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The Current Macro Picture (Pt.1)
Hi guys! - Welcome back to Market Macro Hub. There’s a tonne to talk about, especially in this climate. So much so, this will be a trilogy breaking down the current global macro picture. In this piece, we will dissect the following: Global Growth, U.S Labour Market & The Tech Meltdown The IMF’s recent global outlook shows that global growth is expected to slow from 6.0% in 2021 to 3.2% in 2022 and 2.7% in 2023. Keep in mind that this is the weakest growth profile recorded since Covid-19, the GFC (Global Financial Crisis in 2008) & 2001. When observing growth I tend to focus on leading indicators as supposed to lagging indicators/hard data such as GDP, CPI & employment. Surveys are the most common form of leading indicators; readings such as ISM, PMI & consumer confidence provide a forward-looking viewpoint of current conditions. Let’s rewind and explain what this really means for those who may not fully understand. The manufacturing PMI index is a survey that simply measures the month-on-month change in economic activity within the manufacturing sector. Why this sector in particular? Well, it’s the most sensitive to changes in the economy from commodity prices to interest rates and usually, the manufacturing sector is the first to blow up in a recession. A great proxy for judging the cycle of an economy/ the global economy. When the readings are above 50 this is expansionary and vice versa for below 50 being contractionary. Across major economies exporting goods the overall trend has been bearish since July 2021 but remained above 50 which meant managers within the manufacturing industry saw signs of expansion and development within the economy. However, since April, there was an overall acceleration of the downward trend in PMI most likely caused by the uproar in inflation globally, succeeded by the most aggressive hike in interest rates by central banks globally. So what does this mean for equities? Take a look at Figure 2&3. YTD U.S equities have returned anywhere between (-20%) and (-33%) on capital deployed. Sure, you could blame the worsening macro picture, the rising of interest rates and the portfolio rebalance away from riskier assets and into safety but those aren’t the only factors at play. ISM, otherwise known as the Institute for Supply Management is a heavily overlooked survey showing comparable data points to the PMI index. Now, with a correlation near or even over 80% the ISM index is the best indicator of the U.S economy but moreover the direction of the S&P500. Simple business cycles leading the direction of U.S equity markets. As we’re focused on global macro we now need to employ second-order thinking; if the U.S, UK and Europe’s manufacturing industries are signalling signs of a slowdown, what is the source? Where is this coming from? The source of this contraction must also be the source of expansion , so we now need to look beneath the layer and ask. Who drives synchronised global growth? Bingo! China. So rewinding back to February when China enforced strict lockdown measures across Shanghai, affecting goods stuck at trade ports we saw the effect this had on supply chains globally. Consequently, if China slows down that has implications for Germany (a major manufacturer of goods & GDP contributor for Europe), the U.S, Uk and India. So forth and so forth. As a result, you see the chain and domino effect caused by one discrepancy within the global financial system. Yesterday, China's exports YoY came out negative (0.3%) against expectations of a 4.3% increase. Using second-order as a framework we can now put a picture together of the domino effect the markets may have. Add to that cocktail multi-decade-high inflation and numerous cracks within the global economy from a levered pension fund industry, to fragmentation risk in the Euro Area, to Canadian private sector debt, which currently sits at over 280% relative to GDP, a figure that is higher than the peak of the Japanese housing bubble in the 1980s! The moral of the story, we’re cooking up an already overheated economy and screws are starting to come to lose in different places within the global financial mechanism. I broke down on my last note how housing across the Uk, Canada and Australia are on the brink of cracking due to rapid rate increases. Labour As the global financial world enters the next phase of the downturn cycle we’re about to foresee, layoffs have been in the eye of major tech companies in hopes to preserve cash flow & earnings outlooks. It’s a bloodbath out there, with the most notable names Twitter and Meta being forced to cut thousands of employees from their workforce. Total nonfarm payroll employment increased by 261k in October whilst the unemployment rate rose to 3.7% . I’m not going to focus too heavily on the unemployment rate in the U.S as this is a lagging indicator which at the moment is only clarifying the fact that the U.S has bottomed out on the subject of unemployment; I expect to see this particular number increase as companies begin to feel the squeeze of conditions whilst the Fed continue to raise rates all the way until 5%. This is it for pt.1, but we’re back on Friday with an insight into: Thanks for reading! Finally, if you’re gaining knowledge from this could I ask you to share this with someone like you? It’s free game — why not ;) Until next time
Nov 8, 2022 · 5 min read
Everything You Need To Know From The Fed Meeting.
Welcome back guys, I know you missed me on Tuesday with the article; I was working away on a project which I’ll soon share with you guys… As for now, we will depict: As always lend me your attention from here on out Are We About To See A Fed Pivot? That’s the question most were trying to figure out from Jay Powell’s speech after raising rates to 4.00% from 3.25% , a raise of 75bps, the fourth consecutive rate increase of that size, as priced in by the market. To be direct, the answer is no. We are far from seeing a pivot, let me explain why. That sounds pretty hawkish to me if you’re going to ask. In the current situation we’re in, that being; rising interest rates globally, elevated inflationary pressures, risk of fragmentation within economies particularly with the Euro Area and rising debt vulnerabilities amongst emerging/frontier markets, the Fed avoiding the widely anticipated pivot in policy has both positive affects for the U.S but rather negative affects for other major developed economies such as the Uk, Euro Area, Canada & Australia. I’ll quickly dive into this now. Sensitivity to interest rates plays a monumental role within the decision making of central banks to either continue the fight against inflation or to pivot monetary policy to avoid financial conditions blowing up. Here’s why. Take the housing market , one of, if not the most interest rate sensitive sectors ; in the U.S, although mortgage rates are pushing 6%, the average existing home owner doesn’t have to worry about rising interest due to their fixed rate being 10 - 30 years . Meaning there’s no immediate effect as homeowners would have to wait until maturity until they are at risk from interest rate volatility. Now, the dynamic in the Uk, Australia and Canada are completely different to that of the U.S. The average rate of a fixed term mortgage in the Uk is typically a 2-3 year fixed rate mortgage as supposed to a 30 year mortgage in the U.S; meaning, there’s more exposure to interest rates volatility due to the shorter fixed rate period. In Australia the average fixed term is also 3 years and in Canada the average term is 5 years. So you can see, the interest rate sensitivity of the British, Canadian and Australian economies prevents their respective central banks from following the Fed on the path of aggressive tightening due to the overgrowing risk in their housing market imploding. From figure 1, I hope the picture becomes more vivid what the housing market will experience over the next 2 years as over 1.8million home owners in the Uk will be forced to refinance in 2023 at elevated rates north of 4-5%! So what effect does this have on the Pound, Australian Dollar and Canadian Dollar? Very simple answer, further weakening on the respective currencies. It’s a lose lose; you tighten monetary policy in line with the Fed your economy, particularly housing as outlaid, is the first to crumble, leading to a weaker FX exchange rate. You pivot to a dovish standpoint, you now stand to lose foot against the dollar due to the interest rate differential between the central bank and Federal Reserve as the Fed continue ahead with hikes. Back to the Fed meeting now. Here’s two more statements made by Jay Powell further reinforcing his hawkish stance on monetary policy: If I’m being honest, I was expecting a Fed pivot, I priced in the Fed moving in sync and unity with the smaller central banks that have begun to show signs of slowing down i.e the ECB, BoC, RBA. As always, you can never predict the actions of the Fed, now knowing how interest rate sensitivity influences central bank decision explains why we may have not seen an expected pivot; their most interest rate sensitive market can handle the increase in rates. However, I’d expect to see a sharp cut back in jobs across the real estate industry in the U.S but also globally as demand completely evaporates due to unsustainably high mortgage rates for those shopping for homes in the U.S and existing/new home searchers elsewhere across Europe & North America. Yields in the U.S fixed markets are soaring as investors are repricing the hawkish message and intent from the Fed moving forward causing the inversion across the 2s10s to widens even more. (Shown in figure 2 below) Not only did we get a repricing in the bond market but U.S equities extended losses with the Nasdaq closing Wednesday trading -3%!! An aggressive Federal Reserve means the equity market has even further room to sell off as major markets like the tech focused Nasdaq are caught with the issue of struggling to finance operations due to higher rates but majorly become instantaneously less attractive to investor’s as the present value of their future earnings declines. And for the general wider stock market, higher rates leads to less corporate borrowing , that feeds into lower production of serviceable goods , resulting in lower earnings come earning season. This is the idea of how rising rates affect equity markets as a whole. From today’s piece we have clarified the hawkish tone voiced from the Fed meeting which sent markets into confusion as a pivot was widely expected; the next question which determines how the global economy will function is something that Jay Powell said within his speech, now that we’ve seen how fast the Fed will move towards a restrictive policy the question at hand is: “How high to raise our policy rate” and “how long” should conditions remain at a restrictive level? Two questions that we’ll look to uncover in subsequent pieces. For those who aren’t familiar with what an inversion in bond yields means, I’ve linked a previous note on the importance yields play within the economy. Thanks for reading until the end guys! I won’t lie. This one took me a while! If you enjoyed it please show some love to the thread on Twitter & reshape on Instagram . It’ll only take 20 seconds, unlike this article haha Until next time Joe.
Nov 4, 2022 · 6 min read
Did Someone Say ECB Pivot?
Hi guys, glad to be back. In this piece we uncover: As always, lend me your attention from here on out! The ECB Hike & Potential Pivot? For the longest amount of time the Eurozone had been notorious for having their interest rates in negative territory; that was until inflation came in the picture. Ok, so let me break down firstly why a central bank would implement NIRP (Negative Interest Rate Policy) as well as the cause and affect relationship this has on markets. Negative Interest Rate: For the past decade, the Euro Area has utilised a NIRP; the main driving factor behind any central bank doing so is to provide monetary accommodation through the easing of financial conditions . What does that mean? Here’s the answer laid out. Loose financial conditions tend to boost credit demand for investments also portfolio rebalancing towards riskier assets and also consumption (i.e buying a house, a new car, or other discretionary goods). Low/negative interest rates also provide some fiscal space for governments to move budgets/payments around, therefore having a direct impact and increasing demand along with inflation. If you’re scratching your head trying to understand how lower interest rates affect/helps public sector finances aka the government’s budget here’s an explanation. Lower short-term and long-term interest rates make it cheaper for Governments to roll over their existing debt and issue new deb t; interesting isn’t it? So when rates are low managing public sector finances is smoother with less friction; in contrary when rates are rising/high it becomes increasingly difficult for governments to roll over and issue new debt, which is exactly why we had a sell-off/run in the Uk markets particularly the pound and gilts. Investors put two and two together; rising rates in the Uk + further government spending (expansion of government debt) = unsustainable interest payments , risk of something breaking within the financial model of the Uk. That’s how negative rates in ‘theory’ should work, of course, this is financial markets we are talking about, meaning nothing works in theory. Cases such as the Japanese economy represents the effect of an economy that has utilised both NIRP and YCC (Yield Curve Control) but failed to stimulate growth & inflation. But back to the point. The ECB was forced to move out of negative rate territory earlier this year as inflation surpassed all expectations, currently sitting at 10%. We first saw a hawkish committee that convinced markets they were in line with their mandate to return inflation to 2%, but as of yesterday, we saw what could be the beginning of the end when it comes to aggressive tightening with the ECB. We can see from this distribution of CPI within the Eurozone the biggest drivers have been energy (+40%) and food (+10%) , both driven by commodity shortages as well as ongoing feuds with Russia to supply gas. ECB Pivot & Euro Rates The only way one can judge whether we’re about to experience/see a pivot in central bank action can only come from the language of those who are in control. This statement above should send your thoughts back to Jay Powell’s press conferences where he removed forward guidance reverting to a “meeting by meeting” approach. This speech delivered a message lacking clarity on: But, instead sent the message that the ECB is already making “substantial progress” with their tightening of monetary policy. If you’re now asking; why would the ECB want to pivot? Here’s my view Fragmentation Risk I touched upon this in a previous article, but for emphasis on the current Euro Area, I’ll detail exactly what risk lies ahead, starting off with what fragmentation risk is. Within the Eurozone, fragmentation risk is the widening of sovereign spreads in some countries within the EU as the monetary policy system leads to interest rates higher. The risk here is that as rates across the Eurozone increase, so do the refinancing costs involved with each and every country, even the vulnerable ones like Italy particularly. To factor for this risk investors require a ‘risk premia’ and as this process happens the spreads on such vulnerable countries widen to a point where the goal of progressing monetary policy across the grouped economies within the Eurozone becomes delayed due to uncertainty surrounding the weaker economy’s ability to maintain financial stability. As the spread between German & Italian debt deepens the risk of a screw coming loose in the Eurozone economy magnifies exponentially; politically speaking the new Italian Prime Minister Georgia Meloni openly criticised the ECB’s decision in regard to monetary policy saying: Apart from fragmentation risk; the euro exchange rate has felt the short end of the stick this year already hitting parity. Figure 4 shows the spread (difference) between the Federal Funds Effective Rate and the ECB Deposit Facility Rate (Left Hand Side) and the dollar to Euro exchange rate (RHS). From the figure below, the trend is that as the spread between the Fed funds rate and ECB deposit rates widen, meaning the Federal Reserve is hiking rates at a faster rate than the ECB, the dollar appreciates against the euro as shown in the highlighted regions. Vice versa, as the spread between the two economies tightens as shown in 2008, when the ECB maintained rates at 2.5% and the U.S dropped to just above 0%, the euro experiences an uplift against the dollar. That’s the end of today’s piece, hopefully, you picked something up along this read! It’s been a hectic week but glad to be back, I was also a guest on a good friend of mine’s podcast so be sure to check it out here if you want to know a bit more of my back story! As always, thank you for the engagement and support! Please share on social media be that Twitter, Instagram & groups! Let’s get the MMH community to grow if you find my material valuable! Twitter - @JoeOlashugba Instagram - @Joe.olashugba Until next time Joe
Oct 28, 2022 · 6 min read
10.1% Inflation, Lack Of Truss In UK Markets
It feels like I’ve been stuck in a never-ending loop of drama with the Uk; inflation sustaining above the 10% figure, the ousting of Borris initiated by his own cabinet and now the 44-day rise & fall of Liz Truss. Comical to say the least… In this piece, we take a look at: As always, lend me your attention 10.1% Inflation, Again… Yes, again! This is not the first time CPI in the Uk that CPI has touched 10.1% , rewind back to July when we also saw inflation at 10.1%. If you ask me, things just keep on getting worse for the Uk; and there’s no sign of conditions slowing down. Let me outline to you very simply where we are: Back to the inflation. As it stands within the Uk, rates are sitting at 2.25% , the bond market is predicting rates within the Uk to hover between the 3.5% - 4.0% range in the near term (2-5 years). I personally see the Bank of England hiking rates throughout 23’ incrementally before being forced to start the process of quantitative easing once something breaks; the real question I’m wondering is. When is it enough tightening? To that you might answer, Joe that’s pretty simple when inflation is under control; to which I’d then question, what will we have to put markets & the economy through in order to achieve that? Inflation is usually driven by a few very simple factors; accommodative/loose financial conditions, large pent-up demand within the economy and of course increased productivity domestically but also globally as productivity drives growth, growth then drives commodity prices resulting in inflation. But as we all know, this isn’t textbook inflation. An ongoing war, restricted supply chains caused by continuous lockdowns affecting crucial trade ports that are relied on to satisfy demand and global energy prices through the roof. Just a few factors are at play; all of which have led to our current 10.1% inflation figure. Luckily the Uk is far advanced compared to the likes of EM (emerging markets) and FM (frontier markets) or else we would have had the recipe for hyperinflation. Hyper Inflation = Rapid inflation + a collapsing currency leading to a contracting economy The Great Demise For Liz Truss This is probably the most accurate representation of what has happened these past 4 weeks. After only 44 days Liz Truss resigned as PM of the Uk. However, she still walks away with £115,000 per year from the tax payer’s pockets for her ‘service’. What a gig to be involved in. Rather than diving into the politics I value getting a clear understanding of what is ahead for the Uk and where opportunities may lie. As a result of consumers’ finances being heavily hit due to cost of living inflation, from the cost of rental property all the way to the average basket of household goods, an expected slowdown in retail sales is already eminent within the economy as fears surrounding a looming recession drags an already weakened consumer confidence lower. The services sector represents the bulk of the Uk GDP, with declining spending and confidence, both with consumers and corporations the outlook points towards a needed recession. Now, the question that should be lingering within your head is. What exactly are consumers spending less of their money on now? Here’s the breakdown. For those who have seen their cost of living go up, the most common lifestyle changes they have made as a result were: here’s the graphical representation. From a first look, I would begin to raise some red flags if/when the % of adults using credit cards more than usual began to rise rapidly; rising rates and rising credit usage usually end with higher risk and potential for defaults on payments. Looking forward into the next 6-12 months, the Uk is about to experience further tightening and see a further withdrawal of spending from the consumer as living conditions worsen; sterling has found some feet as Jeremy Hunt, the new Uk Chancellor, has reversed the majority of the mini-budget plan. My focus will be on the upcoming BoE meeting to see their stance after such an eventful Sept/October. Thanks for bearing with guys I know this piece came out later than usual on a Saturday morning as supposed to Friday! But we got there in the end As always, share with a macro head and let me know your thoughts! I’m heavily active on Twitter & Instagram so please follow & reach out for anything! Twitter - @JoeOlashugba Instagram - @Joe.olashugba Until next time Joe
Oct 22, 2022 · 5 min read
How Pension Funds Nearly Blew Up Uk Markets
I’ve got to say, financial markets have seen it all these past few weeks here in the Uk… In this piece, we will uncover: Let’s dive in. How Do Pension Funds Work? I’m going to try and break this down as simple as possible, so lend me your attention as we uncover the event’s recently occurred. A pension fund, as you may already know, is a financial intermediary that provides retirement income pooled together from private/corporate pension plans. According to the Global Pension Asset Study, the global pension industry assets have grown to US$56.6trillion as of 2021; so if you were thinking this isn’t relevant to the equity, FX or alternative asset market, think again. Simply put, pension funds are in the business of pooling together capital today, in the form of assets, and investing those assets across markets in order to deliver an income (liability), to the pensioner over the long run (20 -30 years). Sounds straightforward, doesn’t it? Not exactly, you see, because these pension funds are invested over the long run in order to finance retiree’s income 20 to 30 years from now, this exposes them to three major risks: Now, due to the tenor of the bonds the pension fund would hold, mainly 20year & 30year instruments, rising or falling interest rates would have a drastic impact on the liability side of the pension fund. As you can imagine, in the past several years we have experienced ultra-low interest rates with tame inflation, meaning that the pension fund’s liability, being the future retiree’s income, wouldn’t be compounding at such a high rate = to the current interest rate. Just like a savings account, you want the interest rate on the account to be as high as possible, the same logic would apply to a pension pot, the higher the rate of interest the greater value of future income. What Does This Mean For Pension Funds? The obvious investment for pension funds would be 20year & 30year bonds, however, as mentioned, holding a fixed income instrument over a period of 30 years leaves room for risk as the central bank for the economy may decide to increase rates which would decrease the value of the existing bonds as their yield becomes less attractive. Now, this led to pension funds in the Uk, but also globally, seeking greater % returns on their portfolio; which led them to lever up their portfolios through the derivates market. If you’re not aware of what the derivates market is, it is simply the market for leveraged instruments such as futures contracts and options. On my last note , I mentioned how due to the HQLA (high-quality liquid asset) requirement, such funds have to allocate reserves to certain grade/quality investments & bonds: Now, using the 20y & 30y bonds on their books, pension funds would enter the derivates market/swaps in order to hedge risk but also make a greater return than low-yielding corporate and government bonds, in this scenario, gilts. Guess what was used as collateral? You guessed it those same bonds. The domino effect Now, some may say the issue was the fact that pension funds were levering up on some risky instruments whilst others may say the issue came from the Uk’s mini-budget. If you were to ask me, I’d point to both as factors at play; you see after the previous Chancellor Kwasi Kwarteng alongside the face of Britain, Liz Truss announced the large tax cuts and plans to fund the cuts with debt that sent fixed income markets through the floor. The worry that the Uk would not be able to finance such costs with debt and rates relatively high sent investors away from Uk fixed-income markets and that revealed the underlying liquidity issue. As pension funds began to get margin called due to the price of their bonds not meeting the collateral requirements yields on long-term gilts soared to as high as 4% - 5% , whilst bond prices lost as much as 52% as shown in figure 2 from December highs. As the pension funds were in dire need to meet collateral requirements to avoid being margin called and taken out of positions at substantial losses; they sold the most liquid assets they had on their books, be that bonds & even equities according to research. We all know the basics of economics, supply and demand right? That was the issue, there was no one willing to buy up Uk debt after the mini-budget, and the gilt market couldn’t handle the mass selling such that the Bank of England was forced to step in and purchase long-dated gilts to prevent Uk markets from collapsing catastrophically. The Bank of England was purchasing more bonds on both October 11th & 12th than it did the previous few weeks. Without the Bank of England, not only would there be a massive amount of pension funds closing shop and retiree’s losing their pensions but this one failure would have spread like a wildfire into equities, foreign exchange and the wider European/U.S fixed-income markets. I guess this is another lesson on how it takes just one mistake/event to trigger the domino effect! Thanks for getting to the end! Hopefully, you now understand with a bit more clarity what went down in the gilt market the past two weeks! We’re back on Friday & once again, reach out, share with someone and go through previous articles to level up! Twitter - @JoeOlashugba Instagram - @Joe.olashugba Until next time Joe
Oct 18, 2022 · 5 min read