lanes,” said Alphaliner. The speed of the decline in exports from China has made the reactive blanking strategies of carriers ineffective at halting the erosion of spot and short-term rates, and avoiding a collapse in contract rates.
Better Than Expected: Taiwan Exports Fall Slightly as Trade Weathers Cooled Demand - Bloomberg
Exports out of Taiwan dropped by -0.5% in October from a year earlier, the Ministry of Finance reported Tuesday. While still the second consecutive month of declines, it was far better than the -6% contraction forecast in a Bloomberg survey of economists. It was also an improvement from September’s -5.3% decrease. Imports surprised with an 8.2% gain from a year prior, far surpassing expectations of a 5% drop. The trade surplus was nearly $3 billion, compared to $5 billion last month.
Why it Matters:
The figures are a welcome sign for Taiwan, where officials have warned for weeks that trade would be under pressure from global headwinds, including inflation, tighter monetary policy, and cooling Chinese demand. The outlook around the region has worsened, with South Korea recently reporting dismal trade figures because of the drop-off in global demand. Exports to Hong Kong and China, significant markets for Taiwan, were still weak in October, falling by -9.2%. But that was better than September’s -13.3% decline. Exports to other markets offset suppressed demand from China. Shipments to the U.S. increased by 3.1% year-on-year, while shipments to Japan jumped 18.7%, and those to Singapore rose 30.2%.
China Macroprudential and Political Situation:
Neverending Story: China Weighs Gradual Zero-Covid Exit but Proceeds With Caution, Without Timeline – WSJ
Chinese leaders are considering steps toward reopening after nearly three years of tough pandemic restrictions but are proceeding slowly and have set no timeline, according to people familiar with the discussions. Concerns are growing over the costs to the economy that the zero-tolerance approach to fight Covid-19 outbreaks has had. But they are weighing those against the potential costs of reopening for public health and support for the Communist Party.
Why it Matters:
The uncertainty around China’s Covid-19 strategy has led to a guessing game in the financial markets, with some looking for any sign that China would begin easing its Covid-19 policies. Some progress is being made on relaxing border controls for inbound travelers from abroad. Beijing is likely to cut the number of hotel quarantine days required of incoming travelers by early next year to seven days. Domestically, officials have informed retail businesses that the frequency of PCR testing could be reduced as soon as this month, in part because of the high cost of mass testing, according to people familiar with the matter. The people said the government is planning to reduce the thousands of PCR testing stations set up across the country as part of the campaign to institutionalize testing, citing the cost.
China Expands Financing Tool That Can Support Ailing Developers – Bloomberg
China expanded a key financing support program designed for private firms including real estate companies, a move that promises to help developers sell more bonds and ease their liquidity woes. The National Association of Financial Market Institutional Investors widened the program launched in 2018 to support about 250 billion yuan ($34.5 billion) in debt sales by private companies, including property developers, the regulator said in a statement on its website Tuesday. The ways to support such financing include bond guarantees, credit enhancement, and bond purchases, adding that the move is part of efforts to stabilize the economy and could be expanded further if needed.
Why it Matters:
The new statement didn’t say how much bond financing has been supported or how much aid is meant for developers, but an initial estimate of the program in 2018 showed it could support as much as 160 billion yuan in bond sales. The financing tool was not intended for private developers or companies in industries with overcapacity originally, but NAFMII, as the regulator is known, has recently organized credit enhancement support for some private developers and achieved “good effects,” the statement said. As the size and scope of the program expand further in the future, it will have a bigger role in bolstering investor confidence and expanding private companies’ financings, it said.
Longer-term Themes:
National Security Assets in a Multipolar World:
Buh-bye: Canada Orders Chinese Companies to Divest From Miners After Security Review – WSJ
Canada on Wednesday ordered three Chinese companies to divest their shares from domestic companies involved in extracting critical minerals, citing national-security concerns. Last week Canada modified its foreign-investment rules governing critical minerals and said investments or takeovers by foreign state-owned companies in the sector would be essentially banned unless there were exceptional circumstances. Canada has said any transaction that involved the transfer of control of critical minerals (essential for the production of electric vehicles, cellphones, and wind turbines) to foreign entities could be subject to a national-security review.
Why it Matters:
The move marks the latest step by Canada and other developed-world economies to protect their critical mineral assets. Demand for minerals such as cobalt, lithium, and nickel is surging as the automotive industry shifts to electric power. Canada, along with allies including the U.S. and Australia, are concerned about China’s dominance over the market and have begun to funnel money to ore refiners and battery makers because they want to counterbalance their Asian rival. “We will act decisively when investments threaten our national security and our critical minerals supply chains, both at home and abroad,” François-Philippe Champagne, Canada’s minister for innovation, who is responsible for foreign-investment policy, said in announcing the divestitures.
Electrification and Digitalization Policy:
Open and Decentralized: The Election That Saved the Internet From Russia and China – Wired
The conclusion of the ITU’s 2022 Plenipotentiary Conference, held in Bucharest, Romania, had advocates for an open and decentralized internet celebrating. American candidate Doreen Bogdan-Martin won a decisive victory with 139 of 172 votes cast against Russian nominee Rashid Ismailov. Bogdan-Martin’s win and other down-ballot shakeups mark a major shift for the ITU that some analysts say will better ensure the internet is free from censorship and meddling from authoritarian nation-states.
Why it Matters:
The ITU is primarily concerned with regulating radio frequencies and technology standardization for telephony and telegraphy, in essence, setting rules to ensure that technology works across borders. While the ITU, which sits within the United Nations and is primarily directed by nation-states, has played a big role in advancing internet connectivity, it has been governed by industry associations and non-state bodies who have been responsible for managing the core elements of the internet architecture. Despite the election “win,” many warn that the ITU has far more work to help guarantee an open global internet. Mallory Knodel, chief technology officer at the Center for Democracy & Technology, says this year’s meeting may have just kicked some of these issues down the road. “In all honesty, it was another PP where the ITU is in a holding pattern on its most important but divisive issues,” she says. “This tactic has an expiration date.”
Commodity Super Cycle Green.0:
The New Oil: The Metals for Your EV Are Stuck in a 30-Mile Traffic Jam - Bloomberg
In order to get a truckload of copper out of Africa and into the hands of tech-hungry buyers, drivers must spend a week sitting in one of the world’s longest traffic jams. The 1,900-mile journey from mines in Congo and Zambia to the ports is so riddled with bottlenecks and jams that it can take more than a month from end to end. It’s a region that many big international miners avoided for years, but now production is booming just as other key mining countries fall short. Congo’s copper output has tripled over the past decade, and there’s more to come. Already the world’s largest cobalt producer, Congo is set to increase production by 79% by 2025 compared to 2020. Other nations are also increasing output. The region could add nearly 1 million tons of annual copper production over the next decade.
Why it Matters:
This scene on the border between Democratic Republic of Congo and Zambia, where the sound of idling diesel engines and the sour odor of sulfur fills the air, seems an unlikely front line for the battle against climate change. Yet it is as important as any wind farm or electric-vehicle plant. Because while everyone from the International Monetary Fund to Elon Musk is warning that shortages of metals like copper could hinder the energy transition, production here is actually booming: the region supplies two-thirds of the world’s cobalt, and it accounted for more than 80% of global copper output growth over the past three years. Expect more investment and more geopolitical turmoil.
ESG Monetary and Fiscal Policy Expansion:
COP27: U.S. works on plan for companies to fund emerging nations’ fossil fuel switch - FT
The U.S. is working on a plan to harness cash from the world’s largest companies to help developing countries cut their use of fossil fuels, an idea it aims to unveil at the UN climate summit this week. U.S. President Joe Biden’s climate envoy John Kerry is trying to marshal support from other governments, companies, and climate experts to develop a new framework for carbon credits to be sold to businesses. Under the potentially transformational plans, regional governments or state bodies would earn carbon credits by reducing their power sector’s emissions as fossil fuel infrastructure such as coal-fired plants were cut and renewable energy increased. The proceeds could then fund new clean energy projects.
Why it Matters:
The use and trading of carbon credits is unregulated and a controversial solution to global warming. In theory, one credit represents one ton of carbon avoided or removed from the atmosphere, but critics say they do not always deliver the emissions savings they promise. However, the concept has boomed as companies and countries come under pressure to cut their emissions and meet net zero emissions targets, which are legally binding under the Paris climate agreement.Several industry groups are working to develop standards in an effort to bring more credibility to carbon credits. The system being devised by the U.S. team is billed as a power-sector version of the so-called Lowering Emissions by Accelerating Forest Finance (Leaf) venture launched at last year’s COP26.
Supreme Court Hears Challenges to FTC and SEC In-House Courts – WSJ
Progress: Data-Privacy Bill Advances in Congress, but States Throw Up Objections – WSJ
Bipartisan legislation to give Americans more control over their online data moved forward in Congress on Wednesday, even as new objections to the bill emerged from California and other states. The House Energy and Commerce Committee voted 53-2 to approve the American Data Privacy and Protection Act, with backers calling it a milestone. The legislation, which must still be approved by the full House and the Senate, would put sweeping new limits on how businesses, especially large technology companies, can collect and use consumers’ data.
Why it Matters:
There are still disputes over the particulars, however, and this week a group of state attorneys general raised concerns that the bill could pre-empt tougher privacy standards adopted at the state level. They also said it could preclude protections states might adopt in the future as technology evolves. “It is critical that Congress set a federal privacy-protection floor, rather than a ceiling, to continue to allow the states to innovate to regulate data privacy and protect our residents,” said a letter to lawmakers Tuesday from the attorneys general of California, New York, Illinois, Massachusetts and six other states. Sponsors of the legislation said they already have taken steps to ensure that existing state privacy protections and authority are preserved, for example, giving state data-privacy agencies authority to enforce the proposed federal law.
Appendix:
Current Macro Theme Summaries:
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