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Futures Flat As Crushing 37bps Curve Inversion Screams Recession

Futures Flat As Crushing 37bps Curve Inversion Screams Recession

US futures are mixed on Thursday, first trading in the red, then turning…

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Futures Flat As Crushing 37bps Curve Inversion Screams Recession

US futures are mixed on Thursday, first trading in the red, then turning green before moving unchanged, as investors shrugged off growth warnings from the bond market while Taiwan war fears faded further despite drills launched by China overnight. Oil bounced back from the lowest level in almost six months. Contracts on the S&P 500 were flat while Nasdaq futures were modestly green, suggesting the tech-heavy Nasdaq will extend an advance of 19% from its June 16 low on the back of a massive CTA, buyback and retail-driven buying frenzy.

In premarket trading, Alibaba gained 3.4% after reporting revenue for the first quarter that beat the average analyst estimate. Adjusted earnings per American depositary receipt also topped expectations. Altice USA shares jumped 5% after the cable television provider reported second-quarter results and announced it received inquiries for its Suddenlink assets. US-listed Chinese tech stocks including JD.com, Pinduoduo and Baidu rise in premarket trading Thursday as Alibaba shares jump 3.9% after reporting better-than-expected revenue in the first quarter. Here are some other notable premarket movers:

  • AMTD Idea (AMTD) shares slump 11.5% putting the Hong-Kong based financial services firm on track to slump for a second straight day after a wild 237% jump earlier this week.
  • Eli Lilly (LLY) falls 2% after the company cut its adjusted earnings per share forecast for the full year.
  • Equinox Gold Corp. (EQX) slides 2.5% after reporting second quarter results that missed consensus analyst estimates for revenue and posted a loss per share, and announced a CEO change.
  • Fastly Inc. (FSLY) shares are down 7% after the infrastructure software company reported second quarter revenue that beat expectations.
  • Gannett Co. Inc. (GCI) shares plunge 5% after the company lowered its full-year revenue and Ebitda outlook, citing “current economic conditions.”.
  • Kohl’s Corp. (KSS) was downgraded to market perform from outperform at Cowen, with analyst Oliver Chen saying a “weakening and inflationary consumer backdrop” could drive EPS downside. Shares decline 3%.
  • Pacific Biosciences (PACB) 2Q results look broadly in line but guidance has been cut significantly, albeit this is not a major surprise, analysts say. Shares down 4% in US premarket trading.
  • Revolve Group Inc. (RVLV) shares are down 13% after the e-commerce fashion company reported quarterly net sales and earnings per share that fell short of analysts’ expectations.
  • Skillz (SKLZ) shares tumble 11.6% after the mobile games platform operator cut its full-year guidance for revenue, with Citi noting that revenue and user metrics disappointed.
  • Under Armour (UAA) is downgraded to neutral from outperform at Baird, which says its view of the athletic-wear retailer’s near-term prospects has “deteriorated materially” over the past two quarters, and faces further pressure from an uncertain macroeconomic environment. The stock declines 0.5% in premarkettrading.
  • Yellow Corp. (YELL) shares jump 37% after the logistics company reported earnings per share for the second quarter that beat the average analyst estimate.

So far US stocks have proven resilient to heightened bond market anxiety and an inverted Treasury yield curve flashing warnings on economic risks, as the S&P 500 climbs back toward the highest level in two months ignoring the screaming recession warning from the 2s10s curve which is now 37bps inverted.

But a global wave of monetary tightening risks upending those gains. The Bank of England unleashed its first half-point hike since 1995 in an effort to control inflation, joining some 70 other institutions around the world moving rates up in outsized steps.

“There’s an intense tug-of-war happening in the economy and markets,” said Dan Suzuki, deputy chief investment officer at Richard Bernstein Advisors. “On one side, you have a narrative that reasonable growth is going to support continued inflation pressure and keep the Fed hiking. The other narrative is that slowing growth is going to ease inflation and allow the Fed to stop hiking.”

Meanwhile, US-China tension remains among the uncertainties clouding the outlook. Taiwan braced for the Chinese military to start firing in exercises being held around the island in response to US House Speaker Nancy Pelosi’s visit. Here are the latest headlines surrounding Taiwan/Pelosi:

  • China's Taiwan Affairs Office said the Taiwan issue is not a regional issue but is a China internal affairs issue, while it added that punishment of pro-Taiwan independence diehards and external forces is reasonable and lawful.
  • Taiwan's Defence Ministry said unidentified aircraft which were likely drones, flew above Kinmen Islands on Wednesday night, while the military fired flares to drive away the aircraft, according to Reuters.
  • Taiwan's Defence Ministry said troops will continue to reinforce alertness level and are carrying out daily training as usual, while the military will react appropriately to an enemy situation and safeguard national security and sovereignty, according to Reuters.
  • ASEAN Foreign Ministers are concerned about international and regional volatility and are concerned volatility could lead to a miscalculation, serious confrontation, open conflicts, and unpredictable consequences among major powers, according to Reuters.
  • US House Speaker Pelosi plans to visit an inter-Korean border area jointly controlled by the American-led UN Command and North Korea, according to a South Korean official cited by Reuters.
  • China's PLA has added an additional zone for its military exercise encircling Taiwan starting Thursday, exercises have been extended until Monday at 10:00, via dwnews' Yang citing Taiwan's port authority. Now seven zones around Taiwan.

Gains in the Stoxx Europe 600 Index were led by retailers, leisure and technology firms, alongside an advance in shares of Chinese tech companies.  Among individual stock moves, Glencore Plc shares fell as much as 2% as its capital return plans overshadowed solid first-half results. Ubisoft shares surged as much as 21% after Tencent reached out to Ubisoft’s founding Guillemot family and expressed interest in increasing its stake, according to Reuters. Here are the most notable European movers:

  • Rolls-Royce drops as much as 12% in London. Jefferies highlights that 1H adjusted Ebit came in 24% below consensus, is disappointed Civil margin “once stripped of a number of one-offs, remains well below breakeven.”
  • SES shares drop as much as 10%, the most intraday since April 2020, as some analysts raised doubts about a potential combination with Intelsat after the FT reported deal talks between the two companies.
  • Ambu falls as much as 16%, the most intraday since May 6, after the company slashed its organic revenue forecast for the full year and said it will cut about 200 jobs from its global workforce.
  • Lufthansa gains as much as 7.4% after the airline forecast a “significant increase” in earnings in the third quarter compared to the second and provided a clearer outlook for full-year profit, predicting adjusted Ebit of more than EU500m.
  • Next shares climb as much as 3.2% after the UK apparel retailer reported better-than-expected 2Q sales and raised its profit outlook for the year.
  • Adidas shares gain as much as 4.4% after the German sportswear company reported 2Q results that were largely in line with expectations, following last week’s profit warning.
  • Merck KGaA shares rise as much as 1.7% after the German pharmaceutical group’s 2Q report showed stable growth for its Life Science division despite abating Covid-19 tailwinds, with Jefferies saying it sends a “positive message” for the rest of 2022.

Earlier in the session, Asian stocks rebounded as easing tensions over Taiwan and overnight gains on the Nasdaq fueled a rally in Chinese tech shares ahead of key earnings reports. The MSCI Asia Pacific Index climbed 0.5%, set for its first gain in three sessions. Alibaba, which is scheduled to release earnings later Thursday, and e-commerce peers Meituan and JD.com helped boost the Hang Seng Tech Index as much as 3.4%, most in more than a month. Other benchmarks in Hong Kong and South Korea’s tech-heavy Kosdaq were among the region’s outperformers. 

“Hong Kong stock markets are getting re-rated after seeing the risk-off mood due to Taiwan tensions, as there were no military conflicts,” said Xuehua Cui, a China equity analyst at Meritz Securities in Seoul.  US House Speaker Nancy Pelosi left Taiwan after reaffirming US support for the democratically elected government in Taipei. China responded with trade curbs and military drills.  Elsewhere in Asia, the main Philippine index reached its highest since June 10 on foreign inflows. Asia’s key stock benchmark has rebounded from its July low, but its recent recovery has been lagging behind US peers amid a property crisis in China and heightened geopolitical risks.

Japanese equities erased earlier gains and slipped as Toyota announced first-quarter earnings that missed estimates and as investors continue to evaluate corporate earnings both domestically and abroad.  The Topix Index was virtually unchanged at 1,930.73 with Toyota Motor leading declines as of market close Tokyo time, while the Nikkei advanced 0.7% to 27,932.20. Toyota Motor shares dropped during market hours as the automaker reported disappointing first quarter earnings and kept its conservative outlook for the current year. Out of 2,170 shares in the index, 1,198 rose and 849 fell, while 123 were unchanged. “Toyota Motor’s financial results confirmed that the impact of high raw material and fuel prices was strong enough to offset the effects of the weak yen,” said Shuji Hosoi, an analyst at Daiwa Securities. “The fact that the company didn’t change its full-year operating income forecast negatively impacted the markets, which had been expecting an upward revision.”

India’s Sensex index snapped a six-session rally, dragged by Reliance Industries and leading lenders, on risk-aversion ahead of a monetary-policy announcement on Friday.  The S&P BSE Sensex fell 0.1% to 58,298.80, in Mumbai, after paring decline of as much as 1.3% in the session. The NSE Nifty 50 Index was flat. Both gauges posted early gains and appeared headed for their longest winning streaks since October 2021, but reversed course.  “The sudden drop in indexes is most likely led by ‘basket selling’ from foreign portfolio investors ahead of the central bank’s rate decision on Friday,” said Abhay Agarwal, a fund manager at Piper Serica Advisors. “Stocks have gained for six straight sessions and investors may want to reap gains ahead of a major policy event.” Reliance Industries fell 1.3%, while State Bank of India and Axis Bank led declines among lenders.  Economists expect the Reserve Bank of India to raise rates for a third consecutive time on Friday but remain divided on the level of the hike aimed at fighting inflation and supporting a weakening currency.  Of 30 shares in the Sensex index, 17 rose and 13 fell. Both of India’s equity benchmarks had gained least 5.5% in previous six sessions driven by $1.7 billion of net purchases by foreigners since the end of June amid signs that inflationary pressures are cooling.  Eight of the 19 sector sub-indexes compiled by BSE Ltd. declined on Thursday. A measure of telecom stocks was the worst performer among the sectoral measures.

In FX,  the dollar consolidated as traders awaited US payrolls data due later in the day for clues on the pace of future Federal Reserve rate hikes. Sterling tumbled after the BOE delivered its biggest rate hike in 27 years, pushing rates up by 50bps, however it also warned of a devastating stagflation, hiking its inflation forecast to 13.3% in October even as it predicted a harrowing 5-quarter long recession.

In rates, Treasuries were moderately cheaper across the curve - which continues to invert deeply with the 2s10s now -37bpsthe biggest yield curve inversion since 2000 as traders increased wagers on Federal Reserve rate hikes ahead of Friday’s US jobs data - as US stock futures added to Wednesday’s gains.  The US 10-year yield dropping to 2.70% as Federal Reserve officials indicated they were resolute on aggressive hikes to cool inflation, dashing market hopes they were ready to embark on a shallower rate path. Treasuries offered little initial reaction to Bank of England decision to hike rates 50bp in an 8-1 vote while warning of a 5 quarter-long recession. Front-end yields cheaper by ~2bp on the day, flattening 2s10s and 5s30s spreads by ~1.5bp and ~0.5bp; 10-year yields around 2.71% trade cheaper by 5bp vs bunds.  European long-end bonds nudged higher. In the UK, focus is on the Bank of England’s rate decision, with a majority of economists anticipating a 50-basis-point hike.

In commodities, oil drifted 0.2% lower to trade at the $90 level as investors weighed weaker US gasoline demand and rising inventories against a token supply increase from OPEC+. Spot gold rises roughly $20 to trade near $1,787/oz. Base metals are mixed; LME lead falls 1.1% while LME zinc gains 1.2%.

Bitcoin slips back below the USD 23k mark but remains in relative proximity to the level in a tight range.

Looking to the day ahead now and we have US June trade balance and Initial Jobless Claims, Germany June factory orders, July construction PMI, UK July new car registrations, construction PMI, Canada June building permits and international merchandise trade. Earnings will include Alibaba, Eli Lilly, Toyota, ICE, ConocoPhillips, Bayer, Glencore, Cigna, Rolls-Royce, adidas, Cheniere, DBS, Apollo, Lyft, Expedia, Deutsche Lufthansa, Warner Bros Discovery, Vertex Pharmaceuticals, DoorDash, Atlassian, Amgen, Block, EOG, Kellogg and AMC.

Market Snapshot

  • S&P 500 futures little changed at 4,153.75
  • STOXX Europe 600 up 0.2% to 439.32
  • MXAP up 0.4% to 159.68
  • MXAPJ up 0.6% to 521.36
  • Nikkei up 0.7% to 27,932.20
  • Topix little changed at 1,930.73
  • Hang Seng Index up 2.1% to 20,174.04
  • Shanghai Composite up 0.8% to 3,189.04
  • Sensex down 0.6% to 57,993.23
  • Australia S&P/ASX 200 little changed at 6,974.93
  • Kospi up 0.5% to 2,473.11
  • German 10Y yield little changed at 0.89%
  • Euro up 0.1% to $1.0178
  • Brent Futures little changed at $96.78/bbl
  • Brent Futures little changed at $96.75/bbl
  • Gold spot up 0.4% to $1,773.19
  • U.S. Dollar Index down 0.13% to 106.37

Top Overnight News from Bloomberg

  • China’s military fired missiles into the sea on Thursday in live-fire military exercises around the island in response to US House Speaker Nancy Pelosi’s visit, even as Taipei played down the impact on flights and shipping.
  • The Bank of England on Thursday is expected to push through the biggest interest-rate increase in 27 years despite growing risks of a recession.
  • European stocks edged higher on Thursday as investors continued to weigh the path of corporate earnings, while attention turned to the Bank of England’s policy decision later in the day.
  • The dollar is close to a 20-year high, despite talk of its inevitable demise. While reluctant to add another article that ends up in traders’ trash cans, current pricing is extreme.
  • Asia’s emerging economies are drawing on large foreign exchange reserves to help prop up their currencies rather than going all-out with interest-rate hikes.

A more detailed look at global markets courtesy of Newsquawk

Asia-Pac stocks were firmer as the positive momentum rolled over from global peers. ASX 200 was kept afloat by tech after similar outperformance of the sector stateside. Nikkei 225 briefly reclaimed the 28k level amid recent JPY weakness and as the earnings deluge continued. Hang Seng and Shanghai Comp conformed to the heightened risk appetite with firm gains in tech including Alibaba ahead of its earnings and with Hong Kong set to provide HKD 2k in consumption vouchers from Sunday.

Top Asian News

 

  • China’s Yiwu city will conduct mass testing and China's Sanya city is on lockdown amid a COVID flare-up, according to state media.
  • China Cancels Japan Meeting Over G-7 Criticism of Taiwan Drills
  • SoftBank Raises $22 Billion Through Alibaba Derivatives: FT
  • China State-Backed Builder’s Dollar Bonds Slump as Worries Mount
  • Tiger Global Fund Halves Stake in India Food Platform Zomato
  • Additional Share Sales Break Asia’s Usual Summer Lull: ECM Watch
  • Li Ka-shing’s CK to Sell AMTD Stake After Unit Soars 14,000%

European bourses are firmer across the board, Euro Stoxx 50 +0.9%, with the general tone constructive though the FTSE 100 lags pre-BoE amid GBP strength. Stateside, US futures have lifted from initial rangebound action, ES +0.3%, with specific newsflow limited pre-data/Fed speak

Top European News

  • Next Raises Profit Outlook as Hot Spell Spurs Fashion Buying
  • French Tech Startup Back Market Said to Start Early IPO Prep
  • Goldman, Bernstein Strategists Say Stocks Rally Can Fizzle Out
  • European Retailers Outperform, Fueled by Zalando Relief Rally
  • Czech Finance Minister Attending Central Bank’s Rate Meeting
  • Credit Agricole’s Investment Bank Drives Earnings Beat

FX

  • DXY remains subdued in early European trade following a relatively contained APAC session; fresh session lows are seen heading into the US entrance.
  • GBP/USD and EUR/USD are currently buoyed, but seemingly more as a function of the Dollar with the former gearing up for the BoE.
  • A mixed session thus far for the non-US Dollars, with the Antipodeans leading the charge whilst the Loonie remained suppressed by crude prices.
  • JPY resides as the current G10 laggard with recent Fed rhetoric fuelling a retracement of last week’s USD/JPY downside.

Fixed Income

  • Core consolidation after recent rampant upward move, knife-edge BoE looms; Bund Sep'22 towards mid-point of a +100 tick range.
  • USTs are following suit with the yield curve flattening modestly but generally quite contained ahead of Mester (2022 voter, Hawk) who has provided commentary recently.
  • Pre-BoE Gilts are supported, but in narrower parameters than EGB peers, as participants look for clarity on the 25/50bp debate as pricing implies a 90% chance of 50bp and circa. 150bp total by end-2022.

Commodities

  • Crude consolidates and moves with broader sentiment post-OPEC & pre-JCPOA.
  • Currently, benchmarks are firmer by circa. USD 1.00bbl and towards the top-end of relatively/comparably narrow ranges.
  • Saudi Arabia OSPs (Sep) vs Oman/Dubai average: Arab Light to Asia at USD +9.80/bbl (exp. 9.80-11.10/bbl), according to Reuters sources.
  • Spot gold is bid and benefitting from a USD pullback that has sent the yellow-metal above the 50-DMA at best; base metals somewhat mixed.

US Event Calendar

  • 07:30: July Challenger Job Cuts YoY, prior 58.8%
  • 08:30: June Trade Balance, est. -$80b, prior -$85.5b
  • 08:30: July Initial Jobless Claims, est. 260,000, prior 256,000; Continuing Claims, est. 1.38m, prior 1.36m

DB's Jim Reid concludes the overnight wrap

One thing we can say for sure is that August hasn’t been dull so far and we’ve only had three days. This is all before the biggest BoE hike for 27 years (50bps) likely today, and then US payrolls tomorrow.

Indeed, there have been some remarkable ranges in treasuries so far in the three days of August. In just over 24 hours from mid-afternoon London time on Tuesday, 2yr US yields moved from 2.83% to 3.18%, 5yrs from 2.58% to 2.96% and 10yrs from 2.52% to 2.83%. These all marked the high points as the three closed at 3.07% (+1.4bps on the day), 2.83% (-2.4bps) and 2.71% (-4.5bps) respectively, 11bps to 13bps off their intra-day highs immediately after a strong US services ISM yesterday. This led to a big curve flattening as 2s10s closed c.6bps lower at -36bps. This morning in Asia, treasury yields are pretty much unchanged.

If that wasn’t enough, the Nasdaq 100 (+2.73%) surged to finish the day at a level last seen on May 4th leaving a strong S&P 500 (+1.59%) slightly behind. The narratives at the moment are struggling to be consistent though as equities have recently rallied on weaker growth that has been seen as helping to limit how far the Fed can hike. However yesterday equities rallied on stronger economic data regardless of the potential Fed impact.

Discretionary (+2.52%), IT (+2.69%) and communications stocks (+2.48%) were the major drivers of the S&P. The broad rally lifted 79% of benchmark’s members with energy (-2.97%) being the only sector to close in the red as oil plummeted. Speaking of which, although the OPEC+ agreed to increase its September output by 100k bpd, way below the July and August increases north of 600k, crude’s short-lived almost +3% gain unwound fairly quickly, with both WTI (-3.87%) and Brent (-3.60%) weaker on lower US gasoline demand as consumers seem to be driving less. Oil is very slightly higher in Asia.

In terms of earnings, Moderna (+16%), PayPal (+9.25%) and CVS (+6.3%) were among top performers in the S&P 500 after a combination of upbeat results and perhaps more importantly buy back announcements. Another interesting snippet from this earnings season came when Bloomberg reported that Meta is looking for a potential debut in bond markets. News of debt sales by Apple and Intel already came through earlier this week as well, supporting narratives of resilience in corporate debt markets.

Dissecting the data, just before the ISM services was released, we got a slight upward revision for the US services PMI (47.3 vs 47.0) but the real surprise was the ISM services index itself. The print showed an unexpected expansion from 55.3 in June to 56.7 last month, the highest since April, while the median Bloomberg estimate stood at 53.5. The employment index also improved to 49.1 from 47.4 and business activity and new orders indicators were the highest since January, while prices paid plunged from 80.1 to 72.3. Another strong reading came from June factory orders that increased +2.0% (vs +1.2% expected), up from May’s revised reading of +1.8% (from +1.6% previously).

This data dovetailed with comments from a list of Fed speakers over the last 24 hours, including Bullard, Daly, Barkin and Kashkari, all saying that the central bank is not close to finishing its work and markets shouldn’t expect a quick reversal to cuts.

This all supports our view that the US isn’t in recession yet. As we’ve said many times before we think it’s almost inevitable it does go into one within say 12 months but that we still might need the lagged impact of an aggressive (but necessary) series of rate hikes first to get us there. The risks to this view in terms of an earlier recession would probably be due to a sudden self fulfilling loss of confidence as everyone talks about imminent recession risk, or if financial conditions dramatically collapse. To be fair the latter was very worrying by mid-June but we’ve seen a tremendous loosening since.

Over to Asia and the strong gains in US equities are echoing in Asia with all the key markets trading higher. As I type, the Hang Seng (+1.78%) is leading the way across the region helped by gains in Chinese technology companies with shares of Alibaba climbing around +5.0% ahead of its earnings results later today. Elsewhere, the Nikkei (+0.54%), and the Kospi (+0.36%) are trading higher in early trade. Over in Mainland China, the Shanghai Composite (+0.15%) and the CSI (+0.40%) are both trading in the green.

Outside of Asia, stock futures in the US are pausing for breath with contracts on the S&P 500 (-0.10%) and NASDAQ 100 (-0.20%) moving slightly lower.

Early morning data showed that Australia’s trade balance swelled to a record high of A$17.67bn in June (v/s A$14.0bn expected) from A$15.97bn in May driven by strong prices of key exports from grains to metals and gold.

Elsewhere, although Pelosi left Taiwan yesterday without incident, remember that China will start 4 days of military drills today around the island. So be prepared for headlines to come through.

Back to yesterday and European shares rallied but missed the main part of the US climb with the STOXX 600 closing with a +0.51% advance for the day after a steady march higher throughout the session. It was an across-the-board rally led by IT (+2.78%), financials (+1.60%) and discretionary (+1.52%) stocks. The few sectors in the red - utilities (-0.94%), healthcare (-0.92%) and communications (-0.35%) - were left behind by a risk-on mood.

Speaking of European utilities, it is a sector that has faced challenges not only amid the Russian gas story but also the extreme heat in Europe. Our European economists cover implications of the drought-driven low water levels for the German economy here. As a reminder, it was an important topic back in 2018 but today’s situation with gas supplies reinforces its effect given coal plants’ reliance on waterways for supplies. Linked in, yesterday’s announcement by Uniper about potentially limiting output at a coal plant in Germany sent gas futures in New York up by almost +10%, with contracts holding on to a +7.71% gain by the close of US markets. Other companies depend on water traffic too and water-intensive industries are likely to get affected as well. Earlier this week EDF has warned about potential further nuclear power cuts as river water, used for plant cooling, becomes too warm. Expect this to be an increasingly pertinent and market-moving issue across industries.

Diving back into market movements, the bullish sentiment in European stocks was strong enough to overpower surging yields. In Germany the belly of the curve surged, with 5y yields (+7.6bps) racing ahead of both the front end (+6.9bps) and the 10y (+5.6bps) that was mainly upheld by higher breakevens (+6.1bps). While a similar story was seen in France (OATs +3.4bps), Italy stood out with an across the curve decline in yields. 2s10s still flattened as the 2y yield (-1.5ps) fell by less than the 10y (-4.1bps). We should note that US yields rallied 7-8bps after Europe closed.

Central banks and yields will be in focus today as well since today’s BoE’s meeting will likely be top of the list in terms of events for European markets and our UK economists expect the Bank to hike by +50bps (taking the Bank Rate to 1.75%). Their full preview is here. This hike would imply the largest single Bank Rate increase since 1995 and come amid the 9.4% CPI print for June, a 40-year high. They also updated their growth outlook for the country yesterday (link here) and now expect the economy to contract in Q4-22 and Q1-23 in a short and mild technical recession. Gilts behaved similar to other European bond markets yesterday, with the 2y yield (+7.1bps) rising by more than the 10y (+4.4bps) but both lagging the 5y (+9.0bps).

Staying with Europe and briefly returning to yesterday’s other data releases, Germany’s exports accelerated to +4.5% in June, way ahead of the +1.0% median estimate on Bloomberg’s and May’s revised +1.3% (from -0.5% previously). Imports came in softer than expected, however, slowing to just +0.2% (+1.3% expected). Elsewhere, Eurozone’s retail sales contracted -3.7% yoy in June, missing estimates of -1.7%. The PPI accelerated to a monthly gain of +1.1% in June relative to the prior +0.5% (revised from +0.7%).

To the day ahead now and we have US June trade balance, Germany June factory orders, July construction PMI, UK July new car registrations, construction PMI, Canada June building permits and international merchandise trade. Earnings will include Alibaba, Eli Lilly, Toyota, ICE, ConocoPhillips, Bayer, Glencore, Cigna, Rolls-Royce, adidas, Cheniere, DBS, Apollo, Lyft, Expedia, Deutsche Lufthansa, Warner Bros Discovery, Vertex Pharmaceuticals, DoorDash, Atlassian, Amgen, Block, EOG, Kellogg and AMC.

Tyler Durden Thu, 08/04/2022 - 08:25

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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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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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