Jay Powell: One Last Bull Run.
Guys, glad to be back, I mean that. Tuesday I was away from my structured schedule hence the missed macro breakdown, but I had to deliver for you all today! As always welcome back to Market Macro Hub! Jay Powell shook the markets this week with his speech so we’ll uncover everything you need to know from his Wednesday speech. Enjoy ;) The Good And The Bad: Powell’s Speech On Wednesday, Fed Chair Jerome Powell delivered a speech that many may call the “Fed pivot”. But was this really a Fed pivot, or did markets just take it out of proportion? Jay Powell confirmed what we were thinking, at the upcoming Fed meeting in December, the Federal Reserve will slow the pace of rate hikes. Now, you can imagine how markets reacted to that, the most powerful central bank has just announced they’ll be slowing down and taking their foot off the accelerator. Risk assets popped. I mean, popped! The Nasdaq closed Wednesday trading north of 4% , and the S&P up over 3%. Ok - you get the point know. Markets reacted with confidence that the Fed would stop/slow down the pace at which they are hiking interest rates. All positive, right? Not exactly, you see, markets seemed to latch onto one message. That being but completely ignored hints and direct intel that: So although the rate at which the Fed will continue to hike rates will slowdown, financial conditions within the economy will remain tighter for longer . So here comes the big question. What’s the good and the bad? The bad news first. Let me deconstruct what this chart means if you can’t already tell. The national financial condition index shows how tight or loose financial conditions are within U.S money markets , debt markets, shadow banks and equity markets . Here’s another view point of financial conditions within the U.S. Now you can see the components that make up the national financial conditions within the U.S. The idea is when the national financial conditions index is positive, as shown in 2006-12 & 2019-20/21, 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 after Jay Powell’s speech on Wednesday we saw the risk metric index, alongside credit and leverage all move towards the average of 0 . This is something you wouldn’t want to see as you tighten monetary policy within the economy, interest rates are at 4% within the U.S, the housing market is experiencing major slowdowns, growth as mentioned by Powell is also expected to be flat across Q4. So the figure 2&3 above reiterate the message that financial markets are clearly disconnected from the economic picture as a whole; for inflation to return to 2%, the acceptable and well functioning level, financial markets have to experience further declines in gains, liquidity & overall bullish investor sentiment in order to help the Fed bring inflation lower. So throw your bull hats away, it’s risk off season for the near future. Further evidence of financial conditions weakening is the yield of U.S10y, (don’t mind the subtle flex of the Bloomberg terminal, an expensive tool I must say!) The decline in US10y shows how investors are now betting on a lower terminal rate of interest from the Fed. Out with the safehavens (bonds, dollar) in with stocks & crypto, with BTC trading up >5% on Wednesday! I know it seems like I’ve gone on and on about the bad from Jay Powell’s speech, honestly speaking, it’s because there’s so much to talk about. The good? With the Fed potentially drawing near to the end of their hiking cycle this puts less pressure on central banks around the world to continue hiking rates in accordance to the largest and most powerful central bank, the Fed. Once the Fed truly pivot, and pause hiking the rest of the world are able to evaluate their hiking cycles and proceed towards the same outcome. Emerging markets and frontier markets started hiking before the Federal Reserve began hiking interest rates; so it’s safe to say that EM/FM countries are at the end of their hiking cycle and could potentially outperform developed markets through 2023, but I’m no expert on EM/FM markets, the main point is with the Fed easing off their hiking, there’s less pressure on these emerging nations to restructure debt/issue debt. As that has been the story over 2022, a tale of debt defaults and restructuring. As of today U.S CPI came out and there’s some hot topics you guys have recommend so I’ll be covering that next week! Thanks for getting to the end of this note, I share simplified tweets and threads here and interactive macro posts/productive content here on my Instagram, so be sure to drop a follow and connect ;) Your support never goes unnoticed. Trust me, I’ve got something good coming for you all just be patient with me! Until next time
Dec 2, 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
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
UK's Autumn Statement Explained.
Hey guys, welcome back to Market Macro Hub! Last week was an extremely significant week economically for the Uk, CPI data, the Autumn Statement, retail sales and even the unemployment figures for Sept. In this piece we break down the ‘alpha’ announcements from the autumn statement and Uk’s market reaction: Enjoy Building The Uk Back (With Higher Taxes…) We’ll start where it hurts the most, (for some). Income Tax. Last week Thursday Jeremy Hunt delivered his Autumn budget covering his fiscal policy plans to bring growth and attraction back to Uk’s financial markets. The most notable change to the higher income earner in the Uk was the reduction of the £150,000 threshold at which taxpayers start paying the additional rate of 45% to £125,140 . For those within this income bracket, discussions on whether a ‘salary sacrifice’, as a means to reduce taxable earnings, have been floating around as workers weigh up the viability of doing so. To bring this into reality, previously, a Uk employee not of retirement age earning £125,140 would take home roughly* £80,227.08 per year. A breakdown of the current tax year 6 April 2022 to 5 April 2023: The result of this hike is that millions more people will be brought into the higher or additional tax bands contributing to the government's need to raise revenue from income tax. Other noticeable changes worth noting: What Did The Markets Have To Say? Well, since the removal of our beloved Kwasi Kwarteng, you can see the bond market has been in favour of Jeremy Hunt. Lower yields are generally associated with lower-risk investments , as opposed to bonds of high yields, commonly known as junk bonds/non-investment grade. A brief reminder that fiscal policy changes can have drastic effects and influence on domestic markets; after the mini-budget, you may recall one of the globally renowned rating agencies Fitch lowered Uk’s bond rating: As aforementioned in a previous article , the rating score of a sovereign bond hugely affects the liquidity available to that economy when financing projects/raising debt. Simply put, the catch is, the lower the investment grade the bond is, the less allocation an institution is allowed to make, due to risk levels associated with the investment. So for sovereigns, a simple downgrade from AA+ to AA- (Fitch rating)significantly increases the perceived risk associated with that country and restricts the capital they can raise as banks/pensions funds/institutions have to rethink their portfolio allocation due to the creditworthiness and rating changing. Hence the massive shake-up in the bond market we had in September. This is due to the Basel III Liquidity Coverage Ratio requirement formed in Switzerland, Basel 2010 and introduced in 2015 globally; after the banking crisis of ‘08 when banks didn’t have enough high-quality liquid assets on their balance sheets to meet immediate liquidity requirements. This is all to emphasise the importance fiscal policy adjustments have when looking into the world of global macro, it’s an easy thing to overlook; especially within your domestic market talk less of globally. I’m an example of that, however, to build depth and broad knowledge within global macro this plays into your investment framework. Here’s my personal viewpoint on Jeremy Hunt’s decision to end the stamp duty land tax; although it seems like a reasonable thought process and policy decision to make at first glance. But, putting a deadline on when you can benefit from reduced/no stamp duty (depending on the home price) surely means inflationary pressure on the housing market in the Uk? This is additional inflation pressure to a housing market already at historically all-time highs when looking at the affordability metric, average household income vs home price. Alarming?! With the deadline in place for 2025, and mortgage rates set to experience volatility both to the upside and downside I’m afraid that we may keep house prices elevated as both first-time buyers and homeowners looking to benefit from the possibility to save on the SDLT reduction. Here’s how the current SDLT policy is looking: I’ll have my eye on Uk home sales in the upcoming months to see what effect this may or may not have when it comes to additional inflationary pressures on the brittle housing market here. As for now, thanks for reading this note ;) Friday we’ll be looking at the Euro Zone crisis and the source of the banking crisis. I need you to do a favour for me macro heads! Send this to someone looking to expand their knowledge, understanding & or skillset— the more this grows, the more value I can deliver for you directly ! It’ll take 30 seconds, these articles have me up until the morning! Until next time
Nov 22, 2022 · 5 min read
How The Bank Of Japan Blew Up Capital Markets...
It’s here. In this piece, we uncover: The Power of The BoJ Now, for those of you who may not understand why I would choose to write on this particular central bank; you need to read this. The Bank of Japan single-handedly plays one of the most crucial roles within capital markets globally, and that starts within the bond market. Japan is the single largest holder of U.S debt in the world, holding roughly 17% of all U.S treasury bonds available, now let me put that into context for you. The U.S treasury market is roughly a $11.2 trillion dollar market place; so owning just under 1/5th of that market shows how important the Bank of Japan is to the U.S market. Let’s take it a bit further and expand on how crucial the Bank of Japan is to both the U.S & global asset markets. Up until now, many of you, including me at a point, believed that U.S treasury yields were priced and dictated by the Federal Reserve’s monetary policy stance and major economic data released from the U.S. That’s not the full picture, the world of U.S treasuries revolves not only on U.S economic data and the Fed but on the large holders such as Japan and China who collectively own just under a 1/3 of the treasury market. If the treasury market was only impacted by the Federal Reserve and U.S data, we would have experienced much higher yields within the U.S as inflation took off throughout the year peaking at 9.1% in June. Effectively, what I’m saying is the Bank of Japan has indirectly capped U.S treasury yields through its lose monetary policy program. Here’s why. Yield Curve Control & Low Rates In 2016 the Bank of Japan initiated a policy known as Yield Curve Control , (YCC), this was implemented to keep borrowing costs at all-time lows in order to prop up an inflation-starved economy. If you’re thinking what is yield curve control here’s an explanation: Yield curve control is the process where a central bank of a country aims to control both short-term and long-term policy interest rates. This creates a framework where the central bank can effectively cap borrowing costs regardless of what shape the economy is in, in order to stimulate inflation within the economy. Japan’s Flaw… Inflation has been a massive problem for the central bankers in Japan as factors such as; a low fertility rate, ageing working demographic and due to the expansionary policy of the Bank of Japan, interest rates have been extremely low. Leading to a continuous outflow of capital to the United States and other countries. Private households, pension funds, life insurance companies and many other institutions have bought US government bonds and U.S assets further decreasing the demand for the Yen. Here’s how the Bank of Japan has indirectly capped U.S treasury yields. Through yield curve control the BoJ has capped 10y JGB’s (Japanese Government Bonds) at 0.25%. If JGB yields are pinned at 0.25% then Japanese investors are forced to seek yield overseas by purchasing U.S bonds as one of the only alternatives to realising positive gains on their investments. Through this process of Japanese investors looking overseas, particularly within the U.S for investments, the yield of U.S debt is less influenced by the factors mentioned above but is now simply perceived as a sound store of capital compared to domestic markets in Japan yielding close to nothing. Let’s play the other hand. What would happen if the BoJ were to move away from yield curve control? Absolute chaos, put it this way. U.S treasuries and global yields/credit spreads would be through the roof, cost of capital would be even more elevated meaning the S&P500 and Nasdaq especially would be hammered to the ground. The main reasons are, tech stocks survive off of low borrowing costs and most importantly higher yields mean tech stocks’ earnings in the future are worth less today. Dollar Yen, Pushed To The Limit? It’s safe to say we know the Bank of Japan has got deep pockets, but this depreciation in the Yen must hurt them, right? YTD the Yen has lost close to 25%, as investors have shifted their focus toward the ever-widening interest rate differential between the BoJ and the Fed among other central banks also on the tightening cycle. 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 where your yield is 0.1%. So for the market participants seeing the purchasing power of the Yen slide uncontrollably, you would probably bet on the Bank of Japan being forced to hike rates and abandon YCC, right? Not so easy. Earlier in May this year, hedge funds had bet that the Bank of Japan would be forced to hike rates and even move away from YCC. Take a look at the yellow region highlighted to the right. Traders began shorting JBG’s in hopes that rates would increase causing the price of existing bonds to decline in value. This trade was met with full force as the Bank of Japan purchased a record amount of JGBs in order to defend its yield curve control and monetary policy stance. This trade is heavily referenced as the widow maker because that’s what the BoJ turned those funds into. Of recent, we saw the BoJ intervene to stop the yen slide after the central bank kept its rates low, abiding by its dovish policy; this intervention was the first in 24 years for the bank where the BoJ sold dollars to purchase Yen. The question one has to ask is, how much suffering until the BoJ is forced to pivot? As the only central bank in the world to have rates extremely low, the exchange makes imports of goods costlier for the nation. What a week, thanks for your attention all the way till now! Hope you’ve enjoyed the articles released this week. Always love to hear from you guys; I’ve got some cool things warming up for the MMH community — just give me some time. Share it! Post it! It’s free to do so! Twitter - @JoeOlashugba Instagram - @Joe.olashugba Until next time, Joe
Sep 30, 2022 · 6 min read