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Futures Flat Ahead Of Another Scorching PPI Print

Futures Flat Ahead Of Another Scorching PPI Print

US futures were little changed on Thursday one day after the highest CPI print since 1982 and just minutes before another red hot PPI print is expected (9.8%, up from 9.6%), as investors tried

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Futures Flat Ahead Of Another Scorching PPI Print

US futures were little changed on Thursday one day after the highest CPI print since 1982 and just minutes before another red hot PPI print is expected (9.8%, up from 9.6%), as investors tried to gauge the timing and pace of monetary tightening. S&P 500, Dow and Nasdaq 100 futures were up 0.1% as investors waited for the next trading signal. 10Y yields were flat around 1.74%, and the dollar edged lower as a growing tide of investors bet the world’s reserve currency has reached a peak with rate hikes largely priced-in to the market with Fed tightening likely to lead to an economic slowdown.

“Markets in 2022 have been volatile as the reality of inflation set in, and this reaction mainly reflects relief that the print did not exceed already lofty expectations,” Geir Lode, head of global equities at the international business of Federated Hermes, said in an email.

Inflation hitting 7% could force a quicker move by the Federal Reserve, with the market now pricing four rate hikes this year starting no later than March, according to technical analyst Pierre Veyret at ActivTrades in London. “Investors still struggle with one crucial question: how will the Fed manage to tackle rising price pressure without derailing the fragile post-pandemic economic recovery?”

Sure enough, San Francisco Fed President Mary Daly and her Philadelphia peer Patrick Harker added their voices to the chorus in interviews published yesterday evening and this morning, calling for a rate hike as soon as March when odds of a rate hike have hit a new high of 90%. Attention today will be on the confirmation hearing of Lael Brainard in the Senate. The vice-chair nominee, who last publicly commented on the economic outlook in September, said in prepared remarks that tackling inflation is the bank’s “most important task.”

In premarket trading, shares in Delta Air Lines rose more than 2% even though the carrier missed revenue and EPS expectations, after the company said the omicron variant won’t derail its expectation to remain profitable for the rest of the year, as it released fourth-quarter financial results. Here are some of the biggest U.S. movers today:

  • U.S. chip stocks are mixed in premarket trading after sector bellwether TSMC gave a 1Q sales outlook that beat estimates and raised its projected annual capex versus last year. Equipment stock Applied Materials (AMAT US) +2% premarket, while TSMC customers are mixed with Apple (AAPL US) -0.1%, Nvidia (NVDA US) +0.7% and AMD (AMD US) +0.6%.
  • Puma Biotechnology (PBYI US) shares surge 13% in U.S. premarket trading, after the company said that its Nerlynx treatment was included in the National Comprehensive Cancer Network’s (NCCN) clinical practice guidelines in oncology for the treatment of breast cancer.
  • KB Home (KBH US) shares rise 6.2% in premarket trading after the homebuilder’s 4Q EPS beat estimates, with Wells Fargo calling the results and guidance “solid.”
  • Planet Labs (PL US) shares rise 1.6% in U.S. premarket trading, after the satellite data provider said that it plans to launch 44 SuperDove satellites on Thursday on SpaceX’s Falcon 9 rocket.
  • Adagio Therapeutics (ADGI US) said ADG20 has neutralization activity against omicron and cites recent findings from three publications on ADG20. Shares jumped 30% in post-market trading.

Discussing yesterday's scorching CPI print, DB's Jim Reid writes that "if you did an MRI scan of US inflation yesterday you’d find things to support both sides of the debate which is surprising when it hit 7% YoY and the highest since 1982 when Fed Funds were more than 13% rather than close to zero as they are today. So a slightly different real rate to back then. In fact the real rate is through any level seen in the 1970s and is only comparable to WWII levels. Back to CPI and the YoY number was in line with expectations, but core and MoM figures were all a bit firmer than expected. However, the beats were small enough that the data didn’t significantly change the outlook for monetary policy, with Fed funds futures still pricing in an 89% chance of a March hike, which is roughly around where it’d been over the preceding days."

In Europe, the Stoxx Europe 600 Index paused after a two-day advance, erasing early declines of as much as 0.3% to trade little changed, with technology and automotive shares offsetting losses in consumer products and health care. CAC 40 underperforms, dropping as much as 0.6%. The Stoxx Europe 600 Technology sub-index is up 1.1%, getting a boost from chip stocks which gained after sector bellwether TSMC gave a 1Q sales outlook that beat estimates and raised its projected annual capex versus last year. Geberit dropped as much as 4.5% to a seven-month low after the Swiss producer of sanitary installations reported fourth-quarter sales.

Bloomberg Dollar Spot dips into the red pushing most majors to best levels of the session. NZD, AUD and GBP are the best G-10 performers. Crude futures maintain a relatively narrow range. WTI is flat near $82.70, Brent stalls near $84.84. Spot gold dips before finding support near $1,820/oz. Most base metals are in the red with LME zinc lagging peers. 

Asian stocks were little changed after capping their biggest rally in a year, with health-care and software-technology names retreating while financials advanced. The MSCI Asia Pacific Index fluctuated between a drop of 0.3% and a gain of 0.2% on Thursday. Hong Kong’s Hang Seng Tech Index lost 1.8% after rising the most in three months in the previous session. Benchmarks in China and Japan were the day’s worst performers, while the Philippines and Australia outperformed.   “The market rose a bit too much yesterday,” said Mamoru Shimode, chief strategist at Resona Asset Management in Tokyo. “Investors keep shifting back and forth from value stocks to growth names and vise versa. It’s because we don’t know yet where U.S. long-term yields will end up settling around.”  The Asian stock measure jumped 1.9% Wednesday on views that the Federal Reserve’s anticipated rate hikes will help curb inflation and allow the global recovery to chug along. U.S. inflation readings overnight, at an almost four-decade high, were in line with expectations and helped investors keep previous bets

Japanese stocks fell after Tokyo raised its Covid-19 alert to the second-highest level on a four-tier system. The Topix dropped 0.7% to 2,005.58 at the 3 p.m. close in Tokyo, while the Nikkei 225 declined 1% to 28,489.13. Recruit Holdings Co. contributed the most to the Topix’s decline, decreasing 4%. Out of 2,181 shares in the index, 500 rose and 1,604 fell, while 77 were unchanged. HIS, Japan Airlines and other travel shares fell. Tokyo’s daily cases jumped more than fivefold on Wednesday to 2,198 compared with 390 a week earlier.

India’s benchmark equity index eeked out gains to complete its longest string of advances since mid-October, buoyed by the nation’s top two IT firms after their earnings reports. The S&P BSE Sensex rose for a fifth day, adding 0.1% to close at 61,235.30 in Mumbai, while the NSE Nifty 50 Index climbed 0.3%. Infosys and Tata Consultancy Services were among the biggest boosts to both measures. Of the 30 shares in the Sensex index, 19 rose and 11 fell. Thirteen of the 19 sector sub-indexes compiled by BSE Ltd. advanced, led by a gauge of metal companies.  Infosys’ quarterly earnings beat and bellwether Tata Consultancy Services’s better-than-expected sales offer some hope that the rally in India’s technology sector has further room to run, according to analysts. Still, Wipro sank the most in a year after its profit missed estimates

Fixed income is relatively quiet, with changes across major curves limited to less than a basis point so far. The 10-year yield stalled around 1.75%, slightly cheaper on the day, and broadly in line with bunds and gilts. Eurodollar futures bear steepen a touch after a round of hawkish Fedspeak during Asian hours. Treasuries were steady with yields broadly within a basis point of Wednesday’s close.  Eurodollars are slightly lower across green- and blue-pack contracts after Fed’s Daly and Harker sounded hawkish tones during Asia hours. Across front-end, eurodollar strip steepens out to blue-pack contracts (Mar25-Dec25), which are lower by up to 4bp. 30-year bond reopening at 1pm ET concludes this week’s coupon auction cycle.$22b 30-year reopening at 1pm ET follows 0.3bp tail in Wednesday’s 10-year auction, and large tails in last two 30-year sales. The WI 30-year yield at ~2.095% is above auction stops since June and ~20bp cheaper than last month’s, which tailed the WI by 3.2bp.

In FX, the pound advanced to its highest level since Oct. 29 amid calls for U.K. Prime Minister Boris Johnson to resign over a “bring your own bottle” party at the height of a lockdown meant to stem the first wave of coronavirus infections in 2020. The Bloomberg Dollar Spot Index held a two-month low as the greenback weakened against all of its Group-of-10 peers, and the euro rallied a third day as it approached the $1.15 handle. Implied volatility in the major currencies over the two- week tenor, that now captures the next Fed meeting, comes in line with the roll yet investors are choosing sides. The Australian dollar extended its overnight gain as the greenback declined following as-expected U.S. inflation. Iron ore supply concern also supported the currency. The yen hovered near a two-week high as long dollar positions were unwound. Japanese government bonds traded in narrow ranges.

In commodities, cude futures maintain a relatively narrow range. WTI is flat near $82.70, Brent stalls near $84.50. Spot gold dips before finding support near $1,820/oz. Most base metals are in the red with LME zinc lagging peers. Bitcoin traded around $44,000 as the inflation numbers rekindled the debate about whether the cryptocurrency is a hedge against rising consumer prices.

Expected data on Thursday include producer prices, an early indicator of inflationary trends, and unemployment claims.

Market Snapshot

  • S&P 500 futures little changed at 4,715.50
  • STOXX Europe 600 down 0.1% to 485.67
  • MXAP little changed at 196.79
  • MXAPJ up 0.1% to 643.93
  • Nikkei down 1.0% to 28,489.13
  • Topix down 0.7% to 2,005.58
  • Hang Seng Index up 0.1% to 24,429.77
  • Shanghai Composite down 1.2% to 3,555.26
  • Sensex up 0.1% to 61,220.38
  • Australia S&P/ASX 200 up 0.5% to 7,474.36
  • Kospi down 0.3% to 2,962.09
  • German 10Y yield little changed at -0.04%
  • Euro up 0.2% to $1.1465
  • Brent Futures down 0.1% to $84.58/bbl
  • Gold spot down 0.3% to $1,820.68
  • U.S. Dollar Index little changed at 94.83

Top Overnight News from Bloomberg

  • Federal Reserve Bank of San Francisco President Mary Daly and her Philadelphia Fed peer Patrick Harker joined the ranks of officials publicly discussing an interest-rate increase as early as March as the central bank seeks to combat the hottest inflation in a generation
  • Global central banks will diverge on the way they respond to inflation this year, creating risks to economies everywhere, Bank of England policy maker Catherine Mann said
  • Norway’s race to appoint a new central bank governor is reaching a finale mired in controversy at the prospect of a political ally and friend of Prime Minister Jonas Gahr Store getting the job
  • Italy’s government is working on a spending package that won’t require revising its budget to expand the deficit, people familiar with the matter said
  • Several of China’s largest banks have become more selective about funding real estate projects by local government financing vehicles, concerned that some are taking on too much risk after they replaced private developers as key buyers of land, people familiar with the matter said

A more detailed look at global markets courtesy of Newsquawk

Asia-Pac stocks traded mixed following the choppy session in the US where major indices eked mild gains as markets digested CPI data in which headline annual inflation printed at 7.0%. ASX 200 (+0.5%) was underpinned as the energy and mining related sectors continued to benefit from the recent upside in underlying commodity prices, while Crown Resorts shares outperformed after Blackstone raised its cash proposal for Crown Resorts following due diligence inquiries. Nikkei 225 (-1.0%) declined with the index hampered by unfavourable currency flows and with Tokyo raising its COVID-19 alert to the second-highest level. Hang Seng (+0.1%) and Shanghai Comp. (-1.1%) were initially subdued, but did diverge later, after the slight miss on loans and aggregate financing data, while there is a slew of upcoming key releases from China in the days ahead including trade figures tomorrow, as well as GDP and activity data on Monday. In addition, the biggest movers were headline driven including developer Sunac China which dropped by a double-digit percentage after it priced a 452mln-share sale at a 15% discount to repay loans and cruise operator Genting Hong Kong wiped out around half its value on resumption of trade after it warned of defaults due to insolvency of its German shipbuilding business. Finally, 10yr JGBs traded rangebound and were stuck near the 151.00 level following the indecisive mood in T-notes which was not helped by an uninspiring 10yr auction stateside, while the lack of BoJ purchases in the market also added to the humdrum tone.

Top Asian News

  • Asia Stocks Steady After Best Rally in a Year; Financials Gain
  • Country Garden Selloff Shows Chinese Developer Worries Spreading
  • China Banks Curb Property Loans to Local Government Firms
  • China’s True Unemployment Pain Masked by Official Data

Bourses in Europe now see a mixed picture with the breadth of the price action also narrow (Euro Stoxx 50 Unch; Stoxx 600 -0.10%). The region initially opened with a modest downside bias following on from a mostly negative APAC handover after Wall Street eked mild gains. US equity futures have since been choppy within a tight range and exhibit a relatively broad-based performance with no real standout performers. Back in Europe, sectors are mixed and lack an overarching theme. Tech remains the outperformer since the morning with some follow-through seen from contract-chip manufacturer TSMC (ADR +4.3% pre-market), who beat on net and revenue whilst upping its 2022 Capex to USD 40bln-44bln from around USD 30bln the prior year, whilst the CEO expects capacity to remain tight throughout 2022. Tech is closely followed by Autos and Parts and Travel & Leisure, whilst the other end of the spectrum sees Healthcare, Oil & Gas, Retail and Personal & Household goods among the straddlers – with Tesco (-1.5%) and Marks & Spencer (-5.3%) weighing on the latter two following trading updates. In terms of other individual movers, BT (+0.5%) trades in the green amid reports DAZN is nearing a deal to buy BT Sport for around USD 800mln, a could be reached as soon as this month but has not been finalized. Turning to analyst commentary: Morgan Stanley’s clients have aligned themselves to the view that European equities will likely perform better than US counterparts. 45% of respondents see Financials as the top-performing sector this year, 14% preferred Tech which would be the lowest score in over six years.

Top European News

  • Johnson Buys Time With Apology But U.K. Tory Rage Simmers
  • U.K. Retailers Slide as Updates Show Lingering Impact of Virus
  • Wood Group Plans Sale of Built Environment Unit Next Quarter
  • Just Eat Advisers Pitching Grubhub Sale or Take-Private: Sources

In FX, the Dollar has weakened further in wake of Wednesday’s US inflation data as ‘buy rumour sell fact’ dynamics are compounded by more position paring and increasingly bearish technical impulses to outweigh fundamental factors that seem supportive, on paper or in theory. Indeed, the index only mustered enough recovery momentum to reach 95.022 on the back of hawkish Fed commentary and some short covering before retreating through the psychological level, then yesterday’s 94.903 low and another trough from late 2021 at 94.824 (November 11 base) to 94.710, thus far and leaving little bar the 100 DMA, at 94.675 today, in terms of support ahead of 94.500. However, the flagging Greenback could get a fillip via PPI and/or IJC, if not the next round of Fed speakers and final leg of this week’s auction remit in the form of Usd 22 bn long bonds.

  • NZD/AUD - A change in the running order down under where the Kiwi has overtaken the Aussie irrespective of bullish calls on the Aud/Nzd cross from MS, with Nzd/Usd breaching the 50 DMA around 0.6860 on the way to 0.6884 and Aud/Usd scaling the 100 DMA at 0.7288 then 0.7300 before fading at 0.7314.
  • GBP/EUR/CHF/CAD/JPY - Also extracting more impetus at the expense of the Buck, but to varying degrees as Sterling continues to shrug aside ongoing Tory party turmoil to attain 1.3700+ status and surpass the 200 DMA that stands at 1.3737, while the Euro has overcome Fib resistance around 1.1440, plus any semi-psychological reticence at 1.1450 to reach 1.1478 and the Franc is now closer to 0.9100 than 0.9150. Elsewhere, crude is still providing the Loonie with an incentive to climb and Usd/Cad has recoiled even further from early 2022 peaks beneath 1.2500 as a result, and the Yen is around 114.50 with scope for a stronger retracement to test the 55 DMA, at 114.22.
  • SCANDI/EM - Some signs of fatigue as the Nok stalls on the edge of 9.9000 against the Eur in tandem with Brent just a few cents over Usd 85/brl, but the Czk has recorded fresh decade-plus highs vs the single currency following remarks from CNB chief Rusnok on the need to keep tightening and acknowledging that this may culminate in Koruna appreciation. The Cnh and Cny are firmer vs the Usd pre-Chinese trade and GDP data either side of the weekend, but the Rub is lagging again as the Kremlin concludes that there was no progress in talks between Russia and the West, but the Try is underperforming again with headwinds from elevated oil prices and regardless of a marked pick up in Turkish ip.

In commodities, WTI and Brent front-month contracts have conformed to the indecisive mood across the markets, although the benchmarks received a mild uplift as the Dollar receded in early European hours. As it stands, the WTI Feb and Brent Mar contract both reside within USD 0.80/bbl ranges near USD 82.50/bbl and USD 84.50/bbl respectively. News flow for the complex has been quiet and participants are on the lookout for the next catalyst, potentially in the form of US jobless claims/PPI amid multiple speakers, although the rise in APAC COVID cases remains a continuous headwind on demand for now – particularly in China. On the geopolitical front, Russian-backed troops have reportedly begun pulling out of the 1.6mln BPD Kazakh territory, but Moscow’s tensions with the West do not seem to abate. Russia's Kremlin suggested talks with the West were "unsuccessful" – which comes after NATO’s Secretary-General yesterday suggested there is a real risk of a new armed conflict in Europe. Elsewhere, spot gold has drifted off best levels as the DXY found a floor, for now – with the closest support yesterday’s USD 1,813/oz low ahead of the 50 and 21 DMAs at USD 1,807/oz and USD 1,806.50/oz respectively. LME copper has also pulled back from yesterday’s best levels to levels under USD 10,000/t as the mood remains cautious, although, copper prices in Shanghai rose to over a two-month high as it played catch-up to LME yesterday.

US Event Calendar

  • 8:30am: Dec. PPI Final Demand YoY, est. 9.8%, prior 9.6%; MoM, est. 0.4%, prior 0.8%
  • 8:30am: Dec. PPI Ex Food and Energy YoY, est. 8.0%, prior 7.7%; MoM, est. 0.5%, prior 0.7%
  • 8:30am: Jan. Continuing Claims, est. 1.73m, prior 1.75m
  • 8:30am: Jan. Initial Jobless Claims, est. 200,000, prior 207,000

DB's Jim Reid concludes the overnight wrap

Today I have a first. I have two MRI scans. A fresh one on my back and one on my right knee which gave way as I was rehabbing (squats and lunges) the left knee after recent surgery. In my fifth decade of playing sport averagely, but vigorously, it’s all catching up with me very quickly. I’ve exhausted all strengthening exercise routines and injections on my back and the pain gets worse. My surgeon does not want to operate but we will see if he changes his mind after today. If he says play less golf I will walk out mid-meeting even if he may be medically correct. In contrast my knee surgeon is an avid skier and he keeps on doing things to prolong my skiing career even though I’ve said to him that I just really care about golf. So I’ll soon be looking for an avid golfer who just happens to be a back surgeon.

Talking of confirmation bias, if you did an MRI scan of US inflation yesterday you’d find things to support both sides of the debate which is surprising when it hit 7% YoY and the highest since 1982 when Fed Funds were more than 13% rather than close to zero as they are today. So a slightly different real rate to back then. In fact the real rate is through any level seen in the 1970s and is only comparable to WWII levels. Back to CPI and the YoY number was in line with expectations, but core and MoM figures were all a bit firmer than expected. However, the beats were small enough that the data didn’t significantly change the outlook for monetary policy, with Fed funds futures still pricing in an 89% chance of a March hike, which is roughly around where it’d been over the preceding days.

Looking at the details of the release, (our US econ team’s full wrap here) headline month-on-month number came in at +0.5% in December (vs. +0.4% expected), which is the 8thtime in the last 10 months that the print has come in above the consensus expectations on Bloomberg. However, that does still mark a deceleration from the +0.9% and +0.8% monthly growth in October and November respectively. The core CPI reading was also a touch stronger than anticipated, with the monthly print at +0.6% (vs. +0.5% expected), thus sending the annual core CPI measure up to +5.5% (vs. +5.4% expected) and its highest since 1991. Diving into some of the key sub-components, Covid-era favorite used cars and trucks grew +3.5% MoM. More concerning for policymakers, is the continued growth in persistent measures such as shelter, with primary and owners’ equivalent rent both increasing +0.4% MoM. If you were expecting Omicron to slow down American holiday travel, think again, lodging away from home and airfares both posted large increases, +1.2% and +2.7%, respectively. Most forecasters think the peak for inflation is sometime soon, but the pace of the glide path is open to debate. This is a topic we covered in yesterday’s CoTD, found here.

Even though Treasuries had rallied strongly in the immediate aftermath of the report, with the 10yr yield falling back to 1.709% at the intraday low, yields pared back those losses to end the session basically unchanged at 1.74% (+0.7bps). CPI was expected to be bad and therefore the ability to shock was relatively low.

However this tame overall move masked a divergence between a sharp bounceback in the 10yr real yield (+7.5bps) and a decline in inflation breakevens (-7.5bps) as the worst fears from the report weren’t realised. Over in Europe however, there was a more sustained rally, with yields on 10yr bunds down -3.2bps to -0.06%, having come very close in recent days to moving back into positive territory for the first time since May 2019. Furthermore, there was a continued divergence between the two regions at the front end of the curve, with the gap between 2yr yields on Treasuries and bunds widening to 153bps yesterday, which is the biggest since the pandemic began.

Staying with bonds, our US econ and Rates strategy team published a joint piece last night outlining their early expectations for QT, here.

For equities, the lack of an inflation surprise meant that they got a continued reprieve following last week’s selloff, with the S&P 500 (+0.28%) advancing for a 2nd day running for the first time this year, whilst in Europe the STOXX 600 (+0.65%) posted an even stronger advance. Megacap tech stocks were a noticeable outperformer, with the FANG+ index gaining +1.25%, whilst in Europe the STOXX Banks index (+1.22%) hit a fresh 3-year high.

On the topic of inflationary pressures, one asset that continued its upward march was oil yesterday, with Brent Crude (+1.13%), just missing its first close above $85/bbl since October yesterday. Bear in mind it was only 6 weeks earlier that Brent hit its post-Omicron closing low, just beneath $69/bbl, so it’s now up by more than $16/bbl over that period. WTI (+1.75%) saw a similar increase yesterday, which won’t be welcome news to those who’d hoped the recent decline in energy prices late last year would offer some relief on the inflation front. That said, WTI oil is making a great case to be the top-performing major asset for a second year running at the minute, having advanced by over +10% since the start of the year..

This morning, Asian markets are mostly trading lower. The Nikkei (-0.91%) is leading losses in the region, followed by the CSI (-0.55%), Shanghai Composite (-0.31% ) and Kospi (-0.19%). Elsewhere, Hong Kong's Hang Seng index (+0.07%) is swinging between gains and losses. In stock news, Cruise operator Genting Hong Kong Ltd nosedived by a record 56%, after it resumed trading today following last week's suspension as the company indicated the possibility of default. Looking forward, US equity futures are indicating a weak start with the S&P 500 (-0.15%), Nasdaq (-0.26%) and Dow Jones (-0.11%) contracts trading in the red.

On the Covid front, there was further good news from the UK as the latest wave showed further signs of ebbing. For the UK as a whole, the total number of reported cases over the last 7 days is now down -19% compared with the previous 7 day period, whilst in England the number of Covid patients in a mechanical ventilation bed has dropped to its lowest in almost 3 months, before we’d even heard of the Omicron variant.

For those following credit, our colleagues in the European Leveraged Finance Research team have just published their quarterly top trade ideas. You can find the report here.

Looking at yesterday’s other data, Euro Area industrial production grew by +2.3% in November (vs. +0.3% expected), although the October reading was revised down to show a -1.3% contraction.

To the day ahead now, and one of the highlights will be Fed Governor Brainard’s nomination hearing at the Senate Banking committee to become Fed Vice Chair. Other central bank speakers include the Fed’s Barkin and Evans, ECB Vice President de Guindos and the ECB’s Elderson, along with the BoE’s Mann. Separately, data releases from the US include December’s PPI and the weekly initial jobless claims, whilst there’s also Italy’s industrial production for November.

Tyler Durden Thu, 01/13/2022 - 08:00

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Economics

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…

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Where Are Interest Rates Headed? Is The Fed Correct Or The Eurodollar Curve?

Authored by Mike Shedlock via MishTalk.com,

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.

Eurodollar Curve

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

  1. Inflation is transitory. 

  2. The Fed realizes this in time.

  3. The jobs market cools enough to slow wage rises. 

  4. But not so much it means falling household spending.

  5. 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. 

Globally Speaking 

  1. China Does Surprise Rate Cut to Help Its Economy, But It Won't Work

  2. German Costs to Ship by Barge are up Twenty Times and May Soon Be Impossible

  3. UK Average Electricity Cost Will Soar to $5,370 Per Year By 2023

  4. US Industries Are Buckling Under Pressure of Surging Electricity Costs

Good luck with goldilocks, especially with the Fed still hiking. 

*  *  *

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Tyler Durden Wed, 08/17/2022 - 09:45

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Bonds

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…

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Futures Tumble After UK Double-Digit Inflation Shock Sparks Surge In Yields

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.

Market Snapshot

  • 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

FX

  • 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.

Fixed Income

  • 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.

Commodities

  • 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.

Geopolitics

  • 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.

Tyler Durden Wed, 08/17/2022 - 07:55

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Economics

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…

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“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.

tga account

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.

liquidity Fed
liquidity S&P 500

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.  

Summary

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.

The post S&P 3500 By Year End If QT Continues appeared first on RIA.

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