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Is Uk & EU's Financial Outlook As Bad As Analyst' Reports Say?
I know a lot has happened these past 24 hours alone so before we dive into it quickly take a look at how the major economies are positioned. Not good at all. Painful Times Are Ahead For The Uk As you may have already seen, Queen Elizabeth II died yesterday at the age of 96. A sad moment for millions around the world, but a life well lived if you ask me. ‘Operation London Bridge’ is underway so expect a lot of changes to happen and on top of the Queen’s untimely passing, we’ve had a change within the parliament as Liz Truss took over her predecessor Borris Johnson to navigate the Uk out of what seems to be an unavoidable crisis. Liz Truss Announces Cap on Energy Bills Being a citizen of the Uk I must admit the recent weeks have really presented challenges as you hear projected costs of living and the cost of energy jumping by north of 80% from the month of October. Within her first week Liz Truss has sworn to cap energy bills to £2,500 a year for the next two years compared with the figure of £3,548 we would have been paying if not for the energy plan. Now, similar to the Covid-19 relief package there's always a tail-end of any support package, as this energy relief plan is expected to run into the billions for the Treasury. The question is, how will we pay for it all, taxes? Judging this situation from an unbiased view there’s little one can do to avoid any sort of extreme outcome as the current economic climate has deteriorated faster than one could have predicted leaving two outcomes. One, soaring inflation amidst uncontrollable energy inflation (due to Russia) or two, elevated inflation with more spending/debt incurred to finance such support to Uk Citizens. The strain isn't just being felt in consumers’ pockets, take a look at cable rates below. YTD the pound is down 17% , yes 17%. A price point of 1.16 Analysts across tier 1 banks have been calling for the pound to hit PARITY against the dollar! I would have never expected to see that in an analysts report but with the current array of financial conditions unfolding never say never. With the Bank of England expected to continue with it’s path of hiking there’s realistically only one way this ends, a deep recession within the Uk which resets everything. When glancing at all major economic indicators the picture worsens; the rule is manufacturing is the first industry to take a hit before a recession starts then housing . The reason being both manufacturing and the purchasing of new homes requires one thing. Accessible and attainable credit , which in an environment where rates are sitting at 1.75% and expected to go up only makes it increasingly difficult to finance such projects/ purchases. The knock on effect you may ask? Simple, we see that same conservative and fearful mindset, seep into retail sales as consumers step back on discretionary items flowing throughout the wider economy. So you end up with lacklustre growth, declining consumer confidence, negative real wage growth and elevated inflation. A perfect recipe for disaster. ECB Move Aggressively To Fight Inflation Frenzy Since the GFC of 2008 we have become immune to seeing Euro area interest rates so low across all three rates; however, yesterday we saw an unprecedented hike in interest rates with rates now sitting at 1.25%! The ECB hiked rates a substantial 75bps taking their deposit interest rate to 0.75%. After recent events in Ukraine it’s clear to say Putin has got the Eurozone at his mercy; cutting off the Nord stream pipeline and strengthening ties with China & India to redirect gas intended for the Europeans to his fellow trade partners. The second layer affects are due to stretch far and wide. You may be thinking; it’s only going to affect energy prices and inflation right? Yes, but think deeper on how the Euro area economy works, what drives its productivity. The ability to attain cheap energy and use that to produce manufacturing goods. What happens when you change the top funnel component which is the golden key? You get a whole new situation which is what the Europeans are awakening to. The central bank only has the ability to control monetary policy not individual, sensitive parts of an economy. As Ben Bernanke former Chair of the Federal Reserve said: For now, that’s all we’ll cover but next week we’ll take a deeper look at the energy crisis. Thank you for reading, for those who have been sharing thank you as well, we’re seeing an influx of new macro heads! I would love to hear from you guys, both topics you would like covered and even ideas; you can reach me on Twitter, Instagram, LinkedIn or email. Until next time (Tuesday) goodbye! Joe
Sep 9, 2022 · 5 min read
Let's Talk About U.S NFP Data
Before you say anything, I know exactly what you’re thinking. What happened to the article scheduled for Friday? Here’s the brief answer, I wanted to digest the NFP data coming out later in the afternoon, and being completely honest, writing a piece without covering such a crucial reading wouldn’t be the best value for the MMH community! Now, let’s get into it! Non-Farm Payroll Data & The Labour Market Friday we had the non-farm payroll data release, and once again the actual print beat the expectations of 300k totalling 315k job additions. Now, what I always tend to focus on isn’t the number of jobs added or whether the print "beat” or “missed” the prediction. That doesn’t really matter. What matters to me and what should matter to you is the below: Average hourly earnings. The reason this measurement holds more weight is because non-farm employment numbers only tell you the change in the number of people employed during the previous month; whereas average hourly earnings gives you a broader horizon to get a picture of how conditions are shaping up. Here’s how. If non-farm data beat expectations yet average hourly earnings are lower by 1% (YoY) . What benefit does that have to the economy’s GDP? What value is it to fill the labour market but employees aren’t paid well enough to spark activity within their domestic economy? Absolutely none. The point of tracking such data is to ensure that the labour market remains strong but, more importantly, average hourly earnings grow. So the next time you look at NFP pay attention to more than what the number is, look at how the % change in hourly earnings because that will tell you a lot about the health of the labour market. Unemployment Rate Hits 3.7% Unsurprisingly, we saw the unemployment rate tick higher shown in figure 1 to 3.7% . As a result of the increase in interest rates, we’ve seen massive layoffs across the U.S tech sector; names such as Paypal, Stripe & Robinhood. As it stands the federal funds rate is 2.5% and from figure 3 below we can see the expectations for the upcoming rate decision are tilted towards either a 50bps or 75bps hike. One reason I love looking at the CME FedWatch Tool (source for the above chart), is because you can see the live probabilities and changes in investors’ minds for the Fed funds rate. Predicated on what may be happening, you’ll see investors betting on either a low-size hike, i.e 25-50bps or a larger-sized hike leaning towards 75bps. Take a look at figure 4. Just over a month ago now, market participants were betting on a 25bps hike, probably due to the dovish comments we heard from Jay Powell on the “strength of the U.S labour market”, “neutral rates” and a ‘soft landing’. Shift your focus to 1 Week 26 AUG 2022. What happened that weekend? That’s it, The Jackson Hole summit. From this, we saw equities take a sell-off after listening to a firm message from the man Jay Powell that they will not make the same mistake as they did during the 70’s inflation peak. The result, a sell in any risk-on asset. Plus, Jay Powell basically put a 75bps hike back on the map again so that fuelled bets that we will see further aggressive tightening into deeper restrictive territory in monetary policy. The Dollar Surge The last run I can remember the dollar having like this must have been the rally of late 2014 which ran into 2016 causing many companies like Apple to cut their revenue and profit forecasts. For those who can recall a previous article, we looked at how one could have positioned oneself in a long-on-the-dollar ETF trade to bet on its inevitable appreciation against a basket of G10 pairs. That trade to date has delivered 14%, so believe me I’m just as gutted I missed out on such a good opportunity. Looking forward, I see a short on the dollar as a good opportunity for some alpha as we draw near to the end of the hiking cycle sometime in ‘23. The extension and bull run we have seen have been mainly attributed to rising global fears of war, a recession, an energy crisis across Europe and not to mention a widening interest rate differential between the Fed and other major central banks globally. To touch on the last point and the importance it has, put yourself in the shoes of an investment manager or a large body in charge of capital placement. The drivers of capital flows have all revolved around the stability and growth potential of a nation; meaning the political policy, monetary policy, GDP outlooks and growth. So when eyeing up the U.S economy against other G-10 nations you can see why it would stand out and attract the large majority of capital flows. Number 1, the U.S doesn’t have the basic energy exposure many of the European countries have, 2, the U.S when compared to G-7 nations has a politically sound policy. Take a look at Italy and you’ll understand the importance of that point, Italy has been hit with the brunt of the stick both politically and with inflationary and other economic conditions. Finally reason number 3, the U.S is simply ahead on the tightening cycle within financial conditions so the U.S presents the safety of capital and a good yield. So, due to these fundamental and economic drivers, the flow of foreign capital has found a haven in the dollar which has paid dividends. Coming out of this I am keeping an eye out for the other side. I’ll leave you with this quote from Ken Griffin: Appreciate you as always for reading until this point! Do me a favour and share this with someone you know will pick up some value, subscribe and share your thoughts and ideas with me on Twitter, LinkedIn or Instagram! Until next time
Sep 5, 2022 · 6 min read
Say Goodbye To Any Hopes Of Financial Easing: Jackson Hole
Firstly, glad to be back. Last week I didn’t want to write up some material that I knew wouldn’t provide the most value/insight into what has transpired across global markets, so I gathered some thoughts over the week for you guys today! Let’s unveil the Jackson Hole meeting. Now if you don’t already know what this is, the Jackson Hole event is an annual economic policy conference compromising of major central bank members, policymakers, academics & economists from around the globe. They convene to discuss economic issues, implications and policy options; if you ask me, it’s the most important economic event held each year. Earlier this week I was reading a note by Macro IQ and came across this great explanation of why we’re seeing financial conditions loosening even whilst ‘tightening’ monetary policy Now take a look at Chart 1 for confirmation. And if you need reminding remember when the U.S Government decided to change the definition of a recession? Sounds like you’re trying to leave the elephant in the room unannounced if you ask me… For those who are frequent readers of Market Macro Hub, you’ll already be fond of this index by now. I tend to look it at frequently to gauge how financial conditions are reacting in real-time as this reading is updated weekly to keep up to date with rapid changes in asset markets. If you’re new to this index let me quickly explain: The National Financial Index provides a weekly insight on financial conditions in money markets , (liquid securities <1-year tenure, e.g FX, T-bills & commercial paper), debt & equity markets also traditional & shadow banking systems. The idea is that when the national financial conditions index is positive (greater than 0), this is historically associated with tighter-than-average financial conditions . And when the national financial conditions index is negative, historically this is associated with looser-than-average financial conditions . So back to Chart 1; as Bill Ackman correctly said even though the Fed has been going through back-to-back rounds of tightening at each monetary policy meeting; one question remains. How is it that conditions are still materially weaker? A very simple question to answer, retracing Jay Powell’s comments and U.S equity market performance there’s a clear alignment between his dovish comments and what most deemed either the “bottom” of the equity slump or a “bear market rally”. Now, combined with strong corporate earnings, shown in Chart 3 , comments from Jay Powell such as the below is a major influencer on markets: Now let’s hold on just a minute, if you recall the Fed’s SEP (Summary of Economic Projections) we can see that the long-run interest rate expectation is 2.5%, however, to say we’re at the neutral rate when inflation is 8.5% and expected to increase this fall is what really gave risk-assets and investors wind in the sail to pick up meme stocks, crypto and other high risk/high beta investments. So, from the Jackson Hole meeting, Jay Powell made it very clear that the Federal Reserve will not make the mistake of stopping the tightening cycle too early and will continue to press ahead with large hikes. We can now look forward to the potential of a 75bps hike at the next Fed meeting in September. What does this mean for equities and other risk assets? I see equities falling back into a bear market/sluggish performance & the appetite for risk-reducing drastically. Just by observing Chart 1, we can see the major contributors to the easing in financial conditions have been the increased access to credit and leverage, both of which are heavily affected by how the Fed is positioned towards future growth and inflation. There are a few other fundamental readings that stay on my radar when it comes to observing where we’ve been and where we’re headed in the macro picture: Yield curves are one of the most important readings I look at, mainly because everything is derived from where the yield curve is. Say you want to get a mortgage from the bank; where do you think they get the rate of interest from? Treasury yields. The same applies to investors, pension funds, and private market participants in the VC & Private equity markets. If yields are relatively low, investors’ risk appetite is heightened since there’s little real gain when adjusted for inflation, investing in government debt. So they may expand their horizon to look at corporate debt or even riskier investments i.e, a VC investing heavily in multiple startups. Something we saw over the past 2 years, has come back to bite a few large names notably Softbank’s Vision fund which lost $23.4 Billion. The point is, in a world where everything revolves around the ease of access to credit, where we bring forward tomorrow’s purchases to today, make sure to keep an eye on how things are lining up. Looking forward as the Fed and major G7 countries begin to accelerate their quantitative tightening process the effect we will see on yields is likely going to be a curve flattener as investors will price in the scenario of global growth demising completely, demand destruction, and elevated food & energy price pressures during a recession. You’re probably thinking why would this cause yield curves to flatten? It’s straightforward, as investors price in further rate hikes leading to a recession, the front-end of the yield curve will steepen due to investors' anticipation of higher rates in the short term. On the long end of the yield curve, investors will now price in lower interest rates due to the expectation that the economy will be recovering from a recession, meaning low growth and productivity , requiring monetary policy to be accommodative/loose until we enter the next business cycle. The next thing is to look for a trade opportunity, upon building further confirmation of this playing out. Of recent, we’ve seen some good trades play out in the market, particularly longs on the dollar ( UUP ETF), an ETF that longs the USD and goes short against G10 Basket. YTD returns roughly 13% , seems like the saying is true. When all else fails, turn to the dollar, simple yet effective. I’m going to list a few other fundamental indicators that I’ll touch upon in later pieces and that you should be keeping an eye on. Readings covering home sales, home building, construction spending, labor market, raw commodity prices, manufacturing/ISM readings, credit spreads &retail sales. Without getting to intricate and moving into the more complex readings like OIS Swaps and other readings, these key fundamental readings are the bedrock of building that narrative we all desire in the market. That’s enough info from me today, I’ll be posting articles every Tuesday and Friday moving forward! So look forward to some consistency. As always thanks for reading until the end — Until next time Joe - MMH
Aug 30, 2022 · 7 min read
It's All Under Control...Right? (Inflation)
Now, depending on what side of the political party you’re on the most recent CPI figure was either 8.5% or 0%. Let’s take a trip down memory lane; otherwise known as a period where inflation wasn’t north of 3%. We can see where it all started from, April ‘21 was the first reading where we saw a huge print relative to the previous decade of sub 3% inflation prints. Now, this was the time period when the word “transitory” became a term widely used by members of the Fed (Jay Powell). As we know, CPI is a lagging indicator and also a measurement that is heavily manipulated by the BLS, due to them regularly swapping items within the “basket of goods” used to measure the MoM & YoY change of inflation. What I want you to start thinking of, is how the current macro landscape will shape the upcoming inflation readings for September all the way till year-end both in the U.S and globally. And for us Brits, here in the Uk. Questions such as; These are the types of questions that will develop your ability to recognise trends in the macro world and begin creating somewhat of a narrative. Trust me, it’s a long game. Back to the topic, inflation. After seeing what seems to be the peak in inflation we’ve now got risk assets booming as if we’re back to the golden ages in economic conditions. Just take a look at Chart 2 to get an understanding of how financial conditions have materially loosened since the inflation print. Looking at the previous week just further re-emphasises the fact that conditions are loosening when in actual fact, conditions should be getting tighter as the Federal Reserve hikes interest rates. So if financial conditions are loosening that means we’ll be seeing credit spreads tightening, making credit widely accessible once again. Something you would not want if the economy is already overleveraged and inflation is at multi-decade highs. So leading on from my previous article you can now begin connecting the dots on how markets are disconnected from reality. A period many call Goldilocks within financial markets. Chart 3 will bring to life this statement: Now, the above chart calculates the spread between an index of all bonds in a given rating category and a spot Treasury curve . (Bonds rated BBB or better). You can see credit spreads peaked at the start of July and since then have been dwindling rapidly. The current tightening in credit spreads & sudden excitement within high-beta stocks (high risk relative to the S&P) just goes to show how markets are perceiving this to be the beginning of the end for high inflation. Is it? In short, no. Far from it. It’s pretty clear that the way we kill off inflation can only be through a recession; just to provide some context the manufacturing industry is always the first to get hit when a recession starts, along with housing. And that is purely due to loans being so expensive and the cost of capital running high fees, all these factors make it difficult for a business to start new projects. This prime lending rate is the average rate of interest charged on short-term loans by commercial banks to companies. This is what makes it harder to pursue and fund new projects, and moving onto the housing market yesterday we saw the sixth consecutive decline in existing home sales . With mortgage rates in the U.S peaking at around 6% in the U.S you can imagine why home sales would be running such low figures. Double Digit Inflation, Uk… It would be completely wrong of me to disregard what we’ve seen this past week with inflation data from the Uk. Does this 10.1% reading come as a surprise to me? Not at all. If you recall my previous note on the “5 negative quarters” we’re expected to see here in the Uk you’ll remember the BoE’s prediction that inflation would reach as high as 13% this fall. So let’s lay out the facts; we know exactly what is contributing/leading the inflation figure higher, we know CPI readings are only going to get worse as we enter winter and we know that the Bank of England is positioned to continue raising rates. It’s pretty much the same story in the Uk as it is elsewhere around the globe, see how high you can push rates before something breaks. As of today, cable rates sit at 1.19 , at the start of the year rates were around 1.37 which is a massive 18% depreciation in the pound, mainly due to sentiment and other factors such as interest rate differential when compared to the U.S. The first thing that comes to mind in these situations is a carry trade, between a low rate/yielding country and a higher rate/yielding country as that presents the best opportunity for this type of trade. With the pound, although the opportunity is there it wouldn’t be the strongest of trades for one to look at moving forward. As the inflation figure continues to rise and conditions materially weaken in the Uk we’ll see how the BoE position its stance on further rate hikes. If you ask me? We’ll see them slow down and cut rates sooner than what’s expected or been said. Thank you for reading, for those who have been sharing thank you as well, we’re seeing an influx of new macro heads! As usual, share this with everyone & let me know what you want to see in the articles! Until next time
Aug 19, 2022 · 6 min read
The Current Global Macro Picture
I don’t know about you guys, but sleep hasn’t been so good recently. Let’s unpack what the current macro landscape looks like; I must say it is getting hard to constantly keep up with everything going on globally. BoE “Five Negative Quarters To Come” Last week we heard forecasts from the BoE predicting the Uk to enter a recession from Q4 ‘22 . As we’ve all seen from the Fed, central banks rarely tell the truth when it comes to the reality of how bad things will get. “Transitory” and “temporary”, both terms we soon came to realise were lies from Jay Powell. However, the BoE is embracing the fact that the economy is going face-first into a period of prolonged turbulence. As it stands right now, inflation is sitting at 9.4% and is expected to top 13% in Q4 of the year as gas & energy prices become evermore costly to Uk citizens. On the note of gas prices, we can expect the price cap to rise by around 75% in October compared to around 40% in the May report sighted from the BoE. Take a look at the data for components contributing to UK CPI; you’ll see exactly where it’s all coming from. I know it’s pretty difficult to read with the massive data label but you understand the meaning when seeing inflation broken down, component by component. The biggest factor at play, you guessed it, household services (gas & electricity). Now you’re probably looking at transport thinking what’s the reason it’s added an extra 1.5% to the annual inflation rate, well the reason ties back into the elevated petrol costs we’re experiencing at the minute. Such changes have ripple effects that aren’t susceptible to only one sector but the wider scale economy. Just take at Chart 3 below to see how ridiculous things have gotten in petrol prices. Historically we can say unleaded pump (the most popular form) has ranged between 110.00p - 131.00p. From the range highs of 131.00p until now unleaded pump prices are up 38.9% . That’s on the lower end… So from Jan ‘21 until now, petrol prices are up 56% . Multi-decade high petrol costs, rapidly rising interest rates and a low/negative growth economy, a recipe for a disaster if you ask me. The good thing is we can see what proceeds with every peak in prices, sharp decline. Investors’ Risk Appetite Shifts Back To High-Risk Assets One chart that caught my eye after listening to a macro podcast was the NFCI, which is the National Financial Conditions Index created by the Federal Reserve Bank of Chicago; a release that comes out every week. This index provides a weekly update on U.S. financial conditions in money markets , debt and equity markets and the traditional and “shadow” banking systems. Now for a quick breakdown; the idea is that when the national financial conditions index is positive, as shown in 2008 & 2020, this is historically associated with tighter-than-average financial conditions . And for negative values historically this is associated with looser-than-average financial conditions . So looking at chart 5, 2008 the U.S economy experienced tighter than average financial conditions which shortly declined to a financially looser than average period in markets. Then fast forward until 2020, the peak of covid where we had a sharp tightening in conditions mainly caused by fear/worries and panic over global growth. Now if we are to take a closer look at more recent data, the past few weeks particularly the last two weeks have presented some very interesting messages to asset markets. *Mic drop Now I hope you’re understanding the direct importance such press conferences have on financial markets/conditions. Over the past three weeks, we have seen financial conditions materially loosen which has sent investors seeking risk assets. Look at equities over the past few weeks, names such as Coinbase and Uber are just a few to name who have felt the massive (short-lived) optimism of markets. Bear in mind Uber reported its first positive cash flow quarter ever and it’s up north of 40% this past month. If you ask me Jay Powell is having another moment he might want to forget, although it’s always easier looking in from the outside. What we’re seeing right now is a disconnect between what is actually happening globally, supply chain issues, energy prices set to push inflation to double digits, and even lacklustre growth and what investors are pricing in within asset markets. I won’t even go into what’s happening within bond yields but inversions across the 2s/10s yields are showing just that. The front-end yields are loaded with hikes to kill inflation, whilst backend yields are lower in anticipation of lower growth/lower rates. All in all, there seems to be a bit of fog and smoke appearing. At the end of the day, as Seth Klarman said, the most important thing is whatever decisions you’re making, you’re able to sleep peacefully at night with them. Thanks for reading through to the end. I put a bit more depth within this piece and would appreciate you sharing it with everyone and anyone; the Market Macro Hub community is growing rapidly and I can only thank you guys! Until next time.
Aug 10, 2022 · 5 min read