After a furious late-day selloff on Thursday as markets digested the probability of another red hot inflation number, S&P Futures traded in a narrow range on Friday ahead of the crucial May CPI Print which will dictate the path of Federal Reserve policy (it means the difference between a 25bps and 50bps Sept rate hike... or 0bps), and which is expected to come in 8.3% Y/Y and 0.7% M/M for headline and 5.9% Y/Y and 0.5% M/M for core. S&P 500 contracts fluctuated between modest gains and losses, while Nasdaq 100 futures rose about 0.4% as of 7:30 a.m. ET. The dollar rose slightly, although it has been trading largely flat throughout the session. The yield on the 10-year Treasury is unchanged at 3.04%, while the 2-year Treasury yield rose about 3.4 basis points to 2.8455%. Gold and bitcoin fell. Oil rose.
In premarket trading, DocuSign slumped 25% after the e-signature company earnings missed expectations and cut its full-year billings outlook. Netflix and Roblox declined after Goldman Sachs analysts cut their recommendations on the stocks to sell from neutral amid macroeconomic concerns. Bank stocks are lower in pre-market trading Friday as investors await the release of key inflation data later this morning. In corporate news, Credit Suisse shares hovered near the lowest in at least three decades after State Street Corp. denied that it is interested in taking over the Swiss lender. Here are some other notable premarket movers:
- Stitch Fix (SFIX US) slides 14% in premarket trading as analysts cut their price targets on the online styling platform operator after the company reported earnings that missed estimates and confirmed plans to cut 15% of its salaried workforce.
- Advanced Micro Devices (AMD US) shares rose 1.2% in premarket trading after the chipmaker hosted an analyst event where it outlined long-term financial targets, Xilinx synergies and its plans to take more market share from peers.
- Chinese stocks in US bounce back in premarket trading, a day after the group posted its biggest one-day drop since May. Alibaba (BABA US) rises 3.8% as investors assess whether Beijing’s easing in regulatory crackdown on internet firms supports speculation that Ant’s IPO may be revived.
Investors will be closely watching the US inflation reading. An upside surprise would be a setback for both the Fed and markets, raising doubts about how well rates are working to subdue prices rising at a clip of more than 8%.
Policymakers “are looking for ‘clear and convincing evidence’ that inflation in the US is going to start falling back from its eye-watering level,” Nick Chatters, investment manager at Aegon Asset Management, wrote in a note. “Wishful thinking?”
“In an environment where most major developed market central banks are taking aggressive action to bring inflation down, risk assets are likely to remain volatile and struggle to sustain rallies,” said UBS Global Wealth Management CIO Mark Haefele in a note. “This dynamic should persist until there is clear indication that inflation is trending lower, which may not occur until well into the second half of the year.”
Meanwhile, Bank of America strategists said investors are putting billions of dollars into cash and stock funds as they seek protection from surging inflation, citing EPFR Global data. US equities were the primary beneficiaries of inflows with about $13 billion, while bond fund outflows resumed, the data showed.
While US rates were also rangebound, Euro-area peripheral spreads continued blowing out as the ECB left a wide room for interpretation on what their anti-fragmentation policy might be while they begin to raise rates. 10y BTP/Bund widens ~6bps to 222bps, short end lags. Bund, Treasury and gilt curves all bull flatten while Greek bond yields hit the highest level since early 2019.
The bond turmoil depressed European markets which saw the stoxx 600 slump 1.5% to session lows, with Italy's FTSE MIB underperforming regional peers in a weak session for European equities. Euro Stoxx 50 slumps as much as 1.7%. FTSE 100 outperforms but remains down ~1.3%. Real estate, banks and insurance are the worst performing sectors. Italian stocks underperformed as the country's bonds slid, banks plunged: the FTSE MIB was the worst-performing index among major European countries Friday, with banks dropping the most as Italian bonds slide, following the ECB meeting on Thursday. FTSE MIB -3.5% vs a decline of 1.4% at the Stoxx Europe 600 Index. BPER -11%, BAMI -6.9%, Unicredit -6.7%, Intesa -6.5%.
Here are the biggest European movers:
- Just Eat Takeaway.com shares rise as much as 9.1% after a Bloomberg report that its US unit Grubhub is attracting preliminary interest from private equity firms including Apollo.
- Scandic shares rise as much as 13% after the Swedish hotel group flagged “very strong earnings development” during the second quarter on a “greatly improved” hotel market.
- SAS shares surge as much as 46% after the Danish government reiterated its support for the ailing Scandinavian airline, forgiving and converting its debt and increasing its ownership share.
- Aryzta shares advance as much as 4.2% after Kepler Cheuvreux upgraded the Swiss baker to hold from reduce, citing “credible” new financial targets and improved balance sheet.
- Ericsson shares fall as much as 4.6% after the Swedish telecommunications manufacturer said the US SEC will open an investigation into the company’s handling of a 2019 corruption scandal.
- Shipping stocks drop again, with Maersk down as much as 5.8% and Hapag-Lloyd as much as 7.2% lower, amid ongoing concerns about demand and the normalization of freight rates.
- Swisscom shares slump as much as 4.6% after UBS cut the telecommunication company to a sell recommendation from neutral, citing “a number of headwinds.”
- Credit Suisse shares fall as much as 6% on Friday, extending yesterday’s 5.6% slump after State Street said it is not pursuing any acquisition of the Swiss lender.
- Ageas shares fall as much as 2.5% as ING initiates coverage on the insurer with a hold recommendation, saying that while the potential is there, the “timing is not right.”
Earlier in the session, Asian stocks dropped, giving up gains for the week, as chipmakers slid amid renewed concerns about inflation and Covid lockdowns in Shanghai. The MSCI Asia Pacific Index declined as much as 1.2%, with tech and financials sectors the biggest drags. Most major benchmarks in the region were down, with gauges in Japan, South Korea, Australia, India, the Philippines and Indonesia each falling more than 1%. The region’s semiconductor heavyweights, TSMC and Samsung Electronics, were the largest contributors to the Asian stock benchmark’s decline. China’s tech shares reversed early losses as investors bet the worst of Beijing’s crackdown on the sector may be over even as the nation’s regulator denied a Bloomberg News report that it started early-stage discussions on reviving the initial public offering of Ant Group.
Asian shares also slumped after the European Central Bank opened the door to a half-point interest-rate hike in the fall. In addition, sentiment was fragile as investors monitored virus flare-ups in China. Read: Covid Flares Again in Shanghai, Putting Areas Back in Lockdown “We are seeing a reversal in several developments that had helped markets rebound in the past weeks,” said Heo Pil-Seok, chief executive officer at Midas International Asset Management in Seoul. “With China possibly entering lockdowns again and the ECB moving to raise interest rates, all of these are pouring cold water on markets which believed fear about inflation had eased.” Asia’s equities benchmark is on course for its first weekly loss in four weeks, paring a rebound from a two-year low hit in May
Australian stocks tumbled, with the S&P/ASX 200 index falling 1.3% to 6,932.00, its lowest level since Jan. 27. The gauge notched its biggest weekly loss since April 2020, down 4.2%. Global growth concerns and the RBA’s larger-than-expected rate hike weighed on investor sentiment. All sectors dropped Friday, with real estate and consumer discretionary shares leading declines. In New Zealand, the S&P/NZX 50 index fell 0.7% to 11,136.28.
In FX, the Bloomberg Dollar Spot Index was steady after rising to the highest in three weeks in the previous session. NZD and AUD are the strongest performers in G-10 FX, CAD and GBP underperform. USD/JPY drifts back up toward a 134-handle. Economists see US consumer costs rising 8.3% year-on-year in May when data is released later Friday. Investors are taking profits on dollar-long bets, said Patrick Bennett, strategist at Canadian Imperial Bank of Commerce in Hong Kong. “Dollar gains have dominated recently, there appears to be some squaring into US CPI”.
In rates, the Treasuries curve has extended Thursday’s flattening move ahead of today's CPI print, with 10Y yield trading roughly unchanged from yesterday at 3.04%, and 2s10s, 5s30s near session lows in early US trading following a wider flattening move seen across German curve as markets continue to digest Thursday’s ECB policy announcement. Into front-end Treasuries underperformance, 2- and 3-year yields reach year-to-date highs. US yields are cheaper by up to 3.5bp across front-end of the curve while 7-year out to long-end are richer by up to 2bp with 20- year sector outperforming -- 2s10s, 5s30s spreads flatter by 4.3bp and 2.2bp at ~18bp and ~7bp respectively. IG dollar issuance slate empty so far; Thursday session was quiet and Friday also expected to be subdued with CPI data release. In Europe, the German 2s10s, 5s30s curve are both flatter by over 5bp while bunds outperform Treasuries by ~1.5bp over early European session.
In commodities, oil rose after erasing an earlier loss triggered in part by new restrictions in Shanghai. Chinese President Xi Jinping called on his government to adhere “unwaveringly” to its Covid Zero policy, while at the same time striking a balance with the needs of the economy. WTI rose 0.3% to trade near $121.80. Most base metals trade in the red; LME nickel falls 1.5%, underperforming peers. Spot gold falls roughly $5 to trade near $1,842/oz.
Bitcoin is softer on the session, though only modestly so, and as such remains in recent ranges which continue to pivot USD 30k.
Looking at the day ahead now, economic data slate includes May CPI (8:30am), June University of Michigan sentiment (10am) and May monthly budget statement (2pm). Central bank speakerss include the ECB’s Holzmann and Nagel.
- S&P 500 futures up 0.2% to 4,022.75
- STOXX Europe 600 down 1.3% to 428.90
- MXAP down 0.9% to 166.71
- MXAPJ down 0.8% to 551.64
- Nikkei down 1.5% to 27,824.29
- Topix down 1.3% to 1,943.09
- Hang Seng Index down 0.3% to 21,806.18
- Shanghai Composite up 1.4% to 3,284.83
- Sensex down 1.8% to 54,330.71
- Australia S&P/ASX 200 down 1.3% to 6,931.98
- Kospi down 1.1% to 2,595.87
- Brent Futures little changed at $122.99/bbl
- German 10Y yield little changed at 1.40%
- Euro little changed at $1.0618
- Gold spot down 0.1% to $1,846.06
- U.S. Dollar Index little changed at 103.24
Top Overnight News from Bloomberg
- Shanghai will briefly lock down most of the city this weekend for mass testing as Covid-19 cases continue to emerge, causing more disruption and triggering a renewed run on groceries days after exiting a grueling two-month shutdown.
- Investors are putting billions of dollars into cash and stock funds as they seek protection from surging inflation.
- A selloff in Europe’s weakest bond markets is showing no signs of easing, piling pressure on the European Central Bank to make clearer how it plans to keep diverging borrowing costs contained.
- Public confidence in the Bank of England is at an all-time low, with Britons expecting above-target inflation to persist for years
A more detailed look at global markets courtesy of Newsquawk
APAC stocks were mostly negative after the glum mood rolled over from global counterparts with a hawkish ECB meeting and fresh COVID restrictions in Beijing stoking growth slowdown concerns. ASX 200 was dragged lower by the energy and mining-related sectors after recent declines in underlying commodity prices and with participants taking risk off the table ahead of the extended weekend in Australia. Nikkei 225 retreated beneath the 28k level amid the broad risk aversion and as the domestic currency found some reprieve from its weakening trend. Hang Seng and Shanghai Comp. were both initially subdued after weak earnings and Ant Group’s denial regarding plans to relaunch its mammoth IPO, while participants also digested the mixed inflation data from China and the latest COVID restrictions in Beijing, although the mainland then spent the session recouping lost ground.
Top Asian News
- South Korean Transport Ministry held a meeting with the trucker union leadership on Friday and is holding a working-level meeting with the union, while it added that about 7,500 unionised truck drivers were expected to strike today. It was also reported that striking South Korean truckers halted and turned around non-union truckers from trying to enter the Ulsan petrochemical complex and the movement of containers through South Korea's Ulsan port was totally suspended amid the trucker strike, according to Reuters.
- Beijing City reports 21 (prev. 3) cases during the 15 hours to 3pm on June 10th, according to an official, via Reuters.
- Japan Officials Fire Warning on Forex With Yen Near 1998 Low
- Top Toyota Supplier Denso Mulls $3 Billion Chip Unit Spinoff
- China’s Moderating Inflation Leaves Room for More Easing
- Covid Lab Leak Theory Needs More Inquiry, WHO Advisers Say
The mood across European equities remains downbeat as the region plays catch-up to yesterday’s Wall Street tumble; Euro Stoxx 50 -1.6%. European cash bourses trade lower across the board with the Dutch AEX and UK’s FTSE 100 slightly more cushioned. Sectors in Europe are all lower but largely hold a defensive bias; EZ Periphery banks continue to lag post-ECB while Luxury slips on China/COVID updates. US equity futures trade with modest gains with the ES -0.2% just about holding onto the 4,000 handle. TSMC (2330 TW) - May (TWD): Sales 185.7bln, +65% YY, +7.6% MM. January-May Sales 849.3bln, +44.9% YY.
Tesla (TSLA) CEO Musk says the next FSD beta version will be coming out in two weeks. Amazon (AMZN) is planning to pull out of the USD 7.7bln race for IPL cricket rights, according to Bloomberg.
Top European News
- On the ECB decision, one dovish member said “impression is everybody lost”, described the EGB and EUR downside as “..not what you want”; conversely, a hawk described the meeting as having gone very well. Additionally, re. QT, a dovish member does not believe this will happen any time soon, according to FT.
- UK employers hired staff at the slowest pace since early 2021, according to a survey by REC cited by Reuters which showed the measure declined for a sixth consecutive month to 59.2 from 59.8 M/M but remained in expansion territory above the 50 benchmark level.
- Former UK Brexit Minister Frost has warned that PM Johnson must deliver a "new Conservative vision for Britain" or risk being removed from his position by the autumn, according to the Telegraph.
- DXY recovers from overnight lows of 103.04 heading into the US CPI release.
- Antipodeans stand as the current G10 outperformers with NZD leading the charge, with the AUD/NZD cross subsequently paring back recent ground and falling under 1.1100.
- CAD is under some pressure pre-jobs data; USD/CAD today sees its 100 DMA at 1.2700, 21 DMA at 1.2722, and 50 DMA at 1.2723.
- EUR and GBP are now under pressure as the dollar recovers from early losses.
- The Yen attempts to claw back some ground after the BoJ, MoF, and FSA expressed concern in a joint release.
- BTP-Bund spread continues to widen, out to 234bp thus far, though, offset amid incremental Bund upside via Holzmann.
- Hawk Holzmann took perhaps an incrementally more 'dovish' line than usual re. September's hike increment, alluding to a non-standard increment move.
- USTs are essentially unchanged at 117.30+ pre-CPI though the yield curve continues to flatten in-line with EGBs and after well received long-end issuance.
- WTI and Brent futures are choppy with relatively modest intraday gains following yesterday’s China-induced weakness.
- WTI Jul’ resides just under USD 122/bbl (vs low 120.09/bbl), whilst Brent Aug’ trades around USD 123.50/bbl (vs low 121.60/bbl).
- Kuwait set July KEC crude OSP for Asia at Oman/Dubai +USD 6.15/bbl vs prev. premium of USD 4.35/bbl in June, according to Reuters.
- A minimum of four north-Asian refiners are facing crude oil supply cuts from Saudi in July, according to Reuters sources.
- Peruvian communities said they are ready to end the 51-day shutdown at MMG's (1208 HK) Las Bambas mine and allow the copper mine to restart, while the mine will not begin construction of the Chalcobambas pit during a 30-day truce and the Peru government will lift the state of emergency in the Las Bambas mine area, according to Reuters.
- Metals markets are relatively tentative and uneventful; spot gold trades on either side of its 21 DMA (1,844/oz), while base metals similarly hold a mild downside bias.
US Event Calendar
- 8:30am: US CPI MoM, May, est. 0.7%, prior 0.3%; YoY, May, est. 8.3%, prior 8.3%
- 8:30am: US CPI Ex Food and Energy MoM, May, est. 0.5%, prior 0.6%; YoY, May, est. 5.9%, prior 6.2%
- 2pm: US Monthly Budget Statement, May, est. -$136.5b, prior -$132.0b
DB's Jim Reid concludes the overnight wrap
I'll be another year older on Sunday which is a sobering thought. In addition, yesterday marked 10 years since I proposed to my wife up the top of a mountain. I wasn't 100% sure I was doing the right thing at the time but am certain of it now! She was 100% certain it was the happiest day of her life back then, but now she's not so sure. Anyway, we shall be celebrating both tomorrow night in a rare evening out alone.
It’s been another dramatic 24 hours in markets as the ECB kicked off an incredibly busy week ahead of macro events, including US CPI today, by laying the groundwork for a sustained campaign of rate hikes starting next month. Our European economists' full ECB wrap, and all new updated rates call, is available here.
The immediate headlines of their decision were much as expected, with a confirmation that net asset purchases would conclude at the end of the month, and that their conditions for rates liftoff had been satisfied. But looking forward, not only did they confirm their intent to hike by 25bps in July, they formally opened the door to a 50bps increase at the subsequent meeting in September, saying that the “a larger increment will be appropriate at the September meeting” if the inflation outlook “persists or deteriorates”. It seems by "persists", all that need to happen is for their staff inflation forecast for 2024 to at least remain at 2.1%, the level it got upgraded to yesterday. Core CPI was projected to be at +2.3% that year, a bigger move than expected.
More broadly, the ECB’s statement and President Lagarde’s press conference struck a hawkish tone, and the first paragraph of the statement openly acknowledged the inflation challenge and the need to return it back to target. And when it came to a potential tool to deal with fragmentation in bond markets, Lagarde said that they would “deploy either existing or new instruments that will be made available.”
In light of the decision, our European economists have added to their existing view of a 50bp hike in Q3 and now expect a second 50bp hike in Q4. So their new baseline is for a 25bp move in July, then two consecutive 50bp moves in September and October, and then a 25bp move in December that puts the deposit rate back up to 1% by year-end. The team still thinks the terminal deposit rate will be 2%, reached in the middle of next year, but the path there will be quicker given inflationary pressures and hawkish tone from the ECB.
When it came to the market reaction, investors interpreted the ECB’s decision in a hawkish light, with a fresh selloff in sovereign bonds taking yields up to multi-year highs yet again. Those on 10yr bunds were up by +7.4bps to a post-2014 high of 1.42%, with those on OATs (+10.3bps) and BTPs (+22.2bps) also hitting their highest in years. Meanwhile, the decision also coincided with a serious widening in peripheral spreads, with both the Italian and the Spanish 10yr yield spread over bunds widening to 2-year highs of 216bps and 118bps respectively. That widening in spreads was seen on the credit side too, with iTraxx Crossover up 15.9bps to 471bps, and closing back in on its post-Covid closing high of 488bps.
Importantly, our European economists connected the peripheral spread widening to an apparent lack of progress on anti-fragmentation tools, with President Lagarde apparently leaning on using PEPP flexibility to support implementation in the interim. They believe a tool is inevitable, but will require market stress first so that policymakers can pass off the tool as “proportionate” to make it more legally durable. That proportionality is harder to prove in advance. So this feels like a slow-motion crisis building for Italy but one that will have a solution with limited stress. An odd state of affairs.
Back to markets, and the hawkish rhetoric from the ECB proved similarly bad news for European equities, with the STOXX 600 (-1.36%) losing ground for a third consecutive session. US equities saw an even heftier decline, with the S&P 500 down -2.38%. The Index opened down following the ECB, and slid lower still in the last hour or so of New York trading. Every sector was lower in a broad-based decline, with all but three sectors down by more than 2%.
Alongside the ECB, risk appetite was further dampened by an unexpectedly large jump in the US weekly initial jobless claims, with the number for the week through June 4 coming in at 229k (vs. 206k expected), which is also their highest level since January, as well as the largest week-on-week jump in claims since last July. One week doesn't make a trend but this series has been a bit more volatile of late which will increase its relevance in the weeks ahead.
Given the ECB’s move yesterday, investors in turn reassessed the likelihood that other central banks were set to move in a more hawkish direction. In fact there was a significant milestone yesterday, since Fed funds futures moved to price in their most aggressive profile of rate hikes for 2022 so far, with the implied rate by the December meeting now at 2.92%, which surpasses the previous record of 2.88% in early May. That was seen for other central banks too, with the rate implied by the December meetings for the Bank of England also at its highest to date.
Those moves led to a further rise in bond yields elsewhere, with 10yr US Treasuries up 2.0bps to a one-month high of 3.04%. Real yields led the bulk of the move higher, and the 5yr real yield almost breached positive territory, before ending the day at -0.04%. Meanwhile 10yr gilt yields (+7.6bps) hit a post-2014 high of 2.32%.
Speaking of Treasuries, there’s another focal point today in the form of the US CPI reading for May, which is the last major piece of data the FOMC will get before their next decision on Wednesday. Our US economists expect that the monthly headline print will accelerate again to +0.7% (from +0.3% in April), which will keep the year-on-year measure at +8.3%. That’s because of re-accelerating gas prices along with solid food inflation, and they expect the monthly core reading to fall back to +0.5% (vs. +0.6% expected), which will push the year-on-year rise in core down to +5.8%. Given the FOMC are now in their blackout period ahead we won’t be able to get their reaction, but it’s been 9 months since we last saw the monthly CPI print come in beneath the Bloomberg consensus, and it would now be a massive surprise at this point if the Fed did anything other than a second consecutive 50bps hike next week. So most of the action from this report will come in the form of September onwards Fed pricing. A potential portent of today’s print, yesterday the Atlanta Fed wage growth tracker ticked higher to 6.1% in May, its highest reading since the series began publication back in 1983.
Overnight markets have stabilised a bit with Chinese equities higher after relatively subdued inflation. PPI climbed 6.4% (vs 8% last month), in-line with estimates but the lowest print since March 2021, with CPI up 2.1%, a tenth lower than expectations and in-line with last month. This has seemingly encouraged markets to believe China can continue to ease policy offsetting the news over the last 24 hours that Shanghai is going to lockdown 7 districts at the weekend for mass testing after six community infections were found. The lockdown may only be for the period of testing but the risk is clearly that more cases are found. Chinese equities are around half a percent higher with tech stocks out-performing as regulatory concerns are easing. Elsewhere the Nikkei is catching down with US markets and is around -1.5% lower as we type. US futures are slightly higher and 10yr treasury yields are up another basis point with 2yr yields up a couple.
To the day ahead now, and the highlight will be the aforementioned US CPI reading for May. Other data releases include the University of Michigan’s preliminary consumer sentiment index for June, as well as Italian industrial production for April. Finally, central bank speakers include the ECB’s Holzmann and Nagel.
Where Are Interest Rates Headed? Is The Fed Correct Or The Eurodollar Curve?
Where Are Interest Rates Headed? Is The Fed Correct Or The Eurodollar Curve?
Authored by Mike Shedlock via MishTalk.com,
The Eurodollar curve…
The Eurodollar curve implies four quarter-point cuts are on the way starting in 2023. The Fed believes otherwise. Let's discuss stock market implications.
Data from CME and Fed via Wall Street Journal.
The eurodollar curve has nothing to do with euros or dollars. Rather it is an interest rate curve and one of the world's most widely traded futures.
After peaking at about 3.9% this year, eurodollar betters believe the Fed will then cut rates all the way down to 2.8%.
Five Not-Quite-Impossible Things the Market Believes
Wall Street Journal Contributor James Macintosh discussed the above chart in Five Not-Quite-Impossible Things the Market Believes
Inflation is transitory.
The Fed realizes this in time.
The jobs market cools enough to slow wage rises.
But not so much it means falling household spending.
So consumer spending rises in real terms.
In reference to the led chart, Macintosh says "The first assumption is the hardest to believe."
I disagree. The hardest thing to believe is the overall goldilocks scenario and that the current rally makes any sense at all.
Inflation may easily come down if the Fed tightens too much too fast causing a severe recession. What would that do to corporate profits?
But assume otherwise, that inflation does not come down more. What would that do to corporate profits?
While any of the first three points may easily be correct, the combination of all five being correct and that stocks will rise in a goldilocks scenario is what I find hard to believe.
Is the Market Forward Looking?
Goldilocks proponents will tell you that the market is forward looking.
The market isn't forward looking and never was. It is a coincident indicator of current sentiment, wildly wrong at major turns.
If the market was forward looking, what precisely was it looking forward to at the November 2007 peak with recession starting the next month?
What was it looking forward to at the 1929 peak, the 1933 bottom, the 2009 bottom or any other top or bottom?
The Fed Will Hike Until It Breaks Something
I believe the eurodollar curve is more likely to be correct than the Fed. When has the Fed gotten much of anything correct?
The eurodollar view has two ways to win. The first is the Fed actually does tame inflation to the degree that it wants.
That's possible in a severe enough recession. And the global picture is easily weak enough for that to happen.
The second way the eurodollar curve might be correct is if the Fed breaks the credit market.
The Fed would immediately reverse course, regardless of inflation, should that happen.
Neither a credit event nor strong recession would be good for the stock market.
The least likely thing is that the Fed achieves a goldilocks soft landing. Yet, assume that happens.
Macintosh says, and I agree, "The bull case that stocks and corporate bonds are pricing requires the combination of low joblessness and wage rises to allow spending to rise faster than inflation even after pandemic savings run out. But not so much faster that it hits capacity constraints and accelerates inflation."
The problem with goldilocks is stocks are priced so much beyond perfection that they may decline anyway.
Good luck with goldilocks, especially with the Fed still hiking.
* * *
Futures Tumble After UK Double-Digit Inflation Shock Sparks Surge In Yields
Futures Tumble After UK Double-Digit Inflation Shock Sparks Surge In Yields
Futures were grinding gingerly higher, perhaps celebrating the…
Futures were grinding gingerly higher, perhaps celebrating the end of the Cheney family's presence in Congress, and looked set to re-test Michael Hartnett bearish target of 4,328 on the S&P (which marked the peak of yesterday's meltup before a waterfall slide lower when spoos got to within half a point of the bogey), when algos and the few remaining carbon-based traders got a stark reminder that central banks will keep hammering risk assets after the UK reported a blistering CPI print, which at a double digit 10.1% was not only higher than the highest forecast, but was the highest in 40 years.
The print appeared to shock markets out of their month-long levitating complacency, and yields - both in the UK and the US - spiked...
... and with yields surging, futures had no choice but to notice and after trading at session highs just before the UK CPI print, they have since tumbled more than 40 points and were last down 0.85% or 37 points to 4,271.
Nasdaq 100 futures retreated 0.9% signaling a selloff in technology names will continue. The dollar rose as investors awaited the minutes of the Fed’s last policy meeting for clues on policy makers’ sensitivity to weaker economic data.
In US premarket trading, retail giant Target slumped 4% after reporting earnings that missed expectations despite still predicting a rebound. Applied Materials and PayPal dropped at least 1.3%. Tech stocks are the forefront of the growing pessimism over equity valuations on the back of Fed rate increases. The S&P 500 had posted a small gain on Tuesday, aided by earnings reports from retailers Walmart Inc. and Home Depot. Here are some of the other biggest U.S. movers today:
- Manchester United (MANU US) rises as much as 17% in US premarket trading before trimming most of the gains, after Tesla CEO Elon Musk said he was buying the English football club but later added that he was joking.
- Hill International (HIL US) shares rise 61% in premarket trading hours after it announced Global Infrastructure Solutions will commence an all-cash tender offer for $2.85/share in cash, representing a premium of 63% to the last closing price.
- BioNTech (BNTX US) was initiated with a market perform recommendation at Cowen, which expects demand for Covid-19 vaccines to mirror annual flu trends as the pandemic enters its endemic phase.
- Bed Bath & Beyond (BBBY US) shares surge 20% in premarket trading, putting the stock on track for its sixth day of gains. The home-goods company has helped reinvigorate a wave of meme stock buying
- Agilent (A US) saw its price target boosted at brokers as analysts say the scientific testing equipment maker’s results were strong thanks to growth in biopharma and a recovery in China, while the company’s guidance was on the conservative side. Shares rose .
- Jefferies initiated coverage of Waldencast Plc (WALD US) class A with a buy recommendation as analyst Stephanie Wissink sees 29% upside potential.
- Sea Ltd. (SE US) ADRs slipped as much as 2.1% in US premarket trading, extending Tuesday’s declines, as Morgan Stanley cut its PT on expectations of slowing growth at the Shopee owner’s e-commerce business in the third quarter.
- Weber (WEBR US) downgraded to sell from neutral at Citi, which says there are too many concerns to remain on the sidelines, including a decline in point-of-sale traffic and macro factors like inflation weighing on consumer demand
In the past two months, US stocks rallied on signs of peaking inflation and an earnings-reporting season that saw four out of five companies meeting or beating estimates. Boosted by relentless systematic (CTA) buying and retail-driven short squeezes, as well as a surge in buybacks, stocks recovered more than 50% of the bear market retracement. Yet, continuing rate hikes and the likelihood of a recession in the world’s largest economy are weighing on sentiment. Meanwhile, concern is growing that Fed rate setters will remain focused on the fight against inflation rather than supporting growth.
“We expect the FOMC minutes to have a hawkish tilt,” Carol Kong, strategist at Commonwealth Bank of Australia Ltd., wrote in a note. “We would not be surprised if the minutes show the FOMC considered a 100 basis-point increase in July.”
In Europe, the Stoxx 600 fell after a strong start amid signs the continent’s energy crisis is worsening. Benchmark natural-gas futures jumped as much as 5.1% on expectations the hot weather will boost demand for cooling. In the UK, consumer-price growth jumped to 10.1%, sending gilts tumbling. Real estate, retailers and miners are the worst performing sectors. The Stoxx 600 Real Estate Index declined 2%, making it the worst-performing sector in the wider European market, as focus turned to UK inflation that soared to double digits for the first time in four decades and also to today's FOMC minutes. German and Swedish names almost exclusively account for the 10 biggest decliners. TAG Immobilien drops 5.4%, Wallenstam is down 4.7%, Castellum falls 4% and LEG Immobilien declines 3.3%. The sector tumbles on rising bond yields, with 10y Bund yield up 11bps, and dwindling demand for Swedish real estate amid rising rates.
Earlier on Wednesday, stocks rose in Asia amid speculation that China may deploy more stimulus to shore up its ailing economy while Japanese exporters were boosted by a weaker yen. After a string of weak data driven by a property-sector slump and Covid curbs, China’s Premier Li Keqiang asked local officials from six key provinces that account for 40% of the economy to bolster pro-growth measures. The MSCI Asia Pacific Index advanced as much as 0.8%, with consumer-discretionary and industrial stocks such as Japanese automakers Toyota and Honda among the leaders on Wednesday. The benchmark Topix erased its year-to-date loss. Chinese food-delivery platform Meituan also rebounded after dropping more than 9% in the previous session on a Reuters report that Tencent may divest its stake in the firm. Chinese stocks erased declines early in the day, as investors hoped for more economic stimulus after a surprise rate cut on Monday failed to excite the market. Premier Li Keqiang has asked local officials from six key provinces that account for about 40% of the country’s economy to bolster pro-growth measures.
“I believe policymakers have the tools to prevent a hard landing if needed,” Kristina Hooper, chief global market strategist at Invesco, said in a note. “I find investors are overly pessimistic about Chinese stocks -- which means there is the potential for positive surprise.” Asia’s stock benchmark is trading at mid-June levels as traders attempt to determine the trajectory of interest-rate hikes and economic growth globally -- as well as the impact of China’s property crisis and Covid policies. Meanwhile, minutes of the US Federal Reserve’s July policy meeting, out later Wednesday, will be carefully parsed. New Zealand stocks closed little changed as the country’s central bank raised interest rates by a half percentage point for a fourth-straight meeting. Australia's S&P/ASX 200 index rose 0.3% to close at 7,127.70, supported by materials and consumer discretionary stocks. South Korea’s benchmark missed out on the rally across Asian equities, as losses by large-cap exporters weighed on the measure
In FX, the Bloomberg Dollar Spot Index rose as the dollar gained versus most of its Group-of-10 peers. The pound was the best G-10 performer while gilts slumped, led by the short end and sending 2-year yields to their highest level since 2008, after UK inflation accelerated more than expected in July. The yield curve inverted the most since the financial crisis as traders ratcheted up bets on BOE rate hikes in money markets, wagering on 200 more basis points of hikes by May. The euro traded in a narrow range against the dollar while the region’s bonds slumped, led by the front end. Scandinavian currencies recovered some early European session losses while the aussie, kiwi and yen extended their slide in thin trading. EUR/NOK one-day volatility touched a 15.12% high before paring ahead of Norges Bank’s meeting Thursday where it may have to raise rates by a bigger margin than indicated in June given Norway’s inflation exceeded forecasts for a fourth straight month, hitting a new 34-year high. Consumer sentiment in Norway fell to the lowest level since data began in 1992, according to Finance Norway. New Zealand’s dollar and bond yields both rose in response to the Reserve Bank hiking rates by 50bps, while flagging concern about labor market pressures and consequent wage inflation; the currency subsequently gave up gains in early European trading. The Aussie slumped after data showing the nation’s wages advanced at less than half the pace of inflation in the three months through June, backing the Reserve Bank’s move to give itself more flexibility on interest rates.
In rates, treasuries held losses incurred during European morning as gilt yields climbed after UK inflation rose more than forecast. US 10-year around 2.87% is 6.5bp cheaper on the day vs ~13bp for UK 10-year; UK curve aggressively bear-flattened following inflation data, with long-end yields rising about 10bp. Front-end UK yields remain cheaper by ~20bp, off session highs, leading a global government bond selloff. US yields are higher on the day by by 4bp-7bp; focal points of US session are 20-year bond auction and FOMC minutes release an hour later. Treasury auctions resume with $15b 20-year bond sale at 1pm ET; WI 20-year yield at around 3.35% is ~7bp richer than July’s sale, which stopped 2.7bp through the WI level.
In commodities, oil fluctuated between gains and losses, and was in sight of a more than six-month low -- reflecting lingering worries about a tough economic outlook amid high inflation and tightening monetary policy. Spot gold is little changed at $1,774/oz
Looking at the day ahead, the FOMC minutes from July will be the main highlight, and the other central bank speaker will be Fed Governor Bowman. Otherwise, earnings releases include Target, Lowe’s and Cisco Systems, and data releases include US retail sales and UK CPI for July.
- S&P 500 futures down 0.3% to 4,293.00
- STOXX Europe 600 little changed at 443.30
- MXAP up 0.5% to 163.48
- MXAPJ up 0.2% to 530.38
- Nikkei up 1.2% to 29,222.77
- Topix up 1.3% to 2,006.99
- Hang Seng Index up 0.5% to 19,922.45
- Shanghai Composite up 0.4% to 3,292.53
- Sensex up 0.5% to 60,168.83
- Australia S&P/ASX 200 up 0.3% to 7,127.68
- Kospi down 0.7% to 2,516.47
- German 10Y yield little changed at 1.06%
- Euro little changed at $1.0178
- Gold spot down 0.0% to $1,775.21
- U.S. Dollar Index little changed at 106.50
Top Overnight News from Bloomberg
- More market prognosticators are alighting on the idea of benchmark Treasury yields sliding to 2% if the US succumbs to a recession. That’s an out-of-consensus call, compared with Bloomberg estimates of about a 3% level by the end of this year and similar levels through 2023. But it’s a sign of how growth worries are forcing a rethink in some quarters
- The euro-area economy grew slightly less than initially estimated in the second quarter as signs continue to emerge that momentum is unraveling. Output rose 0.6% from the previous three months between April and June, compared with a preliminary reading of 0.7%, Eurostat said Wednesday
- Egypt became a prime destination for hot money by tethering its currency and boasting the world’s highest interest rates when adjusted for inflation
- Norway’s $1.3 trillion sovereign wealth fund, the world’s largest, posted its biggest loss since the pandemic as rate hikes, surging inflation and Russia’s invasion of Ukraine spurred volatility. It lost an equivalent of $174 billion in the six months through June, or 14.4%
A more detailed look at global markets courtesy of Newsquawk
Asia-Pac stocks just about shrugged off the choppy lead from the US where markets were tentative amid mixed data signals and strong retailer earnings, but with gains capped overnight ahead of the FOMC Minutes and as participants digested another 50bps rate hike by the RBNZ. ASX 200 swung between gains and losses with the index indecisive amid a slew of earnings and with strength in the consumer sectors offset by underperformance in tech, energy and healthcare. Nikkei 225 climbed above the 29,000 level with the index unfazed by mixed data releases in which Machinery Orders disappointed although both Exports and Imports topped forecasts. Hang Seng and Shanghai Comp were somewhat varied with Hong Kong led higher by tech amid plenty of attention on Meituan after reports its largest shareholder Tencent could reduce all or the bulk of its shares in the Co. which a Tencent executive later refuted, while the mainland was less decisive amid headwinds from the ongoing COVID situation and with power restrictions disrupting activity in Sichuan, although reports also noted that Chinese Premier Li told top provincial officials that they must have a sense of urgency to consolidate the economic recovery and reiterated to step up macro policies.
Top Asian News
- RBNZ hiked the OCR by 50bps to 3.00%, as expected, while it stated that conditions need to continue to tighten and they agreed that maintaining the current pace of tightening remains the best means. RBNZ also agreed that further increases in the OCR were required to meet the remit objective and that domestic inflationary pressures had increased since May. Furthermore, the RBNZ raised its projections for the OCR and inflation with the OCR seen at 3.69% in Dec. 2022 (prev. 3.41%) and at 4.1% for both Sept. 2023 and Dec. 2023 (prev. 3.95%), while it sees annual CPI at 4.1% by Sept. 2023 (prev. 3.0%).
- RBNZ Governor Orr stated at the press conference that they are not forecasting a recession but expected below-potential growth amid subdued consumer spending. Governor Orr also stated that they did not discuss a 75bps rate hike today and that 50bps moves have been orderly and sufficient, while he added that getting rates to 4% would buy comfort for the policy committee and that a Cash Rate of around 4% is unambiguously above neutral and sufficient to meet the inflation mandate.
- Chongqing, China is to curb power use for eight days for industry.
- China’s Infrastructure Boom Gets Swamped by Property Woes
- Tencent 2Q Revenue Misses Estimates
- Hong Kong Denies Democracy Advocates Security Law Jury Trial
- UN Expert Says Xinjiang Forced Labor Claims ‘Reasonable’
- Singapore’s COE Category B Bidding Hits New Record
- Delayed Deals Add to Floundering Singapore IPO Market: ECM Watch
European bourses have dipped from initial mixed/flat performance and are modestly into negative territory, Euro Stoxx 50 -0.5%. Stateside, futures are under similar pressure awaiting fresh corporate updates and the July FOMC Minutes, ES -0.6%. Fresh drivers relatively limited throughout the session with known themes in play and focus on upcoming risk events; stocks also suffering on further hawkish yield action. Lowe's Companies Inc (LOW) Q1 2023 (USD): EPS 4.68 (exp. 4.58), Revenue 27.47 (exp. 28.12bln); expect FY22 total & comp. sales at bottom-end of outlook range, Operating Income and Diluted EPS at top-end. Target Corp (TGT) Q1 2023 (USD): EPS 0.39 (exp. 0.72), Revenue 26.0bln (exp. 26.04bln); current trends support prior guidance.
Top European News
- German Gas to Last Less Than 3 Months if Russia Cuts Supply
- European Gas Surges Again as Higher Demand Compounds Supply Pain
- Entain Falls; Citi Views Fine Negatively but Notes Steps by Firm
- UK Inflation Hits Double Digits for the First Time in 40 Years
- Crypto.com Receives Registration as UK Cryptoasset Provider
- Greenback underpinned ahead of US retail sales data and FOMC minutes, DXY holds tight around 106.500.
- Pound pegged back after spike in wake of stronger than expected UK inflation metrics, Cable hovers circa 1.2100 after fade into 1.2150.
- Kiwi retreats following knee jerk rise on the back of hawkish RBNZ hike, NZD/USD near 0.6300 from 0.6380+ overnight peak.
- Aussie undermined by marginally softer than anticipated wage prices and lower RBA tightening bets in response, AUD/USD well under 0.7000 vs 0.7026 at one stage.
- Yen weaker as yield differentials widen again, but Euro cushioned by more pronounced EGB reversal vs USTs, USD/JPY probes 21 DMA just below 135.00, EUR/USD bounces from around 1.0150 towards 1.0200.
- Loonie and Nokkie soft amidst latest slippage in oil, USD/CAD closer to 1.2900 than 1.2800, EUR/NOK nudging 9.8600 within 9.8215-9.8740 range.
- Debt retracement ongoing and gathering pace ahead of Wednesday's key risk events.
- Bunds now closer to 154.00 than 156.00 and 157.00 only yesterday, Gilts not far from 114.50 vs almost 116.00 and 117.00+ earlier this week and T-note sub-119-00 vs 119-31 at best on Monday.
- Sonia strip hit hardest as markets price in aggressive BoE hikes in response to UK inflation data toppy already elevated expectations.
- Crude benchmarks are currently little changed overall, having recovered from a bout of initial pressure; newsflow thin awaiting fresh JCPOA developments
- Spot gold is little changed overall but with a slight negative bias as the USD remains resilient and outpaces the yellow metal as the haven of choice.
- Aluminium is the clear outperformer amid updates from Norsk Hydro that they are shutting production at their Slovalco site (175k/T year) by end-September, due to elevated energy prices.
- OPEC Sec Gen says he sees a likelihood of an oil-supply squeeze this year, open for dialogue with the US. Still bullish on oil demand for 2022. Too soon to call the outcome of the September 5th gathering. Spare capacity at around the 2-3mln BPD mark, "running on thin ice".
- US Private Inventory Data (bbls): Crude -0.4mln (exp. -0.3mln), Cushing +0.3mln, Gasoline -4.5mln (exp. -1.1mln), Distillates -0.8mln (exp. +0.4mln).
- Shell (SHEL LN) announced it is to shut its Gulf of Mexico Odyssey and Delta crude pipelines for two weeks in September for maintenance, according to Reuters.
- Uniper (UN01 GY) says the energy supply situation in Europe is far from easing and gas supply in winter remains "extremely challenging".
- China sets the second batch of the 2022 rare earth mining output quota at 109.2k/T, via Industry Ministry; smelting/separation quota 104.8k/T.
- China's military is to partake in a military exercise in Russia, their participation has nothing to do with the international situation.
- Taiwan's Defence Ministry says they have detected 21 Chinese aircraft and five ships around Taiwan on Wednesday, via Reuters.
- Iran is calling on the US to free jailed Iranian's, says they are prepared for prisoner swaps, via Fars.
US Event Calendar
- 07:00: Aug. MBA Mortgage Applications, prior 0.2%
- 08:30: July Retail Sales Advance MoM, est. 0.1%, prior 1.0%
- 08:30: July Retail Sales Ex Auto MoM, est. -0.1%, prior 1.0%
- 08:30: July Retail Sales Control Group, est. 0.6%, prior 0.8%
- 10:00: June Business Inventories, est. 1.4%, prior 1.4%
- 14:00: July FOMC Meeting Minutes
DB's Tim Wessel concludes the overnight wrap
Starting in Europe, where the looming energy crisis remains at the forefront. An update from our team, who just published the fourth edition of their indispensable gas monitor (link here), where they note the surprisingly fast rebuild of German gas storage, driven by reductions in industrial activity, reduces the risk that rationing may become reality this winter. Many more insights within, so do read the full piece for analysis spanning scenarios. Keep in mind, that while gas may be available, it is set to come at a higher clearing price, which manifest itself in markets yesterday where European natural gas futures rose a further +2.64% to €226 per megawatt-hour, just shy of their closing record at €227 in March. But, that’s still well beneath their intraday high from March, where at one point they traded at €345. Further, one-year German power futures increased +6.30%, breaching €500 for the first time, closing at €507. Germany is weighing consumer relief measures in light of climbing consumer prices and also announced that planned nuclear facility closures would be “temporarily” postponed.
The upward energy price pressure and attenuated (albeit, not eliminated) risk of rationing pushed European sovereign yields higher. 10yr German bunds climbed +7.1bps to 0.97%, while 10yr OATs kept the pace, increasing +7.4bps. 10yr BTPs increased +15.9bps, widening sovereign spreads, while high yield crossover spreads widened +10.2bps in the credit space.
Equities were resilient, however, with the STOXX 600 posting a +0.16% gain after flitting around a narrow range all day. Regional indices were also robust to climbing energy prices, with the DAX up +0.68% and the CAC +0.34% higher. In the States the S&P 500 registered a modest +0.19% gain, with the NASDAQ mirroring the index, falling -0.19%. Retail shares drove the S&P on the day, with the two consumer sectors both gaining more than +1%, following strong earnings reports from Wal Mart and Home Depot.
Treasury yields also climbed, but the story was the further flattening in the curve. 2yr yields were +7.5bps higher while 10yr yields managed to increase just +1.6bps, leaving 2s10s at its second most negative close of the cycle at -46bps. 10yr yields are another basis point higher this morning. A hodgepodge of data painted a mixed picture. Housing permits beat expectations (+1674k vs. +1640k) while starts (+1446k vs. +1527k) fell to their slowest pace since February 2021. However, under the hood, even permits weren’t necessarily as strong as first glance, as single family permits fell -4.3% with gains in multifamily pushing the aggregate higher. Indeed, year-over-year, single family permits have now fallen -11.7% while multifamily permits are +23.5% higher. So the single family housing market continues to feel the impact of Fed tightening. Meanwhile, industrial production climbed +0.6% month-over-month (vs. +0.3%), with capacity utilization hitting its highest level since 2008 at 80.3%.
Drifting north of the border, Canadian inflation slowed to 7.6% YoY in July in line with estimates, while the average of core measures climbed to a record 5.3%. Bank of Canada Governor Macklem penned an opinion piece saying that while it looks like inflation may have peaked, “the bad news is that inflation will likely remain too high for some time.” In turn, Canadian OIS rates by December climbed +16.2bps.
In other data, the expectations component of the German ZEW survey fell to -55.3, its lowest level since October 2008 at the depths of the GFC. In the UK, regular pay (excluding bonuses) fell by -3.0% in real terms over the year to April-June 2022, its fastest decline on record.
On the Iranian nuclear deal, EU negotiators reportedly found Iran’s response constructive, though Iran still had some concerns. Notably, Iran is looking for guarantees that if a future US administration withdraws from the JCPOA the US will "have to pay a price”, seeking insulation from the vagaries of representative democracy.
Asian equity markets are trading higher after Wall Street’s solid performance overnight. The Nikkei (+0.76%) is leading gains across the region with the Hang Seng (+0.57%), the Shanghai Composite (+0.23%) and the CSI (+0.51%) all rebounding from its opening losses this morning. US futures are struggling to gain traction this morning with the S&P 500 (-0.02%) and NASDAQ 100 (-0.09%) trading just below flat.
The Reserve Bank of New Zealand lifted its official cash rate (OCR) for the fourth consecutive time by an expected +50bps to 3%, a seven-year high, while bringing forward the estimate of future rate increases. The central bank expects the OCR will reach 3.69% at the end of this year and expects it to peak at 4.1% in March 2023, higher and sooner than previously forecast.
Early morning data coming out from Japan showed that exports rose +19.0% y/y in July (v/s +17.6% expected) posting 17 straight months of gains while imports advanced +47.2% (v/s +45.5% expected) driven by global fuel inflation and a weakening yen. With the imports outweighing exports, the nation reported trade deficit for the 14th consecutive month, swelling to -2.13 trillion yen in July (v/s -1.91 trillion yen expected) compared to a revised deficit of -1.95 trillion yen in June.
In terms of the day ahead, the FOMC minutes from July will be the main highlight, and the other central bank speaker will be Fed Governor Bowman. Otherwise, earnings releases include Target, Lowe’s and Cisco Systems, and data releases include US retail sales and UK CPI for July.
S&P 3500 By Year End If QT Continues
"Don’t Fight the Fed" echoes through the financial media, Wall Street, and in the minds of retail and institutional investors. The phrasing pertaining…
“Don’t Fight the Fed” echoes through the financial media, Wall Street, and in the minds of retail and institutional investors. The phrasing pertaining to Fed-generated liquidity is often the sole basis for investors to chase bull markets when the Fed employs easy monetary policy. Unfortunately, some investors forget the phrase is equally meaningful when the Fed is not friendly to markets. As we share in this article, we have developed a model to track Fed liquidity, allowing us to quantify the Fed’s influence on the S&P 500.
Before unveiling our liquidity formula and its forecast for the S&P 500, it’s essential to discuss the three primary drivers by which the Fed is influencing liquidity: Reverse Repurchase (RRP), Treasury General Account (TGA), and the Fed’s balance sheet.
Reverse Repurchase Agreements (RRP)
The New York Fed uses numerous repo programs to manage the supply of cash in the banking system, thereby maintaining the Fed Funds rates within the FOMC’s target range. Currently, they are employing its RRP program to accomplish this task. In an RRP transaction, the Fed sells securities to a counterparty and simultaneously agrees to repurchase them at a future date. The duration is often overnight. The transaction temporarily reduces the supply of money from the banking system. Increasing daily RRP balances results in less system liquidity, and a declining balance reduces liquidity.
As shown below, RRP has been around for 20 years but was scarcely used until early 2021. The various pandemic-related rounds of fiscal stimulus and massive Fed liquidity efforts left banks and money market funds with excessive levels of cash. The excess liquidity would have pushed the Fed Funds rate lower than the target rate without the RRP program. As such, RRP sucks up liquidity, making Fed Funds easier for the Fed to manage.
The Fed has other repo tools, such as repurchase agreements and the standing repo facility, which can dampen money market rates by providing the banking system with liquidity.
The RRP facility has been increasing rapidly and now sits at over $2 trillion daily. Rising RRP balances are a drain on liquidity.
As money market yields rise with Fed Funds and asset markets perform poorly, investors tend to prefer higher cash balances. Such should keep RRP levels elevated for the time being.
Treasury General Account (TGA)
The Treasury General Account is the U.S. Treasury Department’s checking account. The account is held at the Federal Reserve Bank of New York. Like your checking account, the TGA receives deposits (tax receipts and proceeds from debt issuance) and makes payments.
The Fed doesn’t manage the TGA balances, but the surplus cash balance held at the Fed affects banking system liquidity. Fed liabilities (bank reserves) must equal its assets. Bank reserves are fodder allowing banks to make loans and, by default, print money. When the TGA account increases, bank reserves must fall, reducing banking system liquidity. Conversely, a shrinking TGA account adds reserves and liquidity to the banking system.
The graph below shows that TGA balances are elevated versus the pre-pandemic years but have fallen as the banking system normalizes from the massive fiscal cash injections. It will likely drop a bit more, but the TGA will not significantly impact liquidity, barring unusual circumstances.
Fed Balance Sheet
The Fed’s assets, mainly Treasury bonds and Mortgage-Backed Securities (MBS), are the liquidity elephant in the room. Its assets currently account for 75% of total Fed-sponsored liquidity and historically average over 90%.
When the Fed does Quantitative Easing (QE), they remove securities from the bond markets and, in their place, leaves reserves with the banks. Again, bank reserves can lead to loan creation which is the creation of new money. Ergo, QE adds to the system’s liquidity. Conversely, Quantitative Tightening (QT) removes liquidity and reserves from the system and increases the amount of securities in the market.
For this reason, QE tends to be bullish for stocks, and QT is bearish.
Liquidity and Stock Prices
With an understanding of the three key factors driving banking system liquidity, we can create a Fed liquidity model. The size of the Fed’s assets less the sum of the TGA and RRP equals the amount of Fed-generated liquidity in the system. Recent changes in net liquidity shed light on how the S&P 500 trends.
The two graphs below compare the liquidity measure and the S&P 500. The first graph shows how the S&P 500 rose in line with liquidity through 2021, and both reversed simultaneously to start 2022. The dotted lines are quarterly moving averages to help smooth out the data. The moving averages track each other almost perfectly this year. The green dashed line forecasts liquidity based solely on the Fed’s plan to reduce its balance sheet by $95 billion a month. The S&P 500 could be close to 3500 by year-end if they follow through with their QT plans and the correlation holds up.
The second graph shares the same data but in scatter plot form. The correlation between liquidity and the S&P 500 is statistically significant, with an R-squared of 0.57. The orange dot shows the S&P 500 is about 3% overpriced based on liquidity.
The model does have an important caveat. Other factors become the predominant driver of market returns when the Fed is inactive and liquidity is relatively stable.
The Fed is not the only game in town, but they are the biggest game in town. While many other factors account for stock price performance, liquidity may be the most important to grasp.
To drive home this point, recall March 2020, when covid struck the economy. Global economies were shutting down worldwide. Unemployment was soaring, and the economy was careening toward a depression. Despite zero clarity on the economic future, stocks began to rally strongly in late March. Why? Liquidity via fiscal stimulus and a surge in Fed QE purchases drove markets higher. The economic situation was awful, and earnings outlooks were crumbling, but liquidity trumped fundamentals.
By accepting what the Fed does, right or wrong, and closely following its actions, we can quantify how liquidity will steer markets. On top of fundamental and technical analysis, this additional layer of research helps us better navigate the market’s twists, turns, and trends when the Fed is active.depression unemployment default pandemic stimulus treasury bonds bonds sp 500 stocks monetary policy fomc qe fed federal reserve unemployment stimulus
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