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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
Rate Hikes Galore
BoE’s Rush To Kill Inflation Let’s talk markets. Up until now, the Uk has maintained an extremely accommodative monetary policy stance with rates at or just above 0% . So if we’re speaking about real interest rates (which accounts for inflation during a period of time) then we have really had negative rates since the GFC (Great Financial Crisis) in 2009. For those who may not be familiar with real/nominal rates; let me quickly break that down. Nominal interest rate refers to the rate of interest before adjusting for inflation; e.g if a bond is paying 2% per year then the nominal rate/yield would be 2% as we wouldn’t need to adjust for any other measurement. Real interest rate as you can assume by the name refers to the rate of interest after adjusting for inflation. So with the same example if inflation across that one-year period was 3.5% then the real interest rate earnt on that bond would be -1.5%. Pretty straight forward right? Negative real interest rates are considered to be accommodative to the wider economy, allowing credit to flow easier within the financial system. As Ray Dalio correctly said we live in a credit-centred economy where we bring forward tomorrow’s expenditure to today. And that’s exactly how we end up over-leveraging up until we fall into a credit crunch, but that’s not where I’m going for today! Currently, the base rate is sitting at 1.25% across the Uk with markets pricing in a hike of 50bps today at noon. Now, something I’ve been paying a bit more attention to is the bond market, mainly because it’s frankly a great forward-looking lense on where investors price rates to be in the future. Now, I’m no pro on the bond market but it doesn’t take an economist to see a potential flattening in the yield curve as conditions continue to weaken in the economy, let’s put it at a 40% probability. FYI, investors, banks & literally everyone pays massive attention to what yield curves are doing as longer-term yields should be higher than shorter-term yields due to the increased risk associated with holding a bond over a longer period of time things such as rate hikes, inflation etc make investors require a risk premia on such term investments. From where we are now I see an ever-increasing chance of a curve flattening in yields, meaning the economy is entering prolonged stagflation/low growth which would force the central bank to keep rates low or even cut back on the hikes we’ve recently seen. Unless we get a super-sized surprise from the BoE, which I doubt but do not completely rule out, the pound is probably well priced at 1.2100 RBA Goes All In. A wise man once said “don’t hate the player hate the game” — That wise man may as well be this man right here, Philip Lowe. What a guy. In response to a tonne of outcries for him to resign Philip Lowe presses forward with his belief that tighter monetary policy conditions are required to cut inflation at its knees. As it stands rates in Australia have risen back to back, meeting upon meeting to 1.85% as of Tuesday morning where rates were positioned at 1.35% before an additional 50bps was added onto the base rate. Now although the RBA may not be one of the “major” central banks everyone pays attention to it’s still equally important to have an understanding of what central banks globally are doing and how they are reacting to this chronic pain of inflation globally. Thanks for reading all the way through! As usual share with your macro heads and I’ll leave you with this quote; that applies to life and investing/trading:
Aug 4, 2022 · 4 min read
Two Negative Quarters, Recession Finally Here?
Is it official, that the U.S is in a recession…or is there more to the story? According to widely accepted knowledge, a recession is defined as two consecutive quarters of negative declines in GDP, which we have seen in the U.S after Thursday’s reading. That was until Jay Powell decided to change the definition across the web; problem solved right? No. In Q1 the U.S economy's GDP figure declined at an annual rate of 1.6%, and over the last three months declined by another 0.9% . However, that is not an official definition of a recession, let me explain what is; A non-profit organisation called the National Bureau of Economic Research defines a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months”. Ok, so now that we know what an actual recession (officially) is, let’s look at what Jerome Powell had to say in response to comments about the U.S sliding straight into one. Typical Powell, to boast about the state of the labour market which we both know is a lagging economic indicator and as we have been seeing across the news prominent corporations like Robinhood , Netflix and Shopify are just a few of the many Technology firms being forced to fire/cut employee numbers due to economic conditions tightening up. So the question to ask is when will we begin to see job layoffs impacting the wider Non-farm Payroll data figure we’re seeing? Now that we’ve opened up the floor let’s take a look at the Fed hike and the message perceived by the markets. We saw the Fed hike rates by 75bps which was pretty much priced in by markets, what wasn’t priced in was the dovish comments made by Powell which sent risk assets rallying. So if your equities or crypto holdings are up, thank Jay Powell :) After reading the transcript of Jay Powell’s conference this week here’s what stood out to me: Powell acknowledged the fact that the unemployment rate is currently sitting near a “50-year low” , which although that sounds good from the outside looking in, we have to understand that his goal and overall purpose is to deliver his speech with the utmost confidence in the labour market further backing the actions the Fed take; however, the markets picked up on the dovish comments made by Powell which I’ll highlight later in this piece. Starting with the labour market I’m seeing a consistent increase in the initial jobless claims, showing more people filling for unemployment on a weekly basis which could be a sign of cracks appearing within the perfect labour market Powell keeps rambling on about. Not only is the outlook looking weak in employment, but a look into pending home sales provides a leading insight into how consumers are pricing up the market for purchasing new homes. If both the housing price and mortgage rates are looking attractive then you can expect a higher number of pending home sales across the U.S and the exact opposite for unpleasant conditions. The latest reading came in at -8.6% , the worst reading we have seen since early March ‘21. It’s clear to say we are already experiencing demand destruction across the U.S with pending home sales declining rapidly as well as new home sales. This shouldn’t come as a surprise considering where 30y Treasuries are at, taking a mortgage out in this environment would be crushing to your pockets. I said I would cover it so here it is, bare with me… Post the Fed Interest rate hike you would expect equities to shift lower and borrowing costs in yields to steepen right? That wasn’t the case and the reason why is statements such as these from Jay Powell: Both statements have indirectly told market participants that we will no longer be looking to hike aggressively above the neutral rate into the restrictive territory; so you can start buying up risk assets since the bad days are over. So in this hiking cycle, Powell has given equities, crypto and other higher-risk assets room to rally with such comments; if there’s one thing we know about inflation is that it’s like a helium balloon, easy and quick to go up but painfully slow to go down. Moving forward I’ll be watching closely how leading/lagging indicators line up giving me a clue on how conditions are shaping up and what that means for the Fed meeting in September. As always, thanks for reading this! Share with your macro heads in your group— much appreciated.
Jul 30, 2022 · 5 min read
Let's Talk Eurozone Economic Conditions
Ok, it’s final. They’ve moved from their negative stance on all three key rates, about time… So let’s dive into what’s really going on in the Eurozone. For the first time in 11 years, the ECB hiked their interest rates by 50bps, taking its rates out of negative territory. Now the hike came at somewhat of a surprise considering markets were pricing in a 25bps hike after hearing from the ECB that they would ideally like to ease into the interest rate normalisation process. Now, although the hike we saw from the ECB was more than what we expected it’s clear to see that markets, particularly bonds didn’t agree. When a central bank tightens its monetary policy, usually we see spreads on bonds decrease/tighten. However, in this particular scenario, we had a widening as shown above. Now, this is simply telling us that the bond market doesn’t believe in the ECB’s ability to navigate this hiking cycle until the point where inflation is no longer a problem. I listen to quite a few good macro voices in the space and the common message is that we’re seeing a curve flattener in Eurobonds. To just clarify, this is why a flattening curve is a bad thing for the economy and sentiment: Before I define what a curve flattener means for the economy let me just say this; bonds are forward-looking instruments, 5y bonds reflect investors’ expectations for the interest rate in 5years . All in all, that shows that investors see economic conditions to be sluggish for the medium-long term as rates will be either lower or the same. So in the case of the ECB, investors aren’t fully believing what Lagarde has to say to us. With the Euro hitting parity against the dollar, it’s pretty hard to see things brightening up for the Eurozone as a whole. Now the ECB has also implemented a new tool called TPI, which in laymen's terms has been introduced to prevent the widening of borrowing costs across the Eurozone, particularly in countries such as Italy, the main culpr i t , Portugal and Spain, and even Greece. What this tool will aim to do is prevent further widening of spreads between countries such as the ones mentioned above; however, with turmoil politically in light of President Draghi’s resignation, the ECB will not be able to stop the uncertainty spilling over into the credit market. I know, it sounds all grim for the Eurozone doesn’t it? On a mixed note, Russia and Ukraine have agreed to release millions of tons of grain piling up on ports since the invasion began. As we know, here in the UK alone food prices have rocketed 9.1% already! That’s based on what we’re told, so we know the figure is already double digits. So with this agreement hopefully we can see a reduction in food prices over the next 6 - 12 months as there’s a delay in how these circumstances evolve into our financial system. Although this was already a signed deal at the time, Russia thought it worthwhile to attack (bomb) the Odesa port after the agreement to resume the trade of grain globally. Remember, 40% of global wheat(grain) comes from Ukraine alone, now looking at the recent CPI figures ( 9.4% in the Uk), what has predominantly been an issue alongside fuel and gas costs; is food prices. If supply chains can get going in full motion we should hopefully start to see a gradual decrease in the food element of inflation over the next few months; my worry is as we approach winter the true force of fuel prices will show its strength cancelling out any reduction we have in other inflationary entities such as food. Now, a quick sidenote and alert that by the time you’re reading this the Bank of Japan would have already met; if you recall my previous article touched on the importance of the BoJ; so expect me to highlight a few things from the meeting. I’ve had a few good weeks to settle other work but feel glad to be back to some sort of routine with my articles; I will be back this week for sure! Thanks for getting through as always! — Any recommendations on pieces or topics send them my way
Jul 26, 2022 · 5 min read
How Aggressive Will The Fed Have To Get?
One Long Inflation Nightmare Last week Thursday was a colourful day, to say the least in markets. Inflation readings for the U.S came out at 9.1%, multidecade highs; but what really stole the show was the Bank of Canada. A surprise 100bps hike came out of the Canadian central bank which rocked FX markets, particularly CAD crosses. The reasoning behind that, well I’m sure you can imagine…kill off their 7.7% inflation figure. With the 9.1% print for June’s inflation, markets are repricing their expectations for the next Fed hike. Just take a look at the image below. Prior to the June inflation print, expectations that the Fed would hike into the 225-250bps range were >90%, after we got the reading notice how expectations have pivoted to now ruling in a 100bps hike from the Fed which was unlikely with <12% probability just a month ago. So to answer the question; “How aggressive will the Fed have to get”. The answer the market is giving us is very aggressive; to a certain degree, I also agree the Fed will really have to tighten to its target rate of 3.4% before we see any real decline in inflation readings. The bond market also agrees, with inversions across the 2s & 10s sighted once again. So on the long end of the yield curve, this hiking cycle is flattening yield curves. If you’re thinking why is this bad, let me quickly explain. If you were tomorrow to take out a loan from the bank to purchase a home (mortgage) over a 30year period with a rate of 4.00% (current mortgage rates in the U.S), and John was to take a loan out for 5 years with a similar rate of 4% that essentially means you are paying the same to borrow money for 5 years as you would for 30 years when the term/rate for 5 years should be less than the term for 30 years since there is more risk/exposure to rate changes or another inflation scare so one has to account for the added risk. Markets clearly are expecting a steep period of tightening followed by easing where rates will be close to 3% in the long run. All this hiking must be doing something to the dollar right? That’s correct. Now, remember, everything is interlocked from FX to Bonds/Credit, to Equities and even commodities. We’ll look into the finer detail of what a strong dollar means for corporate earnings. Let’s rewind back to 2014; AAPL’s 10k filing (Apple) mentioned the below: A strong dollar hurts corporations’ earnings ability as a strengthening dollar cuts into their bottom line as exchange rates are no longer favourable for healthy margins. So businesses are faced with a trade-off, allow the exchange rates to eat into their bottom lines or hike prices to offset the currency exposure. In the case of Apple, the strengthening dollar caused them to raise prices in 2015 across stores ranging from Australia, Canada, France, New Zealand and other EU-based countries. So looking forward as we always do, corporate earnings will become less attractive as we see the full effect of a bullish dollar. Generating Alpha Now for the most part, and by most, I mean a large majority of institutions and retail traders these conditions have proven to be difficult to trade/maintain positive real returns. This also applies to the hedge fund industry. You can see here that the major strategies applied by hedge funds haven’t played out as they would have liked or even forecasted to investors. One umbrella strategy seems to be doing well which is Macro & CTA. So not a bad time to be learning macro at all I’d say… In all seriousness, we’re experiencing market conditions that haven’t yet been experienced when combining all the global events occurring at once. Be wise with positioning and leverage in conditions such as these. Thanks for reading once again! Always appreciated Until next time
Jul 19, 2022 · 4 min read