Recession Risk Resurfaces
Hi guys, glad to back again. I know what you’re thinking, “Joe, where was the Tuesday note?” I’ll spill the beans, I’ve been working on a ‘guide for traders learning macro’ covering the three foundational pillars of macro and a step by step process on how to acquire actionable macro knowledge FAST! It’ll be out before Christmas, just pure value. And yes, it’ll be free. So make sure you’re following me on Twitter and Instagram to keep updated with the drop. So that’s why I’ve been under the radar. Back to it! We’ll dissect the global picture, signs of a deepening recession, the strong dollar and how the U.S is positioned. As always, enjoy. Global Macro Picture, Inflation & The Dollar Alright, we all know the root cause for double digit inflation across Europe and the Uk is food and energy prices. For the U.S, the peak in inflation back in June was 9.1%, which since then has retreated a little over 1.4% to 7.7% annualised. As it stands here’s the interest rate positions of the Fed, BoE & ECB: Fed: 4.00% BOE: 3.00% ECB: 2.00% After Jay Powell said: This has given investors confidence that inflation is headed in the right direction and as a subsequent event, that it could be time to rotate towards riskier assets. So much so that we’ve seen the yield curve across the US10Y retreat to 3.5% . What’s even more worrying is the the inversion between the 2s/10s; this is viewed by many investors a reliable signal that a recession is likely to follow within a short time span (<48months); and as it stands the inversion hasn’t been this deeply inverted since 1980’s where unemployment topped 11% and inflation topped 14%! What exactly does this mean? Looking at the Treasure curve, the frontend of the curve is loaded with rate hikes which is why the yield on T-bills (debt instruments with a 12month maturity) are yielding 4.70%. Now, within a healthy economy the yield curve slope is positive, meaning that bonds with a longer maturity date pay a premium yield compared to bonds with a shorter tenure, this is simply to account for the interest rate and inflation risk associated with holding a bond paying a fixed rate over a longer period of time. As you may have guessed, a flat yield curve means you’ll be paying the same to borrow money for one year as you would for 10 or 30 years, so applying this knowledge to the current macro landscape we can speculate what investors perceive as the current global trend. Prolonged periods of low nominal global growth and lower future interest rates as shown by the yield curve. Inflation in commodities If you recall my recent article on November 11th, the current macro picture pt.2 , this is how my commodity screener was looking. VS my commodity screener today. Friday 9th December The price inflation of major components of fuel/heating have released steam from the high prices, heating oil down 32% from November highs, WTI Crude Oil down 19% , Brent Crude Oil now in negative territory down 21% and gasoline prices down 22% YTD. So, with the declining price pressure on commodities this should continue to allow inflation to retreat back below the 4-5% margin. Commodity shorts, particularly oil shorts, something I mentioned in that same article here . Always good to see a trade idea play out. So stay alert on trends we notice here! Now, onto more pressing information, the dollar and the reason behind the rally of the year. There’s a few reasons at to why we’ve seen the USD gain so much strength this year. Here’s the layout. The dollar is a counter-cyclical currency, meaning when the global economy weakens the dollar strengthens and when the global currency expands the dollar weakens, here’s the reason why. When the global economy weakens this is usually due to a tightening in monetary policy, a restriction in the circulation of dollars domestically and internationally, this has an appreciation affect on the dollar because economies around the world use the dollar to “access” the global liquidity system (bond market). An example, an emerging market economy such as Ghana may issue bonds in USD in order to attract greater foreign investment and activity due to the dollar being the global reserve currency. So, for emerging markets, frontier markets, mainly economies across Asia, Latin America, Eastern Europe, Africa, and the Middle East, to access the global credit system they must do so through the dollar. Result? Take a look at 2022, in a battle against inflation the Fed were forced to hike interest rates, tighten up monetary policy. This leads to less $$ in circulation so the USD global liquidity tightens, now there’s not enough dollars in the world so countries are short on dollars for payments, leading countries to purchase more dollars due to finance dollar denominated debt resulting in the dollar to appreciate widely. So in laymen terms, global tightening/weakening leads to USD strength. A narrative for 2022. Take a look at figure 5 to see how the dollar has faired over the year. Now for the opposite, here’s why the dollar weakness. As the world economy expands, the global system creates more dollars . The institutions responsible for the dollars being printing are not the central banks, it’s the high street and investment banks, the credit system that creates the excess USD; this is through physical money being injected directly into the economy which can be spent, i.e loans, commercial loans and other forms of “real economy” money, very different to what the central bank prints. Looking forward I’ll begin to eye up the next macro trend from which we can put together some actionable trade ideas, something I know you guys want to see more of. Trust me, it’s coming Thanks for reading through, you’re a real one ;) As mentioned at the start of this piece I’ve been working relentlessly to make sure this macro guide I’m creating for you guys puts you on a straight narrow path to acquiring the understanding required to find macro plays and trades. I know I could easily charge for this but I want to give it out for free to you guys, so stay tuned to my Twitter and Instagram especially as I’ll be dropping the release date there. If you’re looking forward to that, I’ve got one ask. Show some love and share on Twitter, Instagram, tag me I’ll engage! Share this with someone who can learn something and get a new perspective on markets— I’m working on much more things for you guys, you’ll see Until next time
Dec 9, 2022 · 6 min read
The Fed: Don't Buy The Dip.
Welcome back to Market Macro Hub, Glad to be back guys, man, it’s been one heck of a week in markets; let’s break it down here. As I mentioned last week, I’ve been working tirelessly on a ‘ Guide For Traders Learning Macro’ for you guys to really accelerate your understanding of macros and how you can trade that in the FX & commodities markets (as I know that’s what most of you trade). This will be out sometime next week, so make sure you’re following my Twitter and Instagram as I’ll announce details about the drop first! Oh yeah, it’s free ;) All I ask is you continue to share this, engage and put to action what you learn here. For now, let’s talk Fed, particularly the recent inflation print Inflation Lower, Rates Still Heading Higher! On Tuesday afternoon U.S CPI came in at 7.1% vs 7.3% forecast! Now, for some context the MoM CPI increase was also lower at 0.1% vs 0.3% forecast ; finally core inflation also surprised to the downside ticking down to 6.0% vs 6.1% forecast. Off the back of the release U.S equities rallied hard, crypto’s were relieved from recent losses and bond yields collapsed, this bullish move into equities is known as the “vanilla reaction”, when one buys equities as a result of lower inflation, but this risk on shift in markets was shortly lived. The bond yield collapse was shortly turned around and yields on treasuries ranging from the 1M to the 30Y treasury all received a lift in yields after Jay Powell and the FOMC forecasted interest rates to rise even further and stay at 5.1% through 2023 - so investors began pricing higher interest rates through the debt market. On last week’s note I touched upon the 2s/10s inversion as it deepened, and from figure two you can see how yields across all instruments have risen, yet the inversion is still in the -0.7% , as we all know an inversion signals a recession, which the Fed isn’t scared of doing after listening to Jay Powell’s press conference. Here’s why. Jay Powell outlined three components of inflation that he is paying attention to: That was it, the last component, “non housing related core services”, is what caused risk assets to quickly sell off right after the inflation release came out. The reason behind that is that non-housing related core services are the stickiest component of the inflation figure because that covers wages and labour related costs which are extremely difficult to bring down once they go up. Unlike goods inflation, which are directly affected by supply chains tightening up or flowing smoothly, wage inflation isn’t as malleable, so the only way the Fed is able to bring inflation down even further, particularly the non-housing related services inflation, is to break the labour market driving unemployment higher. So, now you see why stocks, crypto and all risk assets done a U turn after the release; investors understand that this drop in inflation will not result in a ‘Fed pivot’ move, instead we heard from a very hawkish Federal Reserve at the press conference. (figure 3 below) Here’s some interesting takes from their December SEP (Summary of Economic Projections) The FOMC Federal funds rate projection for 2023 is 5.1%! As it stands the Federal funds rate is 4.50% after the recent 50bps hike; so going into 2023 we can expect a further 60bps of hikes from the Fed. The question is, can markets withstand interest rates at 5%? In my opinion, I don’t think so. From Jay Powell’s press conference he hinted on this point every so slightly I think many may have missed: He went on to say how he believes financial conditions have tightened “significantly” in the past year, now I’m not sure how true that statement is. Let’s look at ‘07 and make a judgement. For those who follow my articles religiously, firstly, shout out to you! My point being, you’ll be familiar with what this chart below represents, but for the new readers I’ll explain what you’re seeing: The National Financial Conditions Index focuses purely on financial markets, and provides a weekly update on U.S. financial conditions in money markets , debt and equity markets and the traditional and “shadow” banking systems.The idea is when the NFCI index is below 0, this means financial conditions in markets are particularly loose, meaning access to things such as credit, leverage and risk are widely available meaning the economy should experience periods of expansion and inflation, shown around 2007. The opposite is true for when the NFCI is positive and well above 0, this shows periods of overly tight conditions within financial conditions. You can see, as we approached the GFC during 2007 the rate at which we saw financial conditions tighten was swift with no loosening, below 0, up until the recession was at its height and conditions had to loosen to reset the economy. The opposite is true for where we are now. Looking at 2022, conditions have materially tightened across the whole, and peaked around the September/October period but since then financial conditions have been loosening in the U.S. mainly access to credit and leverage. I’m inclined to account this loosening in financial conditions to the lower than expected October inflation figure we saw in November, sending markets into a positive frame that inflation is indeed on it’s way lower and that the Fed may be approaching it’s halt in hiking to eventually pivot. Here’s a very interesting chart on Treasury yields within the U.S, I’ll let you break this down and we’ll have a further look in our next piece together! As mentioned at the start of this piece I’ve been working relentlessly to make sure this macro guide I’m creating for you guys puts you on a straight narrow path to acquiring the understanding required to find macro plays and trades. This is coming out next week, so stay tuned and I know you’ll gain tremendous value from this. Until next time -
Dec 16, 2022 · 6 min read
The End Of An Era.
Abit sombre? Yes it is, it’s official guys, as some of you may have seen by my twitter, I have officially moved Market Macro Hub to Substack . I want to be able to interact with you, hear your thoughts, provide even more valuable actionable trade ideas and trade themes for you to grow your knowledge and portfolio. That’s the end goal at the end of the day, alpha. To achieve this we’re moving forward with Substack, Scriber has been an amazing platform to host and birth what has now become an aggressively growing macro army, and I’m proud to have your support moving forward. I’ve already moved your emails to Substack so don’t worry about having to sign up or do anything, you will be seeing all my market insights from next week coming from Substack, so make sure to favourite that email address to avoid it going to junk/spam . It will now be easier to access my research notes both on mobile via the Substack app and email of course, all you have to do is read and react! I say it time and time again, I truly appreciate your support and a huge thanks to the Scriber team for being the home for all 750+ macro heads and growing. Next milestone 1,000. See you next week MMH gang, level is going up. Joe
Feb 24, 2023 · 2 min read
The Deflation Trade.
What’s going on MMH gang? Hope you’re all doing great; welcome back to Market Macro Hub . Quick announcement: I mentioned in my last piece that I will be transitioning to Substack to provide a better service to you all and be able to communicate with you guys, that’s happening in the next two weeks so you will see my market notes coming from a Substack email instead! You won’t need to do anything, just a heads up ; ) Back to markets: This week and last week, two major events were on my radar: Last week Thursday U.S CPI print reaffirmed what markets were thinking and Tuesday just gone the BOJ held rates negative and preserved YCC. As always, welcome all new & existing subscribers, and lend me your attention from here: Risk Is Back. Global Deflation And Slow Growth Last week, Thursday the 12th, U.S CPI print came in line with expectations at 6.5% , now this is positive news for both the economy and the Federal Reserve. Since June of 2022, the U.S has been in a deflationary period, successive declines in CPI prints, leading up to the 6.5% reading we saw last week. In December’s Fed minutes, we heard a very specific statement from Jay Powell, on where his focus would be looking forward: An explanation of what this means: Alright, so we know what the Fed’s focus will be on. The labour market and driving unemployment 110bps higher to 4.6% from current levels of 3.5%. This is where it gets interesting, historically, the U.S economy has never been able to withstand a sharp rise in unemployment by 100bps or more and not fall into a recession; so it’s clear what the Fed mandate is, even if they’re not saying it. I know what you’re probably thinking, if the U.S is clearly headed for a recession, then why the risk on mood in markets? Good question. Here’s why, investors have priced in short term rates exceeding 4.5% in the upcoming months, shown by the UST yield curve below; but what they didn’t price in was the reopening of the second largest economy in the world and the secondary affects of this, neither the BoJ subduing global yields by not moving away from its monetary policy stance. China reopening its economy isn’t just good for the resumption of trade and global consumption, on the 13th of Jan 2023, we heard from Governor Xuan Changneng at a press conference: Here’s what the market interpreted that to be. We will provide additional stimulus and liquidity to markets. Cue the bulls. We all know what stimulus did to the U.S economy in 2020-21, now we’re going to see China’s economy experience “support” from the PBOC, however, it will not be as extreme as the U.S stimulus package. A Chinese support/stimulus package is one of the things investors wouldn’t have been able to price into markets which is why we’re seeing Chinese equities rebound, and developed equity markets in the green. This could be conceived as a temporary period where risk appetite has returned to markets. Similar to a phase in markets called Goldilocks , where economic conditions are neither too hot or too cold, steady growth and controlled inflation- a perfect environment to be long risk assets. The only difference here is we are not in goldilocks-like conditions, we’re in a deflationary regime within markets, growth outlook is meek , the most recent December PMI print for the U.S hit the lowest readings since May 2020 and inflation is now declining consistently. The Deflation Trade This table below shines the light on how financial markets tend to perform during the different market conditions and cycles. For those who may not know, nominal returns is the return before adjusting for inflation and real returns as you can tell factors in the inflation figure to the reading. We can see from the annualised real returns, bonds historically have been the better portfolio allocation for weathering deflationary periods, returning 8.4% net inflation annually, outperforming equities and cash. So bonds would usually be the choice of capital but in this climate I feel as if investors still have appetite for more risk in the immediate time frame of H1 2023. This leads straight into the recent BoJ policy meeting on Tuesday, where Gov Kuroda decided to leave interest rates unchanged at -0.1% and maintain YCC band on 10Y JGBs at 0.5%. Market participants were expecting Kuroda to fold and abandon the YCC policy. As a result the Yen took a 2% dive overnight see figure 5. Bold move not to budge, but I believe Japan at some point will have to abandon the YCC policy or widen the band as Kuroda did last December; that time for me is April 2023 when Gov Kuroda leaves his post as the Governor of the Bank of Japan. When the new BoJ Gov is chosen, I suspect they will be faced with a fork in the road, abandon the outdated YCC policy or hold tight. As many investors & funds believe, the removal of YCC seems most probable, and has a large scale effect on global bond yields and borrowing costs. Due to the low yield of bonds in Japan, institutional investors invest their capital in foreign bonds listed in the U.S and Europe mainly. Total holdings of foreign bonds by private Japanese institutional investors reached c $3 trillion at their peak in 2022. Japan is the single largest holder of U.S debt holding over $1.23 trillion U.S treasuries, accounting for more than 10% of total U.S debt. So it’s clearly no exaggeration to say that Japanese flows have a huge significance to global bond yields. Take a look at figure 6 to see the size of bond holdings by Japanese institutional investors. *OFC = Offshore Financial Centre Drivers of Japanese Outflows: With all that said, if the new Governor of the BoJ decided to abandon YCC, Japanese bond yields would soar, leaving very little incentive for Japanese institutions to hold foreign bonds when they can receive a yield in local bonds. If Japanese investors were to leave foreign debt, European and U.S bond markets would be in a heap of a mess with yields soaring as outflows from Japan repatriate. Looking at figure 7, as long as YCC is in play and yields across all maturities are subdued below 2% we won’t have to worry about that. Short term I’m bullish on risk assets as markets react to stimulus from the PBOC, lower inflation prints from the U.S and a number of readings such as retail sales which also came out negative for the U.S. Wow, that’s the end of this piece. I had a lot to uncover and still so much more, but I’ll save that for next week. As mentioned guys, my new macro guide/economic e-book is in the works; it’s going to 10X better than my previous guide, as it won’t be free. This one is for the serious macro heads trying to get ahead and want a clear connection to macro releases and markets; I’m also working on another mini booklet which will be free so stay up to date! Until next time Joe
Jan 20, 2023 · 7 min read
Europe. The Broken System
Europe - It’s as if there’s been a continuous fire burning under the Euro Area, right out of the 2007 Global Financial Crisis. In today’s piece, we cover The European Sovereign Debt Crisis . Welcome back guys, hope you’re all good & looking forward to this macro note ;) As always, lend me your attention from here on out: The Sovereign Debt Crisis Explained Maintaining price stability and healthy economic conditions for an economy is extremely challenging as we know, just look at the UK & the U.S. Let alone managing this across a whole union of countries. As you already know from previous articles, everything is interconnected. Everything. So, in the case of a debt crisis , the costs and benefits associated with a default within a monetary union are magnified for both the debtor and creditor countries. Because a “monetary union facilitates financial integration ,” and also cross-border-holding of government debts (majorly by banks) inside the monetary union (EU), in the case of a default, the knock-on effects are catastrophic. The cost of default to the creditor in this scenario is multiplied, here’s how. Although Greece wasn’t the only European nation to default on its debt we’ll use it as an example; the costs of a default for the creditor not only is the principal amount loaned out, but even greater collateral damage, through the contagion risk, aka widespread risk associated in being within the same union. Things such as: Liquidity seems to be at the heart of every crisis we’ve seen, or most. In the case of Greece, a sovereign default would put domestic banks within the eurozone at risk mainly because they would have been holding Greek bonds & potentially using those debt instruments as collateral to access liquidity from either the ECB or other financial/sovereign institutions. One man’s debt, another man’s asset, that’s until the first man defaults! All in all, everything would have had a torn apart due to the default of Greece and other countries such as Portugal, Ireland, Cyprus, Spain & Italy who were unable to pay or refinance their government loans or even bailout indebted banks under their supervision without support from third party organisations (IMF). After scanning through documents and fillings online, I found out that a “sovereign default inside the eurozone has been interpreted by many policymakers and economists as the first step towards the potential exit of the defaulter from the monetary union.” Now, I’m not too sure how much truth this statement holds but I can see how such countries may be sidelined and disregarded when it comes to important policy decisions that have to be carried out within the eurozone. Here’s the backstory of how this all fell apart. The Global Financial Crisis After the recession and crisis of 2007, what became apparent within the euroarea was the absurd level of debt to GDP as a percentage, amongst certain nations within the ECB. Debt is a great instrument to drive growth, but as the interest rate environment starts to heat up, restructuring and financing debt becomes extremely hard. Additionally, the sudden halt of foreign investment to countries such as Greece sparked fears that the Greek government would not be able to finance such levels of debt. You’re probably looking at the chart thinking, this can’t have happened. Yes, it really did. Yields on 10-year debt instruments from Greece hit as high as 29.24%! But why you may ask? Here’s the reason: Greece’s debt to GDP was 109% in 2008 and rose to 146% just two years later! Bear in mind, the eurozone put in place a pledge which said the debt of any country within the eurozone shouldn’t exceed 60% and the government budget shouldn’t exceed 3% of its GDP, Greece doubled that by 2009-10 and their government deficit was -15% . Unsustainably high debt to GDP = greater risk of default = greater reward demanded by investors A lesson I have broken down a number of times talking about how credit ratings can cripple an economy. But back to the point. The talk around Greek bonds became so negative that the only way they could attract investors was to offer high double digit yields on their loans. This only accelerated the downgrading of Greek bonds as perceived risk grew, access to capital dried. Here’s the collateral knock on effect. As investors demanded more yield from Greece, they also began looking at Portugal, Spain, Cyprus and many others demanding higher yields on the debt instruments - so the bond market of these countries also suffered major blows as they had to offer +10% on their yields! Knowledge drop: I was speaking with a friend who’s works at an emerging markets research firm, very knowledgeable on that forefront to say the least and he said when bond yields hit 10% funds call it ‘loosing market access’ because these countries are no longer able to raise money in international markets, due to the risk associated that their sovereign debt has reached a certain distressed point that it’s not worth purchasing as its near defaulting/bankruptcy. Now that’s emerging markets, Europe is considered a domestic market so you can imaging how rough financial conditions would have been in Greece, Ireland and Portugal, all countries whose bonds were >10% . By early 2010, Greece requested for a bailout to help pay back its creditors and received support from an EU-IMF( International Monetary Fund) package totalling €110 billion to rescue Greece from defaults. Following Greece, Ireland, Portugal, Cyprus and Spain all requested bailouts to stay afloat. Why Not Devalue The Euro? This may be a question arising in your head. Heck, it did in my mind after some research. China is a perfect example of a country that uses currency devaluation to its benefit. Here’s why. Devaluing a domestic currency reduces the purchasing power and strength of that currency, let’s say the Chinese Yuan in this example. What this does is make the devalued currency’s goods more attractive to the global world of trade as the value of China’s exports will cost less in your respective currency. So a nation’s exports become more competitive globally. It’s not all positives however, as you devalue your currency imports become increasingly expensive as well as debt servicing/repayments if the debt is denominated in a foreign currency like the dollar. So this strategy works great for net exporters of goods & services as supposed to importers. August 11th 2015, China devalued their domestic currency against the dollar in order to boost exports as recent data showed exports were down 8.3% YoY compared to July 2014. After this the dollar strengthened against the euro. The effect of devaluing? The increased demand in global trade markets, spurs higher exports for the devalued currency economy which in return boosts economic activity and drives GD P, growth and development. Only issue in Europe’s sovereign bond crisis was, you guessed right, they’re a net importer of goods. Meaning this would have temporarily boosted goods exporter but the pain of importing goods at a higher cost + increased difficulty to refinance debt outweighed the pros of devaluing the Euro. Austerity Measure Implemented The bailouts provided by the EU and IMF, weren’t free checks. With the lifeline came strict rules, known as austerity measures. Meaning government policies aimed at reducing public sector debt; these policies restricted the fiscal policy actions taken by nations across the EU. Things such as: were reduced/restricted and income taxes were raised to try and shift the current account to positive. The effect? high unemployment rate, greater income inequality and lower standard of living, all which some up the building blocks of fragmentation risk within the euro. Thanks for getting to the end of this note, it was an in-depth piece so make sure you took your time reading through! This piece definitely took it out of me but I know you’ll gain some knowledge from this! A favour to ask, can you share this newsletter on your social media, with your friends and whoever may find value! I’m just about finishing something that’ll really help boost your knowledge so stay tuned! Until next time
Nov 25, 2022 · 7 min read