Most of the time, Wall Street tends to focus on big institutional flows. For years that was probably okay, but that led to horrible decisions during the pandemic. Retail flows were a crucial driver of markets, and we are at an inflection point where retail will be a big determinant of what happens next!
This expands on the “non virtuous” cycle work we first presented in Bad to the Bone. It will also clarify some thoughts on crypto as a leading indicator of stocks that we touched on in Friday morning’s email.
Sorry, Not Sorry
This portfolio construction analysis:
Will be overly simplified.
Will annoy you at times.
Will make you smile at times (hopefully).
Will, after further consideration, help you understand some market dynamics that are at play and could trigger the next big move (and why I’m concerned that is to the downside).
“Traditional” vs “Disruptive” Portfolio Construction
Let’s use “traditional” to mean the sort of investor that existed well before COVID. Maybe an investor that would have been the “norm” for individual investors, circa 2017. Let’s then imagine a class of investor that is “disruptive” by nature and was doing well pre-COVID, but flourished during COVID.
I did warn you that it would be simplistic and some parts would likely anger you, but let’s just run with this as the two main ways that retail is constructing portfolios and once you think about it, probably does cover the vast majority of retail investors.
The Traditional Investors’ “Conundrum”
TINA forced even conservative investors into more risk than they would traditionally take. The fear of not having enough money for their potential lifespan forced them into equities. Equities were no longer the pariah of conservative investors and they remained significant components well into retirement.
That worked great, but there really was no alternative.
I expect this group is already “de-risking.” They can decrease risk for similar expected returns.
The S&P 500 expected dividend yield is up to about 1.6%, though the recent increase from 1.4% in March and 1.3% at the end of December is by stocks dropping in price (the S&P 500 is down 15.6%) rather than by dividend growth. At the same time, the 10-year Treasury yield has risen from 1.5% to almost 3%. You can plow money into corporate credit to pick up additional current income and even the money market funds are back to paying some interest.
Fear of rising rates has caused big bond fund ETF outflows. The Muni market, mostly reflective of retail, has been a seemingly never-ending series of BWIC after BWIC (bid wanted in competition).
But, if you felt you needed to own dividend stocks to get income and those stocks are down hard and their yields now pale in comparison to Treasuries, do you start de-risking?
The “will I have enough” comes down to total return and carry. For whatever reason, and I’m not sure of the reason, the “will I have enough” investors seem to focus on yield more than anything and seem far more willing to take bond losses on a mark to market basis than they do on stocks. Ok, I cannot fully blame them, but there is this strange detachment from total return vs income, at least when I get more involved in that space.
I would not be surprised if these investors, while generally de-risking, weren’t adding some “hot sauce” to their portfolios. Taking some flyers on disruptive stocks and other assets that they “missed” during the crisis, but can now buy at “bargain” prices (or at least much cheaper than their peak prices).
While it will be gradual, I think this “de-risking” is occurring and will continue to occur as “traditional” investors go back to their roots and take on more “traditional” portfolios containing fewer equities and more bonds.
The Disruptive Investors’ Problem #1 - Crypto
While traditional investors face a conundrum, the disruptive investors face a real problem.
Bitcoin is at its lowest levels since December 2020. Anyone who added bitcoin during that timeframe is now underwater.
Making the situation more perilous (and why I’m currently so bearish crypto) is that:
Adoption and interest are waning.
When the average person sees something go up 10% a week and their media streams are filled with people calling for ever-increasing price targets, an asset class gets a lot of attention. When something stumbles and continues to stumble, even after a very successful run, the “told you so” crowd gets a lot more airtime. In December we wrote that TINA, BOGO, and FOMO’s Engines Are Stuttering. That thesis continues to play out and is worth a read.
We had a strong “use case”– Russia invading Ukraine. Currency restrictions. Sanctions. But, after a brief post invasion pop, crypto has renewed its descent. That likely discourages new investors.
When “stable” coins become “unstable.” This is the extent of my current knowledge, but here is my best take. Stable coins act as an “intermediate” step where people transacting in the crypto universe can remain in the crypto space without taking the market volatility of the cryptocurrencies. Terra (Luna), usually referred to as UST, was a $20 billion market cap algo based stable coin. I will be honest, I’m not sure what an algo based stable coin is, and I’m not about to find out, because it apparently went “poof.” Tether, known as USDT (notice how Q Macro Strategy Peter Tchir “Traditional” vs “Disruptive” Portfolio Construction & Why It Matters So Much! May 15, 2022 3 everything about crypto is meant to sound or look like a currency - great marketing), is worth $80 billion and is “supposedly” backed by some sort of assets. That at least I understand. I can relate to something being backed by something. There have been repeated questions about what is actually backing it, but those have been met by repeated assertions that it is in fact backed by assets. Tether (which was trading below $1) has rebounded since Thursday. I don’t know, but if you’ve gotten to this point and haven’t invested in crypto but are thinking about starting now, I’d love an explanation (btw, “stable coins” is another brilliant marketing moniker – there really is a trend here). I’m digging deeper into this whole area, but I don’t see how it is anything but a red flag.
China is trying to crack down on crypto use. One way is enforcement and the other way (no idea how they’d do it but always in the back of my mind) is the fact that you don’t have to worry about money outside of the system if you figure out a way to drive it to zero. I’m told its impossible, but I’ll leave it as low probability rather than impossible.
The U.S. and Western Europe will impose regulations. Mostly for tax purposes, but increasingly to ensure that less can occur outside the system.
I strongly believe that the NSA helped track some well publicized ransomware payments and helped get that returned. One, it tells me what a big, powerful entity can do if they focus on the space (assuming my “guess” is correct) which makes me think back to the China point. Two, ransomware as a “use” case may be dropping.
I’m extremely bearish crypto here. I understand that the “maxis” (bitcoin maximalists, who loath crypto other than bitcoin) point to many of the problems listed above as a reason to view bitcoin as a “flight to safety” play in crypto, but I don’t buy into it.
This is not the time, nor the place, but all you have to do is scroll through Twitter and you will find people with 100s of thousands of followers who say things just blatantly and factually incorrect. I’m not arguing about those who say it is going to $1 million, or those who tout that it is an inflation hedge, or those who say it is going to zero (and pound their chests on every drop, despite being wrong for the past few years), just people who state things as “facts” that are not in fact, facts. How many people are being “influenced” by the influencers? I think a high number and that scares me for the longer-term viability of the product (given everything else mentioned), but more importantly, leads me to believe the price drop could be larger than many expect.
I didn’t even delve into the “alt” coins or NFTs, which are bigger disasters waiting to happen (if it hasn’t already happened). That was the “play” money part of their portfolio and that for many is gone (along with interest in penny stocks).
The Disruptive Investors’ Problem #2 – Disruptive Stocks
I’m not even going to include the cannabis related stocks because it makes the chart too complex, is piling on, and isn’t 100% related to my thesis, but probably could be.
ARKK, at one point in early 2021, had outperformed the S&P 500 (SPY) by 194%! And the S&P’s gains were not shabby! It had even blown away the returns of the Nasdaq 100 (QQQ). Now, in a “stunning” reversal, its returns since the start of 2018 are now lower than either of those!
As mentioned before, I do think more people are betting on a rebound (ARKK and TQQQ - 3x leveraged QQQ - have been getting extreme inflows), but some part of the disruptive investor must be nervous that they aren’t diversified at all?
The Disruptive Investors’ Problem #3 – Cash Equivalents?
Maybe I am wrong in what these investors considered “safe” assets. Ways to park their money. Maybe, they didn’t view giant tech as a cash holding/easy to access and was certain to go higher.
I may be wrong on that, but we have seen some of those companies turn over recently.
What if I’m right? What if the “disruptive investor” suddenly realizes that their portfolio should look a lot more like the traditional investor’s portfolio?
I think it might be difficult to distinguish between capitulation and a rebalancing from “disruptive” to “traditional,” but I’d argue that we have been seeing signs of that and it is unlikely to be over.
The End of “Gambling” Nation?
David Portnoy, the president of Barstool Sports (@stoolpresidente on Twitter) has gone from calling markets and competing with Cramer for social media’s most vocal stock “analyst” to mostly focusing on one-bite pizza reviews and sports, which he does extremely well!
DKNG down from $70 to $12, PENN down from $135 to $31, HOOD down from $70 to $11, and COIN down from $350 to $68 (though it almost broke $40 on Friday) all benefitted from this “gambling” mentality we saw during COVID. Maybe HOOD and COIN were experiencing “investing,” but I don’t think it is a leap of faith to consider at least some of it “gambling” or at least having the mentality of a “gambler” rather than an investor (you cannot convince me otherwise on weekly options on single stocks).
These are all tied together and all represent a dramatic shift in “disruptive” behavior.
I am going to come back to TQQQ for a moment.
It closed on Friday with a market cap of about $13 billion with 414 million shares outstanding. On April first, it had 321 million shares outstanding, so people have added about 100 million shares to this ETF in the last 6 weeks. TQQQ has dropped from $58 to $32 during that time. People are adding almost every day. There is very little capitulation (actually no capitulation). SQQQ - the 3x inverse - has fewer shares now than it did in January despite rallying from $29 to $52 over that time period. The aforementioned ARKK has by far the most shares outstanding in its history (though a much smaller total market cap).
But I digress, so back to TQQQ.
TQQQ had a market cap of $13 billion on Friday. QQQ closed at $302 (TQQQ doesn’t actually buy QQQ, but let’s pretend it does, since that simplifies the math).
On Monday, TQQQ has to be set up to deliver 3x the daily percentage change in the Nasdaq 100 (QQQ is our proxy).
So, let’s assume that TQQQ borrows $26 billion to buy $39 billion of QQQ (129 million shares).
That means that whatever happens on Monday, TQQQ will have made or lost 3x the daily percentage change.
For example, if QQQ went up 3% on Monday, it would close at $311.06 (using $302 as starting price).
The shares held by TQQQ would be worth $40.17 billion, which after they repaid the loan would be worth $14.17 billion (or 9% higher than the $13 billion TQQQ started the day at).
But this is where it gets interesting!
As we went into Monday’s close, QQQ would need to be prepared to match 3 times the daily percentage change.
Even at the elevated price of QQQ, TQQQ would need to hold 136.6 million shares going into Tuesday (instead of the 129 million shares it already had).
So, TQQQ would have a buy order in at the close on 7.5 million shares of QQQ or $2.3 billion!
The daily rebalancing of a 3x leveraged fund creates additional buys on up days and additional sells on down days! It tends to make moves even bigger than they would be otherwise.
Think about that, a fund that is “only” $13 billion needing to buy as much as $2.3 billion if we get a 3% move (which seems the norm) and there were no inflows! This is the exact sort of mechanism that caused the inverse VIX ETFs to explode, though by their nature they actually had much higher leverage because of the way the underlying share count was calculated, but that should be a sobering reminder.
The reverse also happens and TQQQ will have to sell into the close on down days, but so far, that has been largely offset by fund inflows!
What if the fund inflows stop?
My biggest fear is a shift from “disruptive” portfolios to “traditional” portfolios.
The riskiest portion has been hard for many (NFT, Alt Coins, etc.)
The “core” investment, other disruptive stocks, bitcoin, etc., has been hit hard.
The companies they are working for may have gone from upping pay to suddenly being focused on costs, making salary less certain going forward.
The thing that they viewed as the “piggy” bank is suddenly under pressure as well.
These things occurring force a large unwind. Unfortunately, some of the “safe” stocks have come to represent huge portions of the indices, which would quickly spread losses.
Could we have TQQQ “go poof” like the VIX ETNs? No, the leverage isn’t there.
Could we have a limit down day as outflows combine with rebalancing and other selling to hit broad markets? I do not see why not.
Could this happen if crypto rebounds? I doubt it, in fact, I think crypto would need to be the catalyst for more of the moves we have seen, but if crypto goes down and stays down (given its poor liquidity), we see a very ugly day in risk assets.
I think we could see the Fed soften its stance now that Powell is being confirmed. That would help risk assets, but I’m far more concerned that Thursday’s crypto led selling pressure was only a taste of what is to come. I don’t know the timing, but puts for the next month seem worth it.
I will also be watching to see if there is any “profit” taking on the recent bounces in the crypto and disruptive stocks.
On Treasuries, we will get TIC data on Monday that shows what China, the Saudis, and other countries did with their Treasury holdings in March (I suspect that they reduced their exposure and that will explain some of the relative performance of Treasuries versus the debt of other countries).
I don’t see liquidity improving in the coming weeks as we are at best halfway through people rethinking about risk and reward and adjusting their portfolios accordingly (hedge funds, large asset managers, traditional, and disruptive investors included).
Maybe this was all just a crazy way to think about markets, how they are intertwined, and what is happening, but it explains a lot and highlights some serious and plausible risks!
As much as I think tone at the Fed will change, I’m more nervous than bullish (again) – ugh!
The End Game Approaches
The pendulum of market sentiment swings dramatically. It has swung from nearly everyone and their sister complaining that the Federal Reserve was lagging…
The pendulum of market sentiment swings dramatically. It has swung from nearly everyone and their sister complaining that the Federal Reserve was lagging behind the surge in prices to fear of a recession. On June 15, at the conclusion of the last FOMC meeting, the swaps market priced in a 4.60% terminal Fed funds rate. That seemed like a stretch, given the headwinds the economy faces that include fiscal policy and an energy and food price shock on top of monetary policy tightening. It is now seen closer to 3.5%. It is lower now than it was on when the FOMC meeting concluded on May 4 with a 50 bp hike.
In addition to the tightening of monetary policy and the roughly halving of the federal budget deficit, the inventory cycle, we argued was mature and would not be the tailwind it was in Q4. While we recognized that the labor market was strong, with around 2.3 mln jobs created in the first five month, we noted the four-week moving average of weekly jobless claims have been rising for more than two months. In the week to June 17, the four-week moving average stood at 223k. It is a 30% increase from the lows seen in April. It is approaching the four-week average at the end of 2019 (238k), which itself was a two-year high. In addition, we saw late-cycle behavior with households borrowing from the past (drawing down savings and monetizing their house appreciation) and from the future (record credit card use in March and April).
The Fed funds futures strip now sees the Fed's rate cycle ending in late Q1 23 or early Q2 23. A cut is being priced into the last few months of next year. This has knock-on effects on the dollar. We suspect it is an important part of the process that forms a dollar peak. There is still more wood to chop, as they say, and a constructive news stream from Europe and Japan is still lacking. The sharp decline in Russian gas exports to Europe is purposely precipitating a crisis that Germany's Green Economic Minister, who reluctantly agreed to boost the use of coal (though not yet extend the life of Germany's remaining nuclear plants that are to go offline at the end of the year), warns could spark a Lehman-like event in the gas sector.
At the low point last week, the US 10-year yield had declined by around 50 bp from the peak the day before the Fed delivered its 75 bp hike. This eases a key pressure on the yen, and, at the same time, gives the BOJ some breathing space for the 0.25% cap on its 10-year bond. A former Ministry of Finance official cited the possibility of unilateral intervention. While we recognize this as another step up the intervention escalation ladder, it may not be credible. First, it was a former official. It would be considerably more important if it were a current official. Second, by raising the possibility, it allowed some short-covering of the yen, which reduces the lopsided positioning and reduces the impact of intervention. Third, on the margin, it undermines the surprise-value.
Ultimately, the decline in the yen reflects fundamental considerations. The widening of the divergence of monetary policy is not just that other G10 countries are tightening, but also that Japan is easing policy. A couple of weeks ago, to defend its yield-curve-control, the BOJ bought around $80 bln in government bonds. The odds of a successful intervention, besides the headline impact, is thought to be enhanced if it signals a change in policy and/or if it is coordinated (multilateral).
There are a few high frequency data points that will grab attention in the coming days, but they are unlikely to shape the contours of the investment and business climate. The key drivers are the pace that financial conditions are tightening, the extent that China's zero-Covid policy is disrupting its economy and global supply chains, and the uncertainty around where inflation will peak.
Most of the high frequency data, like China's PMI and Japan's industrial production report and the quarterly Tankan survey results, and May US data are about fine-tuning the understanding of Q2 economic activity and the momentum at going into Q3. They pose headline risk, perhaps, but may be of little consequence. It is all about the inflation and inflation expectations: except in Japan. Tokyo's May CPI, released a few weeks before the national figures, is most unlikely to persuade the Bank of Japan that the rise in inflation will not be temporary.
With fear of recession giving inflation a run for its money in terms of market angst, the dollar may be vulnerable to disappointing real sector data, though the disappointing preliminary PMI likely stole some thunder. The Atlanta Fed's GDPNow says the US economy has stagnated in Q2, but this is not representative of expectations. It does not mean it is wrong, but it is notable that the median in Bloomberg's survey is that the US economy is expanding by 3% at an annualized rate. This seems as optimistic as the Atlanta Fed model is pessimistic. May consumption and income figures will help fine-tune GDP forecasts, but the deflator may lose some appeal. Even though the Fed targets the headline PCE deflator, Powell cited the CPI as the switch from 50 to 75 bp hike.
In that light, the preliminary estimate of the eurozone's June CPI that comes at the end of next week might be the most important economic data point. It comes ahead of the July 21 ECB meeting for which the first rate hike in 11 years has been all but promised. Although ECB President Lagarde had seemed to make clear a 25 bp initial move was appropriate, the market thinks the hawks may continue to press and have about a 1-in-3 chance of a 50 bp move. The risk of inflation is still on the upside and Lagarde has mentioned the higher wage settlements in Q2. That said, the investors are becoming more concerned about a recession and expectations for the year-end policy rate have fallen by 30 bp (to about 0.90%) since mid-June.
A couple of days before the CPI release the ECB hosts a conference on central banking in Sintra (June 27-June 29). The topic of this year's event is "Challenges for monetary policy in a rapidly changing world," which seems apropos for almost any year. The conventional narrative places much of the responsibility of the high inflation on central banks. It is not so much the dramatic reaction to the Pandemic as being too slow to pullback. In the US, some argue that the fiscal stimulus aggravated price pressures. On the face of it, the difference in fiscal policy between the US and the eurozone, for example, may not explain the difference between the US May CPI of 8.6% year-over-year and EMU's 8.1% increase, or Canada's 7.7% rise, or the UK's 9.1% pace.
There is a case to be made that we are still too close to the pandemic to put the experience in a broader context. This may also be true because the effects are still rippling through the economies. In the big picture, central banks, leaving aside the BOJ, appear to have responded quicker this time than after the Great Financial Crisis in pulling back on the throttle, even if they could have acted sooner. Some of the price pressures may be a result of some of the changes wrought by the virus. For example, a recent research paper found that over half of the nearly 24% rise in US house prices since the end of 2019 can be explained by the shift to working remotely, for example.
The rise in gasoline prices in the US reflect not only the rise in oil prices, but also the loss of refining capacity. The pandemic disruptions saw around 500k barrels a day of refining capacity shutdown. Another roughly 500k of day of refining capacity shifted to biofuels. ESG considerations, and pressure on shale producers to boost returns to shareholders after years of disappointment have also discouraged investment into the sector. The surge in commodity prices from energy and metals to semiconductors to lumber are difficult to link to monetary or fiscal policies.
Such an explanation would also suggest that contrary to some suggestions, the US is not exporting inflation. Instead, most countries are wrestling with similar supply-driven challenges and disruptions. That said, consider that US core CPI has risen 6% in the year through May, while the ECB's core rate is up 3.8%, and rising. The US core rate has fallen for two months after peaking at 6.5%. The UK's core CPI was up 5.9% in May, its first slowing (from 6.2%) since last September. Japan's CPI stood at 2.5% in May, but the measure excluding fresh food and energy has risen a benign 0.8% over the past 12 months.
Consider Sweden. The Riksbank meets on June 30. May CPI accelerated to 7.3% year-over-year. The underlying rate, which uses a fixed interested rate, and is the rate the central bank has targeted for five years is at 7.2%. The underlying rate excluding energy is still up 5.4% year-over-year, more than doubling since January. The policy rate sits at 0.25%, having been hiked from zero in April. The economy is strong. The May composite PMI was a robust 64.4. The economy appears to be growing around a 3% year-over-year clip. Unemployment, however, remains elevated at 8.5%, up from 6.4% at the end of last year. The swaps market has a 50 bp hike fully discounted and about a 1-in-3 chance of a 75 bp hike. The next Riksbank meeting is not until September 20, and the market is getting close to pricing in a 100 bp hike. Year-to-date, the krona has depreciated 11% against the dollar and about 3% against the euro.
In addition to macroeconomic developments, geopolitics gets the limelight in the coming days. The G7 summit is June 26-28. Coordinating sanctions on Russia will likely dominate the agenda and as the low-hanging fruit has been picked, it will be increasingly challenging to extend them to new areas.
At least two important issues will go unspoken and they arise from domestic US political considerations. Although President Biden has recommended a three-month gas tax holiday, he needs Congress to do it. That is unlikely. Inflation, and in particular gasoline prices are a critical drag on the administration and the Democrats more broadly, who look set to lose both houses. And the Senate and Congressional Republicans are not inclined to soften the blow. Talk of renewing an export ban on gasoline and/oil appears to be picking up. The American president has more discretion here. This type of protectionism needs to be resisted because could it be a slippery slope.
The other issue is the global corporate tax reform. Although many countries, most recently Poland, have been won over, it looks increasingly likely that the US Senate will not approve it. Biden and Yellen championed it, but the votes are not there now, and it seems even less likely they will be there in the next two years. The particulars are new, but the pattern is not. The US has not ratified the Law of the Seas nor is it a member of the International Court of Justice. Some push back and say that the US acts as if it were. That argument will be less persuasive on the corporate tax reform.
NATO meets on June 29-30. For the first time, Japan, Australia, New Zealand, and South Korea will be attending. Clearly, the signal is that Russia's invasion of Ukraine is not distracting from China. Most recently, China pressed its case that the Taiwan Strait is not international waters. Some in Europe, including France, do not want to dilute NATO's mission by extending its core interest to the Asia Pacific area and distracting from European challenges. NATO is to publish a new long-term strategy paper. Consider that the last one was in 2010 and did not mention Beijing and said it would seek a strategic partnership with Russia. Putin's actions broke the logjam in Sweden and Finland, and both now want to join NATO, but Turkey is holding it up.
Disclaimerrecession unemployment pandemic stimulus bonds government bonds monetary policy fomc fed federal reserve budget deficit link euro congress senate recession gdp stimulus oil south korea japan canada european europe uk france germany sweden poland russia ukraine china
HW+ Member Spotlight: Ben Bernstein
This week’s HW+ member spotlight features Ben Bernstein as he shares why it’s an interesting time to be tracking the housing market and all of the…
This week’s HW+ member spotlight features Ben Bernstein, director at Axonic Capital, an investment firm with a deep focus on the structured credit sector of the financial markets. Prior to that, Bernstein held leadership roles in Odeon Capital Group and JPMorgan Chase.
Below, Bernstein answers questions about the housing industry:
HousingWire: What is your current favorite HW+ article and why?
Ben Bernstein: Logan and Sarah’s Monday podcast is my go to. Logan cuts through all the noise and delivers clear concise opinions rooted in the data. So not only do I get updates on what is going on in the housing market but I learn which data points are relevant and how to analyze them. And Sarah always asks insightful questions. On top of that, it is super entertaining!
HousingWire: What has been your biggest learning opportunity?
Ben Bernstein: My biggest learning opportunity (and weirdest job I ever had) was every job I ever had. I started my career at Bear Stearns on February 23 2008. To say that was an interesting time and place to start a career would be an understatement. Two weeks later I was working for JPMorgan and eventually made it to a desk whose focus was working out of the assets that brought Bear down in the first place.
Think funky bonds linked to housing like subprime RMBS and CDOs. Getting to dig deep into what these bonds were and how the underlying mortgages impacted them was priceless. I started at Axonic, a credit fund focused on investments linked to residential and commercial real estate, in November of 2019.
Another interesting time to join an investment firm! Three months later, I was working remotely and figuring out how to be productive from home. Fourteen years into my career and my biggest learning opportunity is right now.
I’m learning new stuff every single day whether it be about the bond market, housing, trading, macro economics, etc. All I need to do is turn around and ask a question out loud and I’ll learn something new.
HousingWire: What is the best piece of advice you’ve ever received?
Ben Bernstein: The best piece of advice I’ve ever received was what is important is what you do when no one is looking. Your reputation, work ethic, success, productivity and integrity are all linked to what you do because you know you need to do it as opposed to what you think other people want you to do.
HousingWire: What’s 2-3 trends that you’re closely following?
Ben Bernstein: I don’t think anyone will be surprised by the trends I’m following these days: Inflation, credit spreads, housing prices and how they are all intertwined. Fortunately I have smart people around me (including HousingWire) to give me their opinions on where we are headed. It’s my job to put it all together. The past two years have been some of the most interesting times in markets and from where I sit I don’t think that will change any time soon.
HousingWire: What keeps you up at night and why?
Ben Bernstein: What keeps me up at night is the state of the housing market. 35+% home price appreciation since COVID-19 began. Two months supply of housing. Mortgage rates going up faster than they ever have. There’s a lot going on!
One thing as bond traders that we do is we look down before we look up. In other words we look at risk before we look at upside. An overheated housing market is something we pay close attention to because we don’t want prices to go down precipitously but we don’t want inflation to run away either. So it’s really an interesting time to be tracking the housing market and all of the ancillary markets that are impacted by it.
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Risk Appetites Improve Ahead of the Weekend
Overview: Equities are higher and bonds lower as the week’s activity winds down. Asia Pacific markets rallied, paced by more than 2% gains in Hong Kong…
Overview: Equities are higher and bonds lower as the week's activity winds down. Asia Pacific markets rallied, paced by more than 2% gains in Hong Kong and South Korea. Japan's Nikkei rallied more than 1%, as did China's CSI 300. Most of the large markets but South Korea and Taiwan advanced this week, though only China and Hong Kong are up for the month. Europe's Stoxx 600 is up 1.3% through the European morning, its biggest advance of the week and what looks like the first weekly gain in four weeks. US futures are trading around 0.6%-0.8% higher. The NASDAQ is 4% higher and the S&P 500 is 3.3% stronger on the week coming into today. The US 10-year yield is virtually unchanged today and around 3.08%, is off about 14 bp this week. European bonds are mostly 2-4 bp firmer, and peripheral premiums over Germany have edged up. The US dollar is sporting a softer profile against the major currencies but the Japanese yen. Emerging market currencies are also mostly higher. The notable exception is the Philippine peso, off about 0.6% on the day and 2.2% for the week. Gold fell to a five-day low yesterday near $1822 and is trading quietly today and is firmer near $1830. August WTI is consolidating and remains inside Wednesday’s range (~$101.50-$109.70). It settled at almost $108 last week and assuming it does not rise above there today, it will be the first back-to-back weekly loss since March. US natgas is stabilizing after yesterday’s 9% drop. On the week, it is off about 10% after plummeting 21.5% last week. Europe is not as fortunate. Its benchmark is up for the 10th consecutive session. It soared almost 48% last week and rose another 7.7% this week. Iron ore’s 2% loss today brings the weekly hit to 5.1% after last week’s 14% drop. Copper is trying to stabilize after falling 7.5% in the past two sessions. It is at its lowest level since Q1 21. September wheat is up about 1.5% today to pare this week’s decline to around 8%.
Japan's May CPI was spot on expectations, unchanged from April. That keeps the headline at 2.5% and the core rate, which excludes fresh food, at 2.1%, slightly above the 2% target. However, the bulk of that 2.1% rise is attributable to energy prices. Without fresh food and energy, Japan's inflation remains at a lowly 0.8%.
The BOJ says that Japanese inflation is not sustainable, which is another way to say transitory. In turn, that means no change in policy. The fallout though is increasing disruptive. The yield curve control defense roiled the cash-futures basis and the uncertainty about hedging may have contributed to the soft demand at this week's auction. In addition, interest rates swap rates have risen as if the market is seeking compensation for the added uncertainty. Meanwhile, for the fourth session there were no takers of the BOJ's offer to buy bonds at a fixed rate.
The approaching month-end pressures saw the PBOC step up its liquidity provisions and injected the most in three months today. Still, the seven-day repo rate rose 16 bp to 1.17%. In Hong Kong, three-month HIBIOR rose to 1.68%, the highest since April 2020. Australian rates moved in the opposite direct. Australia's three-year yield fell 14 bp today after falling 10 bp in each of the past two sessions. It has fallen every day this week for a cumulative 43 bp drop to 3.20%. It had risen by slightly more than 50 bp the previous week. There was a dramatic shift in expectations for the year-end policy rate. The bill futures imply a year-end rate of 3.17%, which is about 68 bp lower than a week ago. It had risen by a little more than 150 bp in the previous two weeks.
The dollar traded in a two-yen range yesterday, but today is consolidating in a one-yen range above yesterday's low near JPY134.25. The pullback in US yields has been the key development and the dollar is lower for the third consecutive day. If sustained, this would be the longest losing streak for the greenback in three months. The Australian dollar is straddling the $0.6900 level, where options for A$1 bln expire today. It is mired near this week's low, set yesterday near $0.6870. Australia's two-year yield swung back to a discount to the US this week after trading at a premium for most of last week and the start of this week. The greenback was confined to a tight range against the Chinese yuan below CNY6.70 today but holding above CNY6.6920. The greenback traded with a heavier bias this week and snapped a two-week advance with a loss of around 0.3% this week. The PBOC set the dollar's reference rate at CNY6.7000, a little below the median forecast (Bloomberg survey) of CNY6.7008. It was the fourth time this week that the fix was for as weaker dollar/stronger yuan.
The week that marked the sixth anniversary of the UK referendum to leave the EU could have hardly gone worse. Consider: The May budget report showed a 20% increase in interest rate servicing costs. Inflation edged higher. The flash June composite PMI remained pinned at its lowest level since February 2021. The GfK consumer confidence fell to -41, a new record low. Retail sales slumped by 0.5% in May and excluding gasoline were off 0.7%. Separately, as the polls had warned, the Tories lost both byelection contests held yesterday. And perhaps not totally unrelated, the Cabinet Secretary revealed that at the Prime Minister's request a position his wife in the royal charity was discussed. This continues a pattern that had included trying to appoint her as Johnson's chief of staff when he was the foreign minister and plays on the image of crass favoritism.
The risk of a new crisis in Europe is under-appreciated. In retaliation for Europe's actions, which in earlier periods, would have been regarded as acts of war, Russia has dramatically reduced its gas shipments to Europe. Many Americans and European who scoff at Russia's "special military operation" may be too young to recall that America's more than 10-year war in Vietnam was a police action and never officially a war. Now, the critics are incensed that Moscow has weaponized gas, while overlook the extreme weaponizing of finance. Aren't US and European sanctions a bit like weaponizing the dollar and euro? In any event, Putin has ended the European illusion that it would determine the pace of the decoupling from Russia's energy. Germany's Economic Minister and Vice-Chancellor heralds from the Green Party. The gas "embargo" has forced him to swallow principles and allow an increased use of coal. Habeck increased the gas emergency warning system and drew parallels with the Lehman crisis for the energy sector.
It is with this backdrop that the Swiss National Bank felt obligated to hike its deposit rate by 50 bp last Thursday (June 17). The euro had been trading comfortable in a CHF1.02 to CHF1.05 trading range since mid-April. Judging from the increase in Swiss sight deposits, the SNB may have intervened in late April and early May. However, in recent weeks there was no "need" to intervene and sight deposits fell for four consecutive weeks through June 17. The euro traded at three-and-a-half week lows against the franc yesterday, trading to CHF1.0070 for the first time since March 8. In fact, the Swiss franc is the strongest of the major currencies this week, rising about 1.15% against the dollar and about 0.75% against the euro.
The German IFO survey of investor confidence weakened again but did not seem to impact the euro. The assessment of the business climate slipped (92.3 from 93.0). This reflected the mild downgrade of existing conditions (99.3 from 99.6) and the sharper drop in expectations (85.8 vs. 86.9). This is the most pessimistic outlook since March, which itself was the poorest since May 2020. The euro remains within the range seen Wednesday (~$1.0470-$1.0605). It closed near $1.05 last week. There are options for almost 1.2 bln euros that expire there today but have likely been neutralized. Assuming the euro holds above there, it will be the first weekly gain since the end of May. Par for the course today, sterling is also trading quietly in a narrow half-cent range above $1.2240. If it closes above there, it too will be the first weekly gain in four weeks. Sterling's range this week has been roughly $1.2160 to $1.2325. The US two-year premium over the UK has risen for the Monday and is now around 110 bp, up from about 88 bp in the first part of the week.
Bloomberg's survey of 58 economists produced a median forecast of 3.0% for Q2 US GDP. Only five of them see growth lower than 2%. The median has it remaining above 2% in H2 before slowing to what the Fed sees as long-term non-inflationary growth of 1.8% throughout next year. The market does not share this optimism. The shape of the Fed funds and Eurodollar futures curve suggests investors sees the Fed breaking something sooner. Given where inflation is, it is hard to take seriously talk about the Fed front-loading tightening, what it is doing is catching up. But monetary policy impacts with notorious lag, and as several Fed officials have acknowledged, financial conditions began tightening six months before the first hike was delivered. The Fed funds futures strip has terminal rate around 3.5% by late Q1 23. The first cut priced in for Q4 23.
The US reports May new home sales. There are supply issues that are important here, but it will likely be the fifth consecutive monthly decline. Through April, they were off 30% so far this year. New home sales stood at 591k (saar) in April. At the worst of the pandemic, they were at 582k in April 2020. The University of Michigan survey was specifically mentioned by Fed Chair Powell at his press conference following the FOMC's decision to hike by 75 bp. The final report is rarely significantly different than the preliminary report, but it cannot help by draw attention.
Mexico's central bank unanimously delivered the widely expected 75 bp hike in its overnight rate to take it to 7.75%. It was the ninth hike in the cycle that began last June for a cumulative 375 bp. The move followed slightly firmer than expected inflation in the first half of this month (7.88%) and stronger than expected April retail sales. The key is that it matched the Fed's move. It indicated that it will likely move just as "forcefully" at its next meeting in August. The swaps market has almost another 200 bp more of tightening this year. Banxico also revised its inflation forecast. Previously, it saw inflation peaking in Q2 22 at 7.6% and now it says the peak will be 8.1% in Q3. It has inflation finishing the year at 7.5%, up from 6.4%. Separately, reports suggest the US is escalating complaints that President AMLO's energy policies, favoring the state companies, violates the free-trade agreement.
The US dollar rose a little more than 3.5% against the Canadian dollar in the past two weeks as the S&P 500 tumbled nearly 11%. With today's roughly 0.25% pullback, the greenback doubled its loss to 0.50% this week, and the S&P 500 is up about 3.3% this week coming into today. The macro backdrop for the Canadian dollar looks constructive: strong jobs market, better than expected April retail sales reported this week and firmer May price pressures. The market 70 bp hike priced in for the July 13 Bank of Canada meeting. The year-end rate is off four basis points this week to 3.41%. In comparison, the US year-end rate is off about 13 bp this week to about 3.44%. The US dollar is off for the sixth consecutive session against the Mexican peso. The peso is the strongest currency in the world this week, leaving aside the machinations of the Russian rouble, with a 1.8% gain, including today's 0.2% advance through the European morning. The greenback frayed support around MXN20.00 yesterday for the first time in nearly two weeks. It is spending more time below there today with a move to MXN19.96. A convincing break of the MXN19.94 area could signal a move toward MXN19.80. There is a $1 bln option expiring at MXN20.00 today, and the related hedging may have weighed on the dollar.
Disclaimerbonds yield curve pandemic sp 500 nasdaq equities monetary policy fomc fed home sales currencies us dollar canadian dollar euro yuan gdp interest rates gold south korea mexico japan hong kong canada european europe uk germany russia eu china
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