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Inflation...Here To Stay?
The ECB’s Commitment To Stop Inflation As we have heard over the quarter, the ECB has initiated rate hike talks with expectations priced in for the following meeting in July to be the start. Now let’s look at FX rates. From recent highs, euro-dollar is down 3%; now you might be thinking why is that the case? Wasn’t the ECB fairly hawkish in their meeting? In short, yes, initially they made hawkish statements. However, a lack of clarity always finds a way to settle into markets. Now if you recall the ECB stated that if things turn really sour they will step back into the European bund market. So that was the loophole for uncertainty. If you ask me, there’s a clear disfunction between what the markets believe and what message the ECB is delivering. As it stands there is no guidance on where we can expect the terminal rate to be for the ECB… Is it 2%, 3%? We’re all playing a guessing game and the markets are showing that. Eurodollar FX rates are down 3% over the week, Euro bund spreads are widening across all maturities, yield curves are flattening and European banks are down 7% for the prior week. Now, just in case you’re not clued up on the basics of what shape yield curves should be, let me break that down. A normal yield curve should have a nice upward slope, longer-term yields should be higher than shorter-term yields and I’ll explain why. A nice positive upward slope means that you are paying a higher rate to borrow money for a longer period of time than for a shorter period of time . So when you hear of a yield curve flattening, this means that you are paying the same amount to borrow money for one year as you would for 5 or 10 years depending on the curve. A positive upward slope is a sign of a healthy market, anything else isn’t. I merely keep a top-level understanding of information like this to help paint a better picture. I’m still composing a piece on breaking down the bond market, particularly the importance of US10ys; that’ll be done soon. Jay Powell And The Fed…What To Expect This feels like a movie sequel that I’ve been waiting months for. I know we all saw the CPI print released on Friday. For many analysts, the print of 8.3% was meant to be the “peak” of inflation. Clearly not. With this chart above in mind take a look at what has contributed to the massive beat in the inflation print. Energy, energy and energy. That’s where the U.S consumer is losing the majority of their spending power, this is also true for us in the UK. Whilst there’s super hot inflation in the U.S, China’s CPI reading stalled at 2.1% YoY for May. The struggles in China are growth-related due to its strict no Covid policy, so turning the production cycle back on is an evergoing question of when will that happen. So, we’re expected to see a 50bps hike by the Fed this Wednesday to take rates into the 1.5%-2.0% range. This has been telegraphed by markets as equities and bonds took a massacre last week. If one was to look at the above chart the clear trade would be precious metals/commodities. Although there have been talks about the relative discount perceived in individual equities, the larger picture for normalisation in equity valuations and readings looms over the optimism. I’ll check in by the end of the action-packed week for some insights. Don’t forget the BoE and BoJ have their interest rate decision later this week. Remember the importance of the BoJ for U.S treasuries but also global markets! Catch you soon
Joe Olashugba
Jun 14, 2022 · 4 min read
Pressure On Central Bankers
Kuroda Presses Forward on Quantitative Easing If you’re thinking why are we looking into BoJ’s monetary policy stance? Then hopefully this can bring some light to your understanding. Simply put, if not for Governor Kuroda and the BoJ doing what they have been doing, with QE, in the current environment bond yields would be through the roof and tech stocks would be finished. Something I took away from Weston Nakamura, he’s got a great viewpoint on macro topics; nonetheless, it’s the truth, the single largest holder of U.S treasuries is the BoJ. So ask yourself this, providing the BoJ were to move away from their loose monetary policy what would the ripple effect be in global markets? What’s the reason for the massive losses on Yen crosses? Simply, investors are shifting their focus toward the ever-widening interest rate differential between the BoJ and Fed among other central banks. If you are a central bank or a large financial institution, say a pension fund or asset management firm and you have FX exposure on your books, the last place you would want to hold that would be in a currency like the Yen as their interest rates are negative 0.1%. Instead, you would look at the likes of the U.S, even the UK with rates now at 0.75%; it all revolves around opportunity cost and where the best yield/safety of principal lies. So as long as the BoJ keep its monetary policy loose and major central banks continue hiking we can expect to see weaker Yen rates. Remember, everything is interlocked. RBA Hikes Rates The RBA is another central bank that is known to adopt Yield Curve Control as a tool to support monetary policy. The RBA announced in March 2020 that it would buy bonds in unlimited quantities in order to cap the three-year yield at the overnight cash rate. The aim of yield curve control is to stimulate the economy when short-term interest rates are already at zero. However, in the case of the RBA governor Phillipe Lowe said it would be unlikely for the central bank to adopt the policy again due to their experience post the Covid crisis. Earlier this week we saw the RBA surprise markets with an outsized hike of 50bps taking rates to 0.85% vs 0.65% expected. This is what Governor Phillipe had to say: Normalisation, normalisation, normalisation — seems to be the policy word of the year if you ask me. Now, although the RBA is not a huge market player it’s still important to keep a top-level view of what’s circulating. ECB Policy Decision Ok, let’s look at what we already know. We heard from ECB Chief Economist Philip Lane last week where he pointed toward a 25bps hike in July followed by another 25bps in September. We also are aware of the ECB’s plan to terminate its PEPP program sometime in Q3. Finally, since the invasion of Ukraine, we’ve heard and seen forecasts of stagflation in the eurozone which is more likely as growth forecasts are slashed even more per revision. As we know, the neutral rate for the ECB sits in the range between 1-2%, current rates are sitting at negative 50bps. Now you’re probably thinking, why on earth has the ECB kept rates negative when inflation is at 8.1%? Honestly, I don’t have the exact answer; but when looking at the situation closer you realise there’s an even bigger issue at hand. As it stands output and inflation are moving in opposite directions, so there’s a trade-off to be made between growth and inflation. From the way things are lining up, it’s clear that the sacrifice will be growth. As for now, I’m waiting for the mammoth releases expected to come in both Thursday and Friday to dive in much deeper— for now, I hope you enjoyed this read and I’ll catch you on Friday.
Joe Olashugba
Jun 9, 2022 · 4 min read
The Macro Data That Matters
U.S Labour Market Still Kicking, For Now… In this piece, I’m going to explore the macro pieces of data that really matter, but before we get into that, let’s take a look at U.S non-farm data. Yesterday we had a massive beat on employment, about 65,000 + expectations, showing that for the month of May the U.S labour market was able to maintain its tightness. The participation rate, which measures the percentage of employers that participate in the readings, was also up for the month. The unemployment rate still sits at 3.6%, which emphasises the strength of the U.S labour market. Now, on the other hand, one must bear in mind that in the world of macro releases there are two types of data . Leading data and lagging data. Surveys are leading indicators whilst hard data shows lagging data, i.e NFP for May, Gdp figures YoY. Surveys are about current sentiment rather than ‘reality’ examples would include PMI. and ISM. Hard data as I mentioned include releases such as CPI, retail sales figures + home sales. Back to my point on the labour market, currently, we’re seeing a robust climate that is poised to weaken as the Fed ramp up quantitative tightening from June; as interest rates increase fulfiling analysts’ prophecy of ‘market normalisation’ this is bound to have an effect on tech firms reliant on ease of access to credit, something I spoke about in my last article. Tesla is just one of many firms in the Nasdaq that are slashing away jobs to free up cash flow as we go into a deeper place within the markets. So what does that mean exactly? For the upcoming months, I’m fairly bearish on unemployment data, meaning the figure we’re seeing will be the lows for a while. This is a clear easy prediction for one to make when looking at the alignment of data and the Fed’s monetary policy stance. The ECB & The Path Ahead As it stands the ECB have its rates sitting in negative territory (50bps); however with the amounting pressure to preserve its credibility (their biggest concern) they have shifted towards a hawkish stance in order to battle 8.1% inflation . Early on Thursday, ECB Chief Economist Philip Lane spelt out forward guidance to the public on the bank’s policy plans pointing at a 25bps hike in July followed by another 25bps in September. This is also in line with the ECB’s planned halt of their asset purchase program (stimulus) or PEPP. This Chart here presents why the ECB has got a sticky job on their hand hiking rate. In the Philip R. Lane: Inflation shocks and monetary policy report the main contributor to their inflation shocks was attributed to; pandemic cycles, which caused shutdowns leading to bottlenecks that bled into ECB’s balance sheet in hopes of propping the economy up. An energy shock, mainly supply disruptions caused by Russia-Ukraine. I could go on and on, you get the point. The expectation for the ECB rate hikes points towards 100bps for the remainder of the year taking their rates into positive territory. This should further support the euro avoiding a parity move against the dollar. The Neutral Rate For The ECB As it stands the neutral rate for the ECB is between 1-2%. If you’re thinking what is the neutral rate? Let me explain that for you. The concept of a neutral interest rate is used to describe the stance of monetary policy. If policy rates are below the neutral level, let’s say 2% and rates are at 1.75%, monetary policy is accommodative and if they are above, the policy is restrictive. This neutral rate is defined as the rate where full employment consists, where an economy is growing at full potential with no output gap and stable price growth. An economy in this environment wouldn’t need to be stimulated or slowed by monetary policy. So now hopefully you understand that what really constitutes to an aggressive monetary policy stance isn’t the just size of the hike, it’s how much higher the rates are above the neutral interest rate . The Macro Data That Matters Now we’re here. On top of what you already know about macro data, there are a few things I thought would be valuable for you to keep in mind going forward. Firstly, understanding the importance but also the weight behind hard and soft data (surveys). Right now everyone is focusing all their attention on the inflation data, but that is all lagging pieces of evidence, not forward-looking insights. That can easily lead to incorrect interpretation of where markets are headed and policy expectations. There’s one heavily overlooked survey to which I pay quite a bit of attention to. ISM readings. With a correlation near or even over 80% this index is the best indicator of the U.S economy. As figures begin to contract and drop, that usually seeps into equities as well. For those who aren’t aware, the higher ISM compared to 50 the greater indication of a growing economy and vice versa for below the 50 mark. So far we have been in a period of expansion so the ISM reading has managed to stay above 50, but looking overseas at China, a great proxy for global growth/cycles, they have dropped to levels not seen since the peak of Covid, which tells me that ISM could soon start painting a similar picture for the U.S. Thanks for getting to the end of my article! Today’s piece was a bit longer than usual but hopefully delivered some value to you. If it did, I would appreciate you forwarding this to friends/market addicts and sharing it on social media to grow our platform! Costs nothing but means everything!
Joe Olashugba
Jun 4, 2022 · 5 min read
Market Open: Behind The Curve
Bear Market Rally In what seems to be one of the best weeks equities have had month to date, U.S equities were up north of 6% before closing higher on Friday just passed. Are these signs of the bulls coming back? In short, no. As you already know a bear market occurs once the price of an index, instrument or individual stock declines more than 20%, now considered bear territory. Within this macro-climate where investors begin capitulating amidst a bleak growth outlook for the world, we occasionally get a bear market rally also known as a ‘dead cat bounce’. This pullback in markets usually gets two reactions from traders and investors; 1. Is the sell-off over? What can I get at a discounted price? Then you have the second persona; What else can I get rid of in my books? Tighter Conditions, Lay-offs & Fed Waller Speech As I search and study more it’s clear that the proxy used by most investors to judge financial conditions is the state of the bond market. Particularly credit spreads (difference between the yield on a risk-free U.S treasury and corporate debt of the same maturity). During periods of weakening conditions within the economy investors flow into Treasury securities across different maturities (2y, 5y, 10y etc) according to their liquidity regulations in order to seek safety. As this happens the yield on Treasury securities decreases due to the increased price as a result of greater demand. During the same period you see capital outflows from corporate bonds, so issuance of new debt becomes increasingly hard as we’re seeing in this climate. As a result of worsening conditions, you see firms rush to increase free cash flow and cut down their workforce in order to support their ‘survivability’ during such times. Now you can imagine when conditions are improving, such as in 2020, credit spreads tend to tighten allowing corporations to access credit easier. This is due to investors seeking more yield in a positive risk environment so capital reverses flowing from safety to risk in hopes of better gains. As the demand for corporate bonds increases, yield decreases and so forth. This is only one part of the debt market, I will look to do a basic bond market 101 at some point in the future. Unsurprisingly, we’re seeing that expected loosening within the labour market with a number of firms listing their layoffs for the year so far. As the Fed continue to push its feet on the tightening pedal this will become the norm with 4.2% unemployment, post the current inflation crisis, considered a ‘masterful performance’ according to Fed Waller; a well-known hawk. From Fed Waller’s speech yesterday the main discussion was his eagerness to address all upcoming meetings with a 50bps hike stating: "I am advocating 50 (basis point hikes) on the table every meeting until we see substantial reductions in inflation. Until we get that, I don't see the point of stopping," Can markets handle all those hikes with QT? Expectations are set for the federal funds rate to sit at 2 - 2.5% by year-end. For now, it’s only right to leave markets to decide what it can or can’t handle. Thanks for reading all the way through! Continue to share, like and support! It costs nothing but goes a long way
Joe Olashugba
May 31, 2022 · 3 min read
Economic Disfunction
Where’s the alpha? According to figure 1, you guessed right, commodities. In a year proclaimed to be the year of “normalisation” in equity markets we’re seeing even more losses than expected. Yesterday U.S equities closed higher yet the economic environment is unchanged, so there’s no real joy in a recovery day as such. European equities have also suffered the test of time with investors juggling an ongoing war, stagflation and unprecedented inflation levels; the last place you would want to have your portfolio invested in is European equities if you have access to other markets. Unsurprisingly we’re seeing bonds yield negative returns in this inflationary environment. Whilst the yield on a Treasury note may be around 2-3% inflation now eats into the real rate of return; so now you have an instrument yielding -5% or more as inflation soars. It wouldn’t take a genius to do the math on that, now on the topic of bonds, the Fed plans to initiate its quantitative tightening process from June 1st. Looking back at figure 1, this is the market currently re-pricing itself based on expectations of Fed policy and market conditions. Once tapering kicks in the markets will be sucked dry of capital leaving inefficiencies that will become evident as the process continues. The first point of focus will be the MBS market (mortgage-backed securities). With the Fed being one of the largest players in the MBS market it’s hard to imagine another institution filling the place of the Fed once they begin offloading their max of $35B in MBS securities per month. So for the wider bond market, corporate IG (investment grade) to be exact, widening credit spreads only makes it more difficult to issue debt and fund operations. Worst Housing Market In U.S A few weeks back I saw this chart but never thought much of it. Take a look at 1978 and take a look at 2022. The % has dropped to its lowest in history. Are we in a worse off real estate market than in 2008? Personally, I don’t think so. However, the market is by no means in a good position, earlier this week we had data for new home sales come out. The overall consensus was 750k expectations with the actual figure coming in at 591k. A massive disappointment, now the housing market can be a very difficult one to navigate but consistent data points like this start to paint a very bleak outlook for the market. Thursday brought us even more negative news: China Slowdown To Ripple Across U.S & EU As I love saying time and time again, China's economy is a leading indicator of where the U.S but majorly the world will go in terms of synchronised growth and contraction. Every time there has been a drastic decline in PMI led by China we see both economies follow suit sooner than later. So, right now the Fed is having to make the trade-off between choking off growth through further rate increases or living within a supply-driven economy. Growth in China has plunged as lockdown measures add to an already broken supply chain so over the next few readings this is expected to filter through the wider economy particularly the U.S and Europe. Thanks for getting to this point! The past few days have been hectic however I like taking more time to go in a bit deeper on things… Let me know your thoughts Appreciate you
Joe Olashugba
May 27, 2022 · 4 min read