Latest articles
Pounded: Did Someone Say Parity?
Alright, before we start I know what you’re going to say. Where’s the piece on the Bank of Japan? The plan was to deliver that piece yesterday but after an eventful Friday evening and start to the week for the pound, something we haven’t seen in over 50 years , I had to make an exception! BoJ piece will be released on Friday, look out for it. Now, back to it: Is It The “Mini-Budget” Or Uk’s Macro Climate? This is the question on most investors’ and traders’ minds. What is the root cause of this crash in the pound? Now, if you’ve been living under a rock the past few days, let me quickly recap what has been going on within the Uk. On Friday 23rd September Kwasi Kwarteng, Britain’s new Chancellor announced his growth plan, which consists of the biggest tax cut in 50 years . The last time the Uk saw a tax cut of such significant size we were in the 1970s inflation period, where the annual inflation rate averaged 12% on a calendar year basis. An inflation figure we will most likely see this fall if economic conditions continue in their current trajectory. Now, the markets’ reaction to this “mini-budget” was nothing short of dreadful. Immediately after the plans were announced there was an immediate withdrawal of capital from the Uk. Earlier this week, the pound touched as low as $1.03 , and gilts also took historical losses as investors weighed away from any assets associated with the Uk; the factor being investors believing that the new growth plan will only add fuel to the inflation fire, which is currently sitting at 9.9% . Not only are investors weighing on the risk of further elevated inflation figures but also the new ‘mini-budget is set to push borrowing to unsustainable levels. Chart 1 shows the market’s verdict on the government’s fiscal plans, and it’s not a positive one at all. During the trading hours on Monday Andrew Bailey, Governor of the Bank of England delivered a statement that many believed was going to be an emergency rate hike to prop up the pound, however, Bailey shut down all bets that we would see an emergency rate hike saying: Feel like I’m watching Jay Powell’s ‘transitory’ speech all over again… Gilts losses, Government Deficits and Quantitative Tightening If you’re still scratching your head trying to figure out whether this destruction in UK markets is because of the mini-budget or the current macro picture let me put your mind to rest. All that has happened since Friday is a massive acceleration in the downwards direction of where the Uk’s economy was already headed. Let me explain. Prior to the mini-budget, the Office for Budget Responsibility (OBR) forecasted that borrowing would be on a steady decline from 2024 onwards; dropping from roughly 84% of national income to just above 80% , a mere 3-4%. After the mini-budget, we can now expect that number to rise an astounding 10% to 94% of national income. Keep the above chart in mind. Now, when looking at data what’s most important isn’t so much the current data point we are seeing, in this case, the yield, it’s the rate of change over a period of time which tells us more about how an economy is shaping up. The chart below will realise this for you. This should set in stone what is happening within the Uk. Just over a month ago, 10y-gilts (government bonds) were yielding just over 2.61% on an annual basis, rewind six months back and you were receiving only 1.68% on an annual basis. Now, 10y-gilts are yielding up to 4.7%! You may be thinking, what effect will this have on the economy? In essence, the realisation that the supply of debt that will have to be sold by the government outweighs the current demand within the market is what has led markets to plunge. This causes investors to flee Uk debt markets and the currency as a whole. Ray Dalio said it best: As it stands sterling has gained some upside pulling back into the $1.07 mark against the dollar; with the current array of factors at hand within the Uk it is hard to see the pound moving any higher than it is right now. Short bets are looming over the currency with hedge funds applying pressure to benefit from the demise. Such an event only makes the dollar even more of an attractive alternative and investment to the pound, equities, crypto/ alt investment. In the past month alone the dollar ETF is up 5.25%! This has more to do with key commodities/assets being priced in dollars, so the repatriation of assets/currency results in dollar demand rather than the actual economic condition of the U.S. At the end of the day, the saying remains, dollar is King! Hey, thanks for reading all the way until the end, I appreciate each one of you guys/girls — we’re experiencing some serious growth within the MMH community so expect some exciting things ahead from me to you! As always, share, subscribe and send me a message so I know your thoughts/feedback, this is our platform. Twitter - @JoeOlashugba Instagram - @Joe.olashugba Until next time, Joe
Joe Olashugba
Sep 28, 2022 · 6 min read
Strap In, The Fed Is Coming.
What’s going on guys? Had a slight issue publishing on Friday, but back to the usual schedule going forward! Lend me your attention for the next few minutes. In what is set out to be a heavy week of economic releases, particularly rate decisions from the big central banks, the Fed, BoE & BoJ, we look at the most recent CPI release and what that means for markets. CPI Overshoots To 8.3% YoY Yes, it’s the topic of the conversation once again! CPI in the U.S beat forecasts of 8.1%, finding some resting ground at 8.3%. Increases in the shelter, food , and medicare indexes were the largest of many contributors that pushed the CPI readings higher. Luckily, a 10.6% decline in the gasoline index offset the majority of the shelter and food-related increases. The Weighting of Shelter Within CPI In case you didn’t know, out of all the categories that combine to form the CPI reading, the weighted shelter takes up roughly 32% of the CPI print! That’s just under 1/3 of the whole reading, and from observing Chart 1 below we can see the sharp increase from July to August when the shelter CPI reading rose the most since 1991! Commodities Shortage Effect on The Housing Market Now, from as early as 2021, post Covid-19 recessions and amidst several global lockdowns in major commodity/goods exporting countries we saw U.S home buildings drop drastically and a surge in the number of construction backlogs due to shortages. Both on the commodity front foot and also on the transportation side where there was a clear reluctance within the U.S workforce. Particularly in the transportation of goods (truck drivers). Now, I am not pointing to this alone as the main contributor to elevated home prices but if we lay out the facts I’m sure you will see why there’s a direct link. During the wake of the Covid crisis, lumber prices, copper prices, aluminium and all construction-related materials were extremely expensive to attain, (as shown in Chart 2). What is the direct effect of elevated commodity prices? Simple, delays and cancellations of new residential construction and commercial developments . So, the delays in construction projects only did one thing to the available supply/demand distribution; this lowered an already scarce housing market even further to the point where new home buyers’ demands couldn’t be met so home prices elevated to levels not seen in decades. To put this into context, the home price to median household income index shows the average cost of a house in the U.S relative to the households’ income. Historically, an average house in the U.S. cost around 5 times the yearly household income. During the housing bubble of 2006, the ratio exceeded 7 - meaning that for a single household, it cost more than 7 times the average annual U.S household income. Pretty scary to see levels in the U.S above 2006 records by a country mile… Bear in mind this ratio is heavily affected by interest rates within the economy; as a result when borrowing rates are relatively accommodative/cheap the demand and cost of homes increase due to the pent-up demand to purchase at low rates. As rates increase and yields on the U.S 10y & 30y increase, (the rate majority borrowing costs derive from), the affordability of homes decreases and so does the home price index. Fed Rate Decision With inflation still elevated despite hopes that we will see a decline following July’s stagnation, asset markets, in particular, the Nasdaq had a horrific close to the week. Close to 6% wiped off tech stocks; I think it’s safe to say the equity bulls are back to hibernation until further notice. Looking forward, the market is expecting to see either a 75bps or a 100bps hike this week, I see a 40% chance the Fed do a supersized 100bps hike ; if you recall my previous note on CPI’s effect on rates, you would remember me specifically noting that if we see inflation come in above expectations we will see yield curve inversions between 2s&10s deepen further. If you didn’t get to read the note I’ve quoted my comments below for you. For those who aren’t familiar with what an inversion in bond yields means, I’ve linked a previous note on the importance yields play within the economy. Short-end yield curves are pricing in interest rates to peak at 4% in the U.S; so this is a forward look at investors’ expectations of the Fed hiking cycle. As the Fed has said, the unfolding of economic releases will reveal to what extent they will have to hike until inflation is under control; that’s a long-winded journey for both the Fed and market participants. I recently caught up with a friend of mine who specialises in EM (emerging markets) and heard how bad some of these EM funds are down due to interest rate hikes. Instantly this put in perspective the ripple effect that this hiking cycle will have across every single market both developed and emerging. Countries like Sri Lanka recently defaulted early in May ‘22 for the first time in history ; the reason rates play a crucial impact on EM countries is because a stronger dollar makes it more expensive to service debt repayments/infrastructure expenditure and usually triggers capital outflows as investors can now attain modest returns at lower levels of risk holding deposits in the U.S. We won’t dive into EM, but that’s just a touch on the depth and weight the Fed interest decision has on the markets. As always appreciate you for reading. Don’t just stop there, make sure to share this, doesn’t cost anything but means everything & subscribe if you haven’t already! We’ll be back on Friday covering the rate decisions & a look into the BoJ Joe
Joe Olashugba
Sep 19, 2022 · 6 min read
Recession Fears & Demand Destruction
Where Are We Now? Starting off with the FOMC speech last week where we heard from Fed Bullard and Waller who both openly backed another 75bps hike in July followed by 50bps until the neutral rate of 2.4% is met. From this point forward they would want to see hikes reduced to 25bps upon review of economic conditions. Waller had this to say about the U.S economy: It seems like the Fed is viewing the economy with a completely different lens than what we’re currently seeing. As it stands the Fed seem to draw its conviction and hawkish tone from the present labour market NFP readings which beat the expectations of 268k by 104k totalling 372k over the month of June. Not bad I must say. But let’s take a look at the chart below; as you know I always prefer leading indicators over lagging data i.e (Non-Farm Payroll) Jobless claims are a forward-looking indicator of the health of the labour market; from what we can see from the most recent reading, the amount of individuals filing for unemployment has risen to levels not seen this year; to add on, since June we have been at elevated levels compared to the period of Apr-May. So what is that actually telling us? Very straightforward, the U.S has peaked in strength within the labour market and with the current pace of tightening within the economy, there has to be a trade-off. Either inflation or employment . We already know the Fed is willing to see unemployment reach 4.1% in 2024 so the next observation is to look at what happens when we get an unwinding of lay-offs and firings (something we’ve seen already in Tech firms thus far). You guessed right, a recession. In this unique scenario that will be combined with demand destruction. Let’s couple the view above with a look at the current commodity landscape and what message is being delivered. When it comes to understanding global growth/cycles there’s no better commodity to look at than copper. With its multi-dimensional use cases, this commodity is a leading indicator of the current level of demand within the economy. When global demand is expected to pick up we’ll see a rally in commodities such as copper and even oil since these two are direct sources for fueling the growth cycle. The same is true for global slowdowns, copper will be the first to let you know when demand is off, or in this case en route to destruction. Not only is the aggressive tightening of the Fed sending market signals that demand is already being destroyed but further lockdowns in China due to covid cases is sending commodities to new lows for the year. Just take a look at the returns of Iron Ore, Copper and Silver. Painful. If you recall my piece where we covered China being the leader of global synchronised growth, you may be able to put two and two together to realise China is also the largest consumer of copper globally . So what happens when you take your biggest buyer and lock them down? Copper alone is down -20% for the month! The next topic to prove how demand is already being destroyed is consumer credit and the potential for us to start seeing defaults later this year as higher yields make it increasingly harder to finance debt. I’ll save that for another piece, the main thing to remember is that in the economy we live in today, credit is what drives the world. One man’s debt is another man’s asset and so forth, as credit increases, we have periods of great conditions (expansions) followed by over-leveraging which leads to our current positioning within the curve where credit is withdrawn and those overleveraged are left dancing to the tune of the easy-access-cash, yet to realise the music has stopped and the Fed is hiking. Thanks again for your consistency in reading through! If you’re new, make sure to give some feedback and share with your macro-addicts! See you soon!
Joe Olashugba
Jul 12, 2022 · 4 min read
Let's Talk About U.S NFP Data
Before you say anything, I know exactly what you’re thinking. What happened to the article scheduled for Friday? Here’s the brief answer, I wanted to digest the NFP data coming out later in the afternoon, and being completely honest, writing a piece without covering such a crucial reading wouldn’t be the best value for the MMH community! Now, let’s get into it! Non-Farm Payroll Data & The Labour Market Friday we had the non-farm payroll data release, and once again the actual print beat the expectations of 300k totalling 315k job additions. Now, what I always tend to focus on isn’t the number of jobs added or whether the print "beat” or “missed” the prediction. That doesn’t really matter. What matters to me and what should matter to you is the below: Average hourly earnings. The reason this measurement holds more weight is because non-farm employment numbers only tell you the change in the number of people employed during the previous month; whereas average hourly earnings gives you a broader horizon to get a picture of how conditions are shaping up. Here’s how. If non-farm data beat expectations yet average hourly earnings are lower by 1% (YoY) . What benefit does that have to the economy’s GDP? What value is it to fill the labour market but employees aren’t paid well enough to spark activity within their domestic economy? Absolutely none. The point of tracking such data is to ensure that the labour market remains strong but, more importantly, average hourly earnings grow. So the next time you look at NFP pay attention to more than what the number is, look at how the % change in hourly earnings because that will tell you a lot about the health of the labour market. Unemployment Rate Hits 3.7% Unsurprisingly, we saw the unemployment rate tick higher shown in figure 1 to 3.7% . As a result of the increase in interest rates, we’ve seen massive layoffs across the U.S tech sector; names such as Paypal, Stripe & Robinhood. As it stands the federal funds rate is 2.5% and from figure 3 below we can see the expectations for the upcoming rate decision are tilted towards either a 50bps or 75bps hike. One reason I love looking at the CME FedWatch Tool (source for the above chart), is because you can see the live probabilities and changes in investors’ minds for the Fed funds rate. Predicated on what may be happening, you’ll see investors betting on either a low-size hike, i.e 25-50bps or a larger-sized hike leaning towards 75bps. Take a look at figure 4. Just over a month ago now, market participants were betting on a 25bps hike, probably due to the dovish comments we heard from Jay Powell on the “strength of the U.S labour market”, “neutral rates” and a ‘soft landing’. Shift your focus to 1 Week 26 AUG 2022. What happened that weekend? That’s it, The Jackson Hole summit. From this, we saw equities take a sell-off after listening to a firm message from the man Jay Powell that they will not make the same mistake as they did during the 70’s inflation peak. The result, a sell in any risk-on asset. Plus, Jay Powell basically put a 75bps hike back on the map again so that fuelled bets that we will see further aggressive tightening into deeper restrictive territory in monetary policy. The Dollar Surge The last run I can remember the dollar having like this must have been the rally of late 2014 which ran into 2016 causing many companies like Apple to cut their revenue and profit forecasts. For those who can recall a previous article, we looked at how one could have positioned oneself in a long-on-the-dollar ETF trade to bet on its inevitable appreciation against a basket of G10 pairs. That trade to date has delivered 14%, so believe me I’m just as gutted I missed out on such a good opportunity. Looking forward, I see a short on the dollar as a good opportunity for some alpha as we draw near to the end of the hiking cycle sometime in ‘23. The extension and bull run we have seen have been mainly attributed to rising global fears of war, a recession, an energy crisis across Europe and not to mention a widening interest rate differential between the Fed and other major central banks globally. To touch on the last point and the importance it has, put yourself in the shoes of an investment manager or a large body in charge of capital placement. The drivers of capital flows have all revolved around the stability and growth potential of a nation; meaning the political policy, monetary policy, GDP outlooks and growth. So when eyeing up the U.S economy against other G-10 nations you can see why it would stand out and attract the large majority of capital flows. Number 1, the U.S doesn’t have the basic energy exposure many of the European countries have, 2, the U.S when compared to G-7 nations has a politically sound policy. Take a look at Italy and you’ll understand the importance of that point, Italy has been hit with the brunt of the stick both politically and with inflationary and other economic conditions. Finally reason number 3, the U.S is simply ahead on the tightening cycle within financial conditions so the U.S presents the safety of capital and a good yield. So, due to these fundamental and economic drivers, the flow of foreign capital has found a haven in the dollar which has paid dividends. Coming out of this I am keeping an eye out for the other side. I’ll leave you with this quote from Ken Griffin: Appreciate you as always for reading until this point! Do me a favour and share this with someone you know will pick up some value, subscribe and share your thoughts and ideas with me on Twitter, LinkedIn or Instagram! Until next time
Joe Olashugba
Sep 5, 2022 · 6 min read
10.1% Inflation, Lack Of Truss In UK Markets
It feels like I’ve been stuck in a never-ending loop of drama with the Uk; inflation sustaining above the 10% figure, the ousting of Borris initiated by his own cabinet and now the 44-day rise & fall of Liz Truss. Comical to say the least… In this piece, we take a look at: As always, lend me your attention 10.1% Inflation, Again… Yes, again! This is not the first time CPI in the Uk that CPI has touched 10.1% , rewind back to July when we also saw inflation at 10.1%. If you ask me, things just keep on getting worse for the Uk; and there’s no sign of conditions slowing down. Let me outline to you very simply where we are: Back to the inflation. As it stands within the Uk, rates are sitting at 2.25% , the bond market is predicting rates within the Uk to hover between the 3.5% - 4.0% range in the near term (2-5 years). I personally see the Bank of England hiking rates throughout 23’ incrementally before being forced to start the process of quantitative easing once something breaks; the real question I’m wondering is. When is it enough tightening? To that you might answer, Joe that’s pretty simple when inflation is under control; to which I’d then question, what will we have to put markets & the economy through in order to achieve that? Inflation is usually driven by a few very simple factors; accommodative/loose financial conditions, large pent-up demand within the economy and of course increased productivity domestically but also globally as productivity drives growth, growth then drives commodity prices resulting in inflation. But as we all know, this isn’t textbook inflation. An ongoing war, restricted supply chains caused by continuous lockdowns affecting crucial trade ports that are relied on to satisfy demand and global energy prices through the roof. Just a few factors are at play; all of which have led to our current 10.1% inflation figure. Luckily the Uk is far advanced compared to the likes of EM (emerging markets) and FM (frontier markets) or else we would have had the recipe for hyperinflation. Hyper Inflation = Rapid inflation + a collapsing currency leading to a contracting economy The Great Demise For Liz Truss This is probably the most accurate representation of what has happened these past 4 weeks. After only 44 days Liz Truss resigned as PM of the Uk. However, she still walks away with £115,000 per year from the tax payer’s pockets for her ‘service’. What a gig to be involved in. Rather than diving into the politics I value getting a clear understanding of what is ahead for the Uk and where opportunities may lie. As a result of consumers’ finances being heavily hit due to cost of living inflation, from the cost of rental property all the way to the average basket of household goods, an expected slowdown in retail sales is already eminent within the economy as fears surrounding a looming recession drags an already weakened consumer confidence lower. The services sector represents the bulk of the Uk GDP, with declining spending and confidence, both with consumers and corporations the outlook points towards a needed recession. Now, the question that should be lingering within your head is. What exactly are consumers spending less of their money on now? Here’s the breakdown. For those who have seen their cost of living go up, the most common lifestyle changes they have made as a result were: here’s the graphical representation. From a first look, I would begin to raise some red flags if/when the % of adults using credit cards more than usual began to rise rapidly; rising rates and rising credit usage usually end with higher risk and potential for defaults on payments. Looking forward into the next 6-12 months, the Uk is about to experience further tightening and see a further withdrawal of spending from the consumer as living conditions worsen; sterling has found some feet as Jeremy Hunt, the new Uk Chancellor, has reversed the majority of the mini-budget plan. My focus will be on the upcoming BoE meeting to see their stance after such an eventful Sept/October. Thanks for bearing with guys I know this piece came out later than usual on a Saturday morning as supposed to Friday! But we got there in the end As always, share with a macro head and let me know your thoughts! I’m heavily active on Twitter & Instagram so please follow & reach out for anything! Twitter - @JoeOlashugba Instagram - @Joe.olashugba Until next time Joe
Joe Olashugba
Oct 22, 2022 · 5 min read