The Fed is Buying Time- MIDDAY MACRO - 11/3/2022
Color on Markets, Economy, Policy, and Geopolitics
Midday Macro – 11/3/2022
Overnight and Morning Recap / Market Wrap:
Price Action and Headlines:
Equities are lower, recovering off their morning lows as yesterday’s hawkish Powell presser, 75 bps rate hike by the BoE, and a weaker ISM Service PMI that still had higher inflationary pressures weigh on risk appetite
Treasuries are lower, with the curve flattening as a higher Fed funds terminal rate for longer is weighing heaviest on the front-end
WTI is lower, likely due to the more risk-off tone as SPR sales are falling, distillate inventories continue to be very low, and exports to Asia have picked back up.
Narrative Analysis:
Equities are down, with the S&P giving back half its October rally gains this week due to a very confidently hawkish J-Powell indicating that the terminal Fed funds rate level would be higher than previously indicated, sending equities, especially more duration and growth-sensitive sectors/factors ripping lower yesterday. This contrasted the initial bullish reaction following the official November FOMC statement which hinted the size of future rate hikes should begin to fall in December. Add in JOLTs data earlier in the week that was stronger than expected, and today’s ISM Service PMI report showing a slowdown in activity/demand but no cooling in prices, as well as a historically high rate hike by the BoE overnight and markets are doing about as well as you would expect. The Treasury curve is flatter as the path to a “soft-landing” has become harder (according to Powell), giving some relief to the long-end with ten-year yields at 4.12%, higher by 20bps post-FOMC. Oil is also cooling today despite a number of more bullish developments. Copper is weaker as rumors that China may be dropping their zero-Covid policy, something that put a bid under all risk assets earlier in the week, are turning out to be, well, just rumors. The agg complex has been volatile, with the Ukraine grain export corridor shutting and quickly reopening while winter conditions in the U.S. continue to be historically poor. King dollar is again near highs as the Pound is down by over -2.5% despite an aggressive rate hike, while almost every other cross is significantly weaker, moving the $DXY to close to 113.
The Russell is outperforming the S&P and Nasdaq with Momentum, High Dividend Yields, and Value factors, and Energy, Industrials, and Materials sectors all outperforming on the day. Factors (Momentum and High Dvd Yield) and sectors (Utilities and Industrials) that are outperforming on the week and providing a more yield-enhancing and resource-orientated (energy = momentum) leadership.
@KoyfinCharts
S&P optionality strike levels have the Zero-Gamma Level at 3862 while the Call Wall is 4100. The volatility trigger is at 3825 while the Put Wall remains at 3600, indicating that until the 11/10 CPI report, we likely remain directionally lower as volatility will likely remain high due to higher levels of negative gamma, although the Put Wall did not shift lower. There was some shift higher in IV for expirations out in time. This suggests that there is/was some demand for longer-dated downside protection. However, Spotgamma’s RiskReversal indicator holds a bullish -0.05 mark, and the VIX had no meaningful negative response to yesterday's +3% intraday decline although rose overnight.
@spotgamma
S&P technical levels have support at 3735, then 3720, with resistance at 3765, then 3805. The initial move following the release of the FOMC statement was a spike reaction to 3900 resistance, which turned out to be the trap move that often occurs now on Fed day, followed by a 125-point pure melt-down. On Oct 21st, the S&P broke out an inverse head and shoulders pattern, which we are now back-testing. This means that in order for this breakout to remain “in play,” this support will need to hold around 3720. The “all clear” technical bull level indicating the October rally is intact is now 3855+.
@AdamMancini4
Treasuries are lower, with the 10yr yield at 4.12%, higher by 1.7 bps on the session, while the 5s30s curve is flatter by 3.5 bps, moving to -20 bps.
Deeper Dive:
This week has seen a rapid reversal in the October rally, as a better-than-expected JOLTs report on Tuesday and an overly hawkish presser by Chairman Powell yesterday have led the S&P to retrace around 50% of its recent gains. When coupled with increases in prices paid by firms in the service sector, as seen in today's ISM Service Sector PMI report, recent price action makes sense. In the end, the Fed opened the door to dialing down the size of the next hike, but Powell raised the ultimate terminal Fed funds level because he wasn’t seeing enough progress on the data front. After some initial confusion, this message moved real rates and the dollar higher, keeping financial conditions from loosening as the new “Slow, Stretch, and Raise” approach was not interpreted as a dovish pivot. We continue to see a growing level of leading inflationary indicators falling. As a result, the fact the Fed is buying itself more time, allowing the lag effects of existing policy moves to weigh on demand more properly, may ultimately reduce the final level of restrictiveness needed, given our beliefs on where inflation is going. Of course, there has been a renewed pick up in business survey inflation readings due to mixed progress on supply-side impairments and continued strong (all be it slowing) consumer activity, muddying our outlook a little. However, we see the recent pullback in equities and rise in the dollar as a chance to increase our $SPY long and $UUP short. Given the positive index level price action in light of recent weaker earnings results and our expectations for slowing labor demand and reduced inflationary pressures, we are willing to increase these tactical trade levels based on the belief that a softer landing (or shallower recession), as well as a less hawkish Fed, will increasingly drive a more risk positive sentiment into year-end.
The main takeaway from the November FOMC was that the Fed will be slowing the pace of tightening while raising the expected ultimate terminal Fed funds level, hence not “pivoting.” This allows the Fed to maintain credibility while buying time for policy actions, which affect the real economy on an increasingly uncertain lag, to push down on demand and, ultimately, drive inflation back to target next year. It also reduces the risk of over-tightening. The modal outcome is now a “Slow, Stretch, and Raise” approach, which sees a 50 bp rate hike in December followed by subsequential 25 bps hikes in the first quarter of 2023 until the mosaic of data points needed to convince the Fed that inflation is not entrenched and is trending lower has been met. Overall this is a more positive development than market reactions may have indicated, as it buys more time while reducing financial stress. It could also indicate a move away from an excess emphasis on backward-looking realized inflationary data.
*The FF futures implied terminal level increased by almost 25bps, generally staying wider across the curve following Powell’s presser remarks on the new higher level and longer duration
*The current rate hiking cycle will be the most aggressive since Volcker, even with a step down in the size of future hikes
The Fed is not unique in making this shift to the next stage of its policy tightening cycle. The RBA, BoC, ECB, and Norges Bank are all making a similar shift to a more pragmatic, gradual, forward-looking reaction function now that policy has entered a more neutral footing. This will reduce the risk of major policy errors and lower the bar for a real pivot if inflation meaningfully falls into 2024.
*Assuming no further shock that exacerbates inflation higher, the rate and size of future central bank hikes are projected to slow entering 2023
Focusing on the data, the real question isn’t how long the lag between Fed rate hikes and their impact on the real economy is (something we believe to be much shorter than past hiking cycle episodes) but how long the lag is in core CPI/PCE data’s ability to capture an increasingly slowing inflation picture? Forward-looking indicators for inflation are all pointing lower. Wage growth has peaked, and despite a bounce back in job openings last month, turnover is slowing while business surveys indicate lower wage increase expectations from firms (and workers) moving forward. Goods inflation is falling hard, with the recent ISM Prices Paid sub-index moving into negative territory and expectations for retailers to discount overstocked inventory heavily this holiday season. Falling shipping costs are also echoing what is being seen in business surveys; demand is dropping, and although not near pre-pandemic levels, many supply chains continue to improve, reducing cost pressures even if recent data showed a step back in progress there. A more normalized demand for leisure, hospitality, and travel will increasingly reduce price pressures there as the reopening rush ends and back-to-work/school changes behavior. Finally, rents have stabilized and, when coupled with increasing drops in home prices, will reduce the impact that further monthly gains in shelter (OER) inflation have on policymakers' decisions.
*BCA Research makes a convincing argument that leading wage indicators have turned over
*This is furthered by falling compensation plans reported by small businesses in the NFIB survey
*JPM economists project U.S. core CPI will fall to a 5.3% YoY rate in Q1, vs. 6.6% currently, mainly due to a decrease in goods
*Small businesses are reducing their intentions to raise prices quickly
Our view regarding risk assets remains cautious, but we push back on this belief that the unemployment rate needs to reach a certain higher level/target (which would likely only occur if the economy was in a proper recession) for the Fed to stop raising rates. To be clear, there can be no sustainable rally until real rates peak and financial conditions begin to loosen. This cannot occur until we reach the terminal Fed funds rate, a level Powell increased yesterday. However, this doesn’t mean that a year-end rally can’t rematerialize in equities or that the dollar isn’t overbought and could depreciate 5-10%. We have not discussed the many other macro factors that affect these views today, primarily focusing on the Fed and our inflationary outlook. We still believe these two things are the primary driver of the core market narrative currently but acknowledge the tail risks have grown due to other factors, primarily the left-tail (negative-side) being an escalation in the Ukraine war and right-tail (positive-side) being an end to zero-Covid in China. Finally, as stated above, we are doubling our long position in $SPY and short in $UUP, as reflected in our updated mock portfolio holdings sheet below,
*Returns since inception are -2.19%, as this week’s declines in the S&P and Copper, as well as gains in the dollar, all hurt performance
We are not in the habit of doing plugs for other services, but we recently subscribed to The Transcript on Substack. They provide quotes from earnings calls, prominent investors, and policy officials. We recommend the newsletter for those interested in hearing what is discussed in earnings calls but who don’t always have the time to go through entire call transcripts. Below are a few recent excerpts from various Q3 calls that caught our eye.
Consumers Spending:
The headline is that consumer spending remained resilient and cross-border travel continues to recover -- overall consumer spending has remained resilient, although we are seeing some shifts in what consumers are buying. Looking at our switched volume trends. Domestic volumes remained steady, showing growth relative to 2019 levels, relatively consistent with the second quarter of 2022. The trend towards spending on experiences continues." - Mastercard CEO Michael Miebach
"As you alluded to, I mean, right now, we are seeing nothing but stability, and it’s been true over the last numbers of quarters." - Visa CEO Al Kelly
If you raise rates and slow down the economy to fight inflation, the expectation is you have a slowdown in consumer spending. It hasn't happened yet. So it could happen, but it hasn't happened yet. You're seeing a mitigation of the rate of growth, not a slowdown. Not negative growth." - Bank of America CEO Brian Moynihan
Bad debt levels look to us consistent with 2019 pre-pandemic levels, and 2019 was one of our best years ever -- So we have seen a creep up from those pandemic levels but only to one of our best years ever -- so far, we're not seeing it in anything outside the norms." - T-Mobile CEO Mike Sievert
Corp/Business Balance Sheets:
U.S. corporates are in pretty good shape from a leverage standpoint. When we look at free cash flow to debt, that’s one way to look at it across our rated U.S. corporates. It’s at about 11%. That’s the best that it’s been since 2011. So that, to me, means that corporates still have some room to take on some additional leverage." - Moody's CEO Rob Fauber
Logistics:
"In the third quarter, the global economy softened, especially outside the United States. International and freight forwarding volumes were challenged" - United Parcel Service CEO Carol Tomé
Inflation:
“We experienced increases in raw materials, freight and logistics costs and more recently, energy costs -- We do expect cost inflation to persist throughout the first half of 2023 and costs moderating in the second half of 2023.” - Whirlpool COO Joe Liotine
Econ Data:
The ISM Services PMI fell to 54.4 in October from 56.7 in September and below market forecasts of 55.5. A slower level of activity and growth was seen in drops in Production (55.7 vs. 59.1), New Orders (56.5 vs. 60.6), and Backlog of Orders (52.2 vs. 52.5) readings. However, all three sub-indexes are still firmly positive. However, there was a historic drop in New Export Orders (47.7 vs. 65.1), moving the sub-index well into contractionary territory, while Imports (50.4 vs. 51.3) moved closer to flat. Supplier Deliveries (56.2 vs. 53.9) increased as logistics worsened during the month. Inventories (47.2 vs. 44.1) moved closer to a more neutral level, although Inventory Sentiment (46.4 vs. 47.2) worsened. The Employment (49.1 vs. 53) reading moved into contraction territory. Finally, Prices (70.7 vs. 68.7) rose at a faster pace.
Why it Matters: The overall PMI index indicates the service sector is growing at its slowest rate since May 2020. The sector had a pullback in growth for the second consecutive month due mainly to decreased business activity, new orders, and employment. Respondent comments were mixed but tilted more negatively as supply chain, and labor challenges were prevalent and worries about a coming recession. “Based on comments from Business Survey Committee respondents, growth rates and business levels have cooled. There are still challenges in hiring qualified workers, and due to uncertainty regarding economic conditions, some companies are holding off on backfilling open positions. Supply chain and logistical issues persist but are not as encumbering as they were earlier in the year,” commented Anthony Nieves, Chair of the Institute for Supply Management.
*The Employment sub-index contributed negatively to the October reading, while the three other major categories all fell
*Demand-orientated readings all cooled while prices and delivery readings increased
*Comments were mixed, with a few outright positive while others emphasized continued logistical issues and labor shortages as well as growing worries of a coming slowdown
The ISM Manufacturing PMI fell to 50.2 in October from 50.9 in September, coming in slightly higher than market forecasts of 50. New Orders (49.2 vs. 47.1 in Sept) improved but are still in contractionary territory. New Export Orders (46.5 vs. 47.8) and Backlogs of Orders decreased (45.3 vs. 50.9) both decreased, while Production (52.3 vs. 50.6) rose while Employment (50 vs. 48.7) was little changed. Price pressures continued to ease for a seventh straight month and fell into contraction territory (46.6 vs. 51.7). Supplier Deliveries (46.8 vs. 52.4) also moved into contractionary territory. Imports (50.8 vs. 52.6) dropped, and finally, Inventories (52.5 vs. 55.5) also fell while Customer Inventories were unchanged at 41.6, a very low level. Of the six biggest manufacturing industries, three: Machinery, Petroleum & Coal Products, and Transportation Equipment registered moderate-to-strong growth in October.
Why it Matters: The story continues to change from capacity-constrained production due to shortages of materials and labor to one of increasingly lower-end demand. October was the first month where supplier deliveries meaningfully shortened while prices have now moved into contractionary territory. Exports continue to weaken, as expected, given what is occurring overseas and with the strong dollar. Finally, the now contracting backlog of orders and the still low level of customer inventories potentially show many firms are hesitant to increase inventory levels (due to future uncertainties over demand), while capacity constraints have fallen, and firms are likely now back to a more normal production/capacity balance. Regarding the employment picture, firms continue to manage headcounts through hiring freezes and attrition to lower levels, with medium- and long-term demand still uncertain. Finally, respondent comments indicate falling demand and improving supply-side dynamics.
*The normalization in logistics is now an increasingly negative drag on the headline PMI reading, with six out of ten sub-indexes in contractionary territory in October
*The manufacturing Prices sub-index often leads overall CPI/PCE, and it just entered contractionary territory while the Employment picture is exactly at 50, with comments indicating a more mixed picture there
*Seven out of the eleven sub-indexes declined in October, with Deliveries, Backlog, and Prices having the largest drops
*Historically, there has been a tight correlation between ISM Manufacturing Prices and headline CPI, but lately, they have diverged
The number of job openings rose by 437K to 10.72 million in September, up from 10.2 million in August and beating market expectations of 10.0 million. Openings were up in several industries, with the most significant increases being reported in accommodation and food services (+215K), health care (+115K), and transportation, warehousing, and utilities (+111K). Meanwhile, job openings decreased in wholesale trade (-104K) and finance and insurance (-83K). Elsewhere, the number of hires was down by -252K to 6.33 million, while total separations, including quits, layoffs and discharges, and other separations, declined by -370K to 5.69 million. The number of quits declined by -123K from a month earlier to 4.06 million. The so-called quits rate, which measures voluntary job leavers as a share of total employment, was 2.7% for the third month in a row, slightly down from a record high of 3.0 percent seen at the end of 2021.
Why it Matters: Any hope that the “tightness” in labor markets was changing quickly ended following the significant increase in job openings in September. In normal times this would have been a solid report, showing increased opportunity, low levels of separation, and a healthy “quits rate.” However, this backtrack from the prior reports' notable drop increased expectations that the Fed would need to raise rates further to dampen labor market tightness and reduce wage spiral concerns. Interestingly most of the job openings were in lower-paying service roles, showing that the mismatch in supply and demand is more a raw numbers game than a “needed skills” one, something that had been more prevelant in manufacturing and higher-skilled service sector job openings. Theoretically, it also means reduced inflationary pressure, as this lower-income cohort does not historically drive aggregate demand enough to drive demand-pull inflation pulses, assuming these openings were filled.
*September’s increased levels of openings notably retraced the significant drop in the prior month
*The three-month average rate for quits fell lower this month after bouncing higher last, with an outsized contribution from the manufacturing sector in Septembers data
*The quits rate has historically correlated to the employment cost index, with both looking to be trending lower
Construction spending increased 0.2% in September, rebounding from a downwardly revised -0.6% fall in August and beating market forecasts of a -0.5% drop. Spending on private construction rose by 0.4%, led by a 1% increase in investment in nonresidential structures, namely for manufacturing (7.6%) and office (0.1%). Investment in residential construction was unchanged, with spending on single-family projects dropping by -2.6% while outlays on multi-family housing projects increased by 0.3%. Public investment fell by -0.4% as health care and transportation spending fell, but highway construction rose by 1.7%.
Why it Matters: September’s construction report was better than expected due to unchanged residential construction activity. Increases in highway, manufacturing, and office construction led to higher nonresidential construction while the majority of the other categories fell. The fact that residential construction was flat even with the growing levels of headwinds facing the housing market and supply-side impairments continuing to pressure homebuilders' margins speaks to the high level of starts/permits in the pipeline due to still historically low levels of inventory. The bottom line is that housing is clearly expected to continue to slow and be a growing drag on growth, but September was a flat month, according to actual construction activity data.
*Total construction rose by 0.2% MoM thanks to a flat residential picture and gains in nonresidential led by the highway, manufacturing, and office space
*Single-family starts continue to fall while multi-family is effectively flat, and home improvement continues to increase
The Chicago PMI fell 0.5 points to 45.2 in October. This is the second month of contraction. Production (45.1) improved marginally, while New Orders (39.2) declined by 3 points. Order Backlogs (47.3) recovered almost half of the September drop. Employment (45.6) rose by 5.4 points but remained in negative territory. Supplier Deliveries (59.3) fell slightly, and Inventories (56.9) grew by almost 4 points. Finally, Prices Paid (74.8) saw a small uptick but are still almost 10 points below the 12-month average. This month's special question asked how firms are looking to move excess inventory. “Cutting back on orders from suppliers was the most heavily implemented strategy (33.3%), whilst 36.7% were not experiencing inventory level issues. Strategies involving repurposing, reselling, reducing prices, and waiting saw relatively even usage by around 13-17% of firms.”
Why it Matters: There was a slight decrease in October from September due mainly to a three-point drop in New Orders while the majority of other sub-indexes improved. Over one-third of respondents noted continued issues with labor and material shortages despite a continued improvement in supplier deliveries. The rebound in order backlogs, all be still in contractionary territory, was due to stronger new demand. However, many respondents saw falling new orders helping capacity clear their backlogs. Prices were stable on the month, with half of the reporting firms experiencing increased prices in October, compared to around 80% in the first half of the year. Falling container costs and the strong US dollar are contributing to lower logistical costs.
*Little changed from September; the Chicago PMI has 5 out of 8 of its subindexes in contractionary territory
The Dallas Fed’s Manufacturing Survey’s General Activity Index decreased to -19.4 in October from -17.2 in September. The Company Outlook index also remained negative but was largely unchanged at -9.1. The Outlook Uncertainty index pushed higher to 38.3. The New Orders index fell to -8.8, its fifth month in a row in negative territory. The Growth Rate of Orders also remained negative and dropped 12 points to -13.2. The Capacity Utilization index was positive but moved down from 13.4 to 9.1, while Shipments fell into negative territory for the first time since May 2020, coming in at -1.6. Labor market measures continued to indicate robust employment growth, with the Employment index rising to 17.1, although workweeks are no longer lengthening. The wages and benefits index remained elevated at 36.7, unchanged from September. Prices continued to increase; however, the raw materials prices index moved down five points to 32.0, while the finished goods prices index rose four points to 22.2. Expectations regarding future manufacturing activity fell notably in October, although the future production index remained positive, though it plummeted 25 points to 3.1, its lowest reading since April 2020. The future general business activity index remained negative, while other measures of future manufacturing activity saw large declines in index values this month, though most remained in positive territory.
Why it Matters: This was a very negative report when considering the significant decreases in future outlook and continued general negative survey respondent comments, and this is on top of current sub-indexes showing decreases in demand, no improvement in logistics, increased inflationary pressures (although wages were flat), and decreases in capital expenditures. The large increase in outlook uncertainty is especially troubling, indicating we should continue to see weaker general activity. However, we also suspect that a split congress/government, the likely outcome of the mid-term elections, will boost the future “outlooks” given the Republican tilt of most of the survey's respondents and the political nature of their negative comments.
*New Orders moved back to recent lows, but a significant drop in Growth Rate of Orders, as well as future expectation readings, showed a growing slowdown in demand
*Broad decreases, especially in future outlook sub-indexes, showed a notable decrease in demand (expectations), while the outlook uncertainty (38.3 vs. 27.2 in Sep) also jumped higher
Policy Talk:
Results from November's FOMC meeting offered a mixed but, on the aggregate, hawkishly tilted message/outcome. The three main takeaways are that the Fed will slow the size of hikes, but the terminal rate has risen, and there is no interest in talking about stopping yet. The statement language was altered to indicate that the future pace of rate hikes would slow to account for “the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments,” something seen initially as a dovish development. However, Chairman Powell's opening remarks and answers throughout the presser indicated that the current expected level of the ultimate terminal rate for Fed funds was too low. His overarching message was inflation remained persistent and continued to grow on the service side. As a result, it was now not enough to see a series of down monthly inflation readings, but a sustained period of below-trend growth and “some” softening in the labor market was needed. He emphasized that the Fed was moving into the next stage of its tightening cycle, with the pace of hikes no longer as important due to now being in restrictive territory. Instead, the ultimate Fed funds level and duration it should stay there was the primary debate now occurring. This debate continued to be data-dependent, and Powell reiterated that positive real rates and continued tighter financial conditions were needed, but ultimately the terminal level was still highly uncertain. He downgraded his assessment of the economy on the margin, indicating that policy tightening had begun to reduce demand, but it is unclear if “modest growth” was equivalent to below trend. Another notable points made throughout the Q&A were a lack of concern for the cooling housing market, with Powell noting it was not a systemic risk. Powell also noted that the committee was aware that rents were falling and that there would be a lag in how that hits the current shelter inflation readings. Finally, it's worth highlighting that he again wants to see job openings and quits fall, clearly weighing those indicators over the UER level. He also spoke extensively about the lag time regarding how policy changes affect the real economy, giving a somewhat unclear indication of his personal views there but signaling that there is likely an active debate occurring among committee members.
“Recent indicators point to modest growth of spending and production this quarter. Growth in consumer spending has slowed from last year’s rapid pace, in part reflecting lower real disposable income and tighter financial conditions.”
“The labor market remains extremely tight, with the unemployment rate at a 50-year low, job vacancies still very high, and wage growth elevated.
“And the recent inflation data have again come in higher than expected. Price pressures remain evident across a broad range of goods and services.”
“Despite elevated inflation, longer-term inflation expectations appear to remain well anchored, as reflected in a broad range of surveys of households, businesses, and forecasters, as well as measures from financial markets.”
“At some point, as I’ve said in the last 2 press conferences, it will become appropriate to slow the pace of increases as we approach the level of interest rates that will be sufficiently restrictive to bring inflation down to our 2 percent goal. There is significant uncertainty around that level of interest rates. Even so, we still have some ways to go, and incoming data since our last meeting suggest that the ultimate level of interest rates will be higher than previously expected. Our decisions will depend on the totality of incoming data and their implications for the outlook for economic activity and inflation.
“I don’t have any sense that we’ve over-tightened or moved too fast. I think it’s been a good and successful program that we’ve gotten this far this fast.”
“Has it narrowed (the window for a soft landing)? Yes. Is it still possible? Yes. I think—we’ve always said it was going to be difficult, but I think to the extent rates have to go higher and stay higher for longer, it becomes harder to see the path. It’s narrowed. I would say the path has narrowed over the course of the last year, really… Because we haven’t seen inflation coming down. The implication of inflation not coming down. And what we would expect by now to have seen is that as the—really, as the supply side problems hadn’t resolved themselves, we would have expected goods inflation to come down by now, long since by now. And it really hasn’t, although it’s—actually, it has come down, but not to the extent we had hoped. At the same time, now you see services inflation—core services inflation moving up. And I just think that the inflation picture has become more and more challenging over the course of this year, without question. That means that we have to have policy being more restrictive, and that narrows the path to a soft landing, I would say.”
*“And that’s been the pattern. I mean, I would have little confidence that the forecast—if we made a forecast today, if we were doing an SEP today, you know, the pattern has been that, one after another, they go up. And you know, that’ll end when it ends, but there’s no sense that—you know, that inflation is coming down.” - Powell
Technicals and Charts:
Four Key Macro House Charts:
Growth/Value Ratio: Value is higher on the day and the week, and 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 on the week.
5yr-30yr Treasury Spread: The curve is flatter 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 post-FOMC selloff was particularly bad due to Powell’s overly hawkish tone in the presser.
With third-quarter results in from roughly half of S&P 500 companies so far, about 72% are beating Wall Street earnings expectations, according to FactSet. That compares with the five-year average of a 77% beat rate. Companies missing earnings and revenue expectations are getting punished sharply by the market.
When excluding the mega-caps, the overall index continues to cheapen, of course, this means making some assumptions about future earnings.
Prior to yesterday’s FOMC selloff, 10-day breadth at its highest level since October 2020 when "reopening" was the sentiment de jour, vaccine efficacy was emerging, and stimulus was running rampant. - @RenMacLLC
November historically has been a strong month for stocks. In fact, the past 10 years it has been the best for stocks and in a midterm year it has been the second best (only October was better). - @RyanDetrick
Earnings "misses are getting punished, underperforming the S&P 500 by 667bps the next day, the largest in history" – BofA U.S. Equity and Quant Research
The U.S. East Coast diesel shortages continue to worsen and have levels well below the 5-year average range.
The U.S. winter wheat crop is not in great shape, with 35% rated poor/very poor.
The Fed's excess reserves continue to shrink, as do reverse repos and bank deposits. The reason is that higher interest can be earned on T-bills, consumer spending is high, and savings are withdrawn. QT is now running at full speed and hitting the economy right this moment - @Marcomadness2
The land market for home building has completely reversed course in just 6 months, according to 78 land brokers we just surveyed. 41% report that prices are falling - probably based mostly on renegotiations. - @johnburnsjbrec
The 7-day average for U.S. air travel (TSA total traveler throughput in million passengers a day) is now 1.2% above the 2019 level. - @staunovo
Nothing has happened to dampen the power of the dollar within the system. Indeed, it is part of 88% of all currency trades, which is slightly greater than it was in 2010. The euro has dropped over that period, while the most significant increase in trading volume, as might be imagined, is in the Chinese yuan. - @johnauthers
Article by Macro Themes:
Medium-term Themes:
Real Supply-Side Situation:
Slow Your Roll: Maersk offers overstocked retailers a slow(er) boat from China – The Loadster
Maersk says it is offering shippers the opportunity to slow cargo arrivals from Asia destined for European and U.S. ports to help retailers manage bloated inventories. The initiative from the Danish logistics integrator comes as demand for retail-lifestyle products from Asia plummets. In its latest Asia-Pacific market update, Maersk says volume prospects “remain weak,” and a continued slide in container spot rates “is likely.”
Why it Matters:
Global trade is likely to slow this year as western economies tip into recession, according to Søren Skou, the chief executive of the world’s second-largest container shipping group AP Møller-Maersk. Skou said freight rates had started to normalize and that supply chain bottlenecks, caused by a surge in demand after the first wave of the pandemic, were easing. “We see a recession looming . . . On the one hand, we have never delivered such a great result financially, but every indicator we are looking at is flashing dark red. Clearly, we expect a slowdown, and we expect lower earnings going forward,” Skou said.
China Macroprudential and Political Situation:
Forcing Change: China Locks Down Area Around ‘iPhone City’ in Blow to Apple - Bloomberg
China has ordered a seven-day lockdown of the area around Foxconn Technology Group’s main plant in Zhengzhou, a move that will severely curtail shipments in and out of the world’s largest iPhone factory.The lockdown will last until Nov. 9, the local government said in a statement posted to its WeChat account. It ordered people and vehicles off the streets except for medical or other essential reasons, a prohibition that threatens to cut off the flow of additional workers and components needed to rev up production ahead of the holiday season crush.
Why it Matters:
The abrupt action reflects the continuing realities of Beijing’s Covid Zero approach and is likely to further disrupt Foxconn’s main operations base, which cranks out an estimated four out of five of Apple’s latest handsets. The plant will keep operating within a “closed loop,” or a self-contained bubble that limits contact with the outside world, Foxconn said in a statement. But the company didn’t address questions about how it will ship goods in and out of the compound during the area lockdown. Foxconn has sought to mitigate the potential disruption by raising wages and arranging for backup from its other Chinese plants should assembly lines stall in Zhengzhou.
Longer-term Themes:
National Security Assets in a Multipolar World:
Pursuit: U.S. Manufacturers ‘Pumped Up’ About Supply-Chain Reshoring Trend - Bloomberg
According to a report by Deloitte, some 62% of manufacturers surveyed have started reshoring or near-shoring their production capacities. The survey included 305 executives at transport and manufacturing firms, mostly in the U.S., with annual revenue of $500 million to more than $50 billion. American firms are expected to reshore almost 350,000 jobs in 2022, an increase of 25% from 260,000 in 2021, according to figures cited in Deloitte’s ‘Future of Freight’ report. Ultimately, the shift could reduce by 20% the share of Asia-originating shipments to the U.S. by 2025 and by 40% by 2030.
Why it Matters:
Moving production lines closer to the U.S. and Europe has been discussed for years but was considered too costly and cumbersome. The pandemic turned much of the chin-scratching into construction spending for several reasons: global supply-chain snarls, rising e-commerce, geopolitical pressures, export restrictions, and a surge in robotics and automation. Another key factor is the massive US subsidies from the Inflation Reduction Act and CHIPS Act, which contain provisions that provide specific financial incentives for products made in the U.S., Canada, or Mexico. The result is increased project planning for US-based manufacturing of electric vehicles, batteries, memory chip plants, and liquid natural gas. It is still unclear whether this is a real entrenched long-term trend (as the magnitude is still small), and its effects on the structural level of inflation may be detrimental to consumers. However, it will undoubtedly ensure the U.S. produces more of its own national security assets.
Electrification and Digitalization Policy:
Konstantin Vorontsov, deputy director of the Russian foreign ministry’s department for non-proliferation and arms, called the West’s use of commercial satellites “an extremely dangerous trend that … has become apparent during the latest developments in Ukraine.” He said that commercial systems as “quasi-civilian infrastructure may become a legitimate target for retaliation.” Russia, in recent months, has aimed its wrath at SpaceX’s internet satellite network Starlink, which has served as a communications lifeline for the Ukrainian military.
Why it Matters:
The aggressive rhetoric from Russia comes as the Pentagon plans to increase its use of commercial space services and considers how it might compensate companies if their spacecraft is damaged during an armed conflict. For many years the U.S. military in strategic space wargames recognized that commercial vendors would play a role in a future conflict. “For a long time, we have worked on ideas and concepts of what it meant to be a commercial operator in a scenario like that, a military service depending on commercial capabilities, and we’ve also exercised it in real-time,” U.S. Vice Chief of Space Operations Gen. David “DT” Thompson said at a Mitchell Institute for Aerospace Studies conference. Since Russia’s invasion of Ukraine, “let’s just say that the conversation between us and our allies and partners in the commercial sector has picked up a sense of urgency, and a better understanding of what it might really look like based on what’s happened in Ukraine,” Thompson said.
Inside a US military cyber team’s defense of Ukraine - BBC
By late last year, Western intelligence officials were watching Russian military preparations and growing increasingly concerned that a new blizzard of cyber-attacks would accompany an invasion, crippling communications, power, banking, and government services to pave the way for the seizure of power. The U.S. military Cyber Command wanted to discover whether Russian hackers had already infiltrated Ukrainian systems, hiding deep inside. Within two weeks, their mission became one of its largest deployments, with around 40 personnel from across U.S. armed services. Thanks to their help and in conjunction with Ukrainian defense forces, Russia failed to take down Ukrainian computer systems at the start of the war.
Why it Matters:
Since 2014, Ukraine has witnessed some of the world's most significant cyber-attacks, including the first in which a power station was switched off remotely in the dead of winter.The infiltration of computer networks had been primarily about espionage for many years but has recently been increasingly militarised and linked to more destructive activities like sabotage or preparation for war. This means a new role for the U.S. military, whose teams are engaged in "Hunt Forward" missions, scouring the computer networks of partner countries for signs of penetration.
Commodity Super Cycle Green.0:
Securing: Germany Backstops Commodity Traders as War Drives Resource Dash - Bloomberg
Germany is offering loan guarantees to commodity trading houses to buy energy and key metals as Russia’s invasion of Ukraine sparks a global scramble for resource security. Trafigura Group, the world’s biggest trader of copper, has already agreed to supply German customers with non-Russian metals for the next five years, helped by $800 million in bank credit that’s ultimately guaranteed by the German government. The trading house is now discussing a similar deal for liquefied natural gas, according to people familiar with the situation, and commodity bankers are pitching more deals that would have state guarantees to other traders.
Why it Matters:
The war has forced Germany to retool its entire energy policy after years of tight dependence on Russia for supplies of oil, gas, and metals. That urgency has meant Berlin is willing to put taxpayer funds on the hook, even if it means backstopping privately owned and highly profitable commodity trading houses. The deals “show it’s dawning on the developed world that strategic sourcing matters,” said Jean-Francois Lambert, who runs a consultancy on commodity trade and structured finance. “In these times, when you need flexibility or to be nimble, you go to the trading houses and nowhere else. Other European governments will have to start thinking along the same lines.”
Developing Alternatives: U.S. to invest $7bn in hydrogen hubs with eye on export to Japan - NikkeiAsia
The administration plans to invest more than $7 billion to develop hydrogen production hubs with a goal of meeting 10 million tonnes of demand for the gas by 2030, becoming "a pillar of the hydrogen economy for decades to come," David Crane, U.S. President Joe Biden's nominee for undersecretary of energy, told Nikkei. Some of the gas produced at these hubs could be exported with the locations spread across the western, eastern, and Gulf Coast regions of the country.
Why it Matters:
The Biden administration has made decarbonization a significant policy initiative, setting aside massive amounts of funding in both the Infrastructure Investment and Jobs Act as well as the Inflation Reduction Act. The goal is to have a carbon-free power grid by 2035 and net-zero emissions by 2050. The Energy Department's draft hydrogen strategy, released in September, says clean hydrogen, hydrogen produced without emitting greenhouse gas, will reach 10 million tonnes by 2030. This is equivalent to about 10% of global hydrogen demand in 2021.
ESG Monetary and Fiscal Policy Expansion:
Hungry Gary: SEC Pulls In Record Enforcement Haul, Moves to Rewrite Mutual-Fund Rules – WSJ
The SEC obtained record monetary sanctions in the latest fiscal year ($6.4 billion) and advanced two more regulatory initiatives Wednesday as part of Chairman Gensler’s campaign to overhaul the rules of Wall Street. The amount received this fiscal year beat the previous record, set in fiscal 2020, by nearly 40%, underscoring Mr. Gensler’s enforcement focus on high-profile cases and steep penalties for misconduct. Separately at a meeting Wednesday, the commissioners finished a proposal requiring money managers to disclose more information about how they use their voting power in public companies, including on executive compensation. It also proposed a rule aimed at making mutual funds more resilient to market stress.
Why it Matters:
Mr. Gensler is moving forward with an agenda that he says will hold companies more accountable to their shareholders, save investors money by wringing excess profits from intermediaries and shore up financial stability. Mr. Gensler, a Democrat nominated by President Biden, has said he also wants to deter Wall Street firms from viewing regulatory settlements as a cost of doing business. Mr. Gensler’s regulatory agenda has stirred opposition from Republicans and industry groups representing some of Washington’s most powerful constituencies: private-equity firms, hedge funds, mutual funds, broker-dealers, and the U.S. Chamber of Commerce.
Appendix:
Current Macro Theme Summaries:
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