The Current Global Macro Picture
I don’t know about you guys, but sleep hasn’t been so good recently. Let’s unpack what the current macro landscape looks like; I must say it is getting hard to constantly keep up with everything going on globally. BoE “Five Negative Quarters To Come” Last week we heard forecasts from the BoE predicting the Uk to enter a recession from Q4 ‘22 . As we’ve all seen from the Fed, central banks rarely tell the truth when it comes to the reality of how bad things will get. “Transitory” and “temporary”, both terms we soon came to realise were lies from Jay Powell. However, the BoE is embracing the fact that the economy is going face-first into a period of prolonged turbulence. As it stands right now, inflation is sitting at 9.4% and is expected to top 13% in Q4 of the year as gas & energy prices become evermore costly to Uk citizens. On the note of gas prices, we can expect the price cap to rise by around 75% in October compared to around 40% in the May report sighted from the BoE. Take a look at the data for components contributing to UK CPI; you’ll see exactly where it’s all coming from. I know it’s pretty difficult to read with the massive data label but you understand the meaning when seeing inflation broken down, component by component. The biggest factor at play, you guessed it, household services (gas & electricity). Now you’re probably looking at transport thinking what’s the reason it’s added an extra 1.5% to the annual inflation rate, well the reason ties back into the elevated petrol costs we’re experiencing at the minute. Such changes have ripple effects that aren’t susceptible to only one sector but the wider scale economy. Just take at Chart 3 below to see how ridiculous things have gotten in petrol prices. Historically we can say unleaded pump (the most popular form) has ranged between 110.00p - 131.00p. From the range highs of 131.00p until now unleaded pump prices are up 38.9% . That’s on the lower end… So from Jan ‘21 until now, petrol prices are up 56% . Multi-decade high petrol costs, rapidly rising interest rates and a low/negative growth economy, a recipe for a disaster if you ask me. The good thing is we can see what proceeds with every peak in prices, sharp decline. Investors’ Risk Appetite Shifts Back To High-Risk Assets One chart that caught my eye after listening to a macro podcast was the NFCI, which is the National Financial Conditions Index created by the Federal Reserve Bank of Chicago; a release that comes out every week. This index provides a weekly update on U.S. financial conditions in money markets , debt and equity markets and the traditional and “shadow” banking systems. Now for a quick breakdown; the idea is that when the national financial conditions index is positive, as shown in 2008 & 2020, this is historically associated with tighter-than-average financial conditions . And for negative values historically this is associated with looser-than-average financial conditions . So looking at chart 5, 2008 the U.S economy experienced tighter than average financial conditions which shortly declined to a financially looser than average period in markets. Then fast forward until 2020, the peak of covid where we had a sharp tightening in conditions mainly caused by fear/worries and panic over global growth. Now if we are to take a closer look at more recent data, the past few weeks particularly the last two weeks have presented some very interesting messages to asset markets. *Mic drop Now I hope you’re understanding the direct importance such press conferences have on financial markets/conditions. Over the past three weeks, we have seen financial conditions materially loosen which has sent investors seeking risk assets. Look at equities over the past few weeks, names such as Coinbase and Uber are just a few to name who have felt the massive (short-lived) optimism of markets. Bear in mind Uber reported its first positive cash flow quarter ever and it’s up north of 40% this past month. If you ask me Jay Powell is having another moment he might want to forget, although it’s always easier looking in from the outside. What we’re seeing right now is a disconnect between what is actually happening globally, supply chain issues, energy prices set to push inflation to double digits, and even lacklustre growth and what investors are pricing in within asset markets. I won’t even go into what’s happening within bond yields but inversions across the 2s/10s yields are showing just that. The front-end yields are loaded with hikes to kill inflation, whilst backend yields are lower in anticipation of lower growth/lower rates. All in all, there seems to be a bit of fog and smoke appearing. At the end of the day, as Seth Klarman said, the most important thing is whatever decisions you’re making, you’re able to sleep peacefully at night with them. Thanks for reading through to the end. I put a bit more depth within this piece and would appreciate you sharing it with everyone and anyone; the Market Macro Hub community is growing rapidly and I can only thank you guys! Until next time.
Aug 10, 2022 · 5 min read
Credit Crunch: It's Worse Than 2008...
Welcome back macro heads; we’re going to dive straight in here, a lot to uncover this week. Strap in and as always, lend me your attention. I was raised to give credit where credit is due. It’s only right to give credit to this man here, Jerome Powell for his policy actions throughout 2021 which have led till the current events. Thanks Jay. Jokes aside, we’re in an extremely strained global housing crisis . The way macro conditions are shaping, there is only one way that this situation relieves itself. A housing crash. Financial Conditions: Too Loose, Too Long.. There’s a common saying in markets; Now although Buffett intended this to reference the importance of diversifying your portfolio to ensure one can weather against a downturn in markets; this also applies to the fundamentals which governs an economy’s financial health. Since the GFC, the Global Financial Crisis of 2007, economies around the world have benefitted from a low rate environment, ease of access to credit, full functionality in financial markets through central bank liquidity and rising deficits amongst government bodies. A period many investors call ‘Goldilocks’ within markets and financial conditions; why you may ask? It’s simple, because conditions are just perfect, neither too hot, neither too cold, lukewarm to be exact. Everyone become’s Jim Simmons making huge bets. The type of environment which nurtures steady growth and stable inflation, until you have a year like 2020. I think it’s clear to say we are now in anti-goldilocks within financial markets, where the economy is both too hot in terms of inflation , but also too cold in terms of growth. The below figure shows the a quick-view of how the rest of the world is battling this period of stagflation; a period where inflation is accompanied by low or non existent economic growth. As you guessed, the darker the red/shading, the higher the country’s interest rate. Not a pretty sight I must say. As shown in figure 2, the most recent central bank rate decision for both nations saw an increase with the Fed maintaining it’s hawkish stance against inflation, however, the Uk only able to deliver a 50bps hike due to the severity of the current economy. But what does this actually mean for the average home owner or tenant both in the UK or U.S? Rising Rates, Rising Fears For Housing Market Before we look at the trouble rates are causing within the housing market this chart shows the Bank of England’s official base rate. As aforementioned, rates within the Uk have hovered around 0.5% for the most part of a decade, if not more. Now the period where growth was on the rise within the Uk and inflation was beginning to peak it’s head above 3-4% , would have been a the perfect time for the BoE to test the market’s ability to stomach a smaller rate increase whilst ensuring inflation is within their monetary policy goal. But as we know, the exact opposite happened, they left monetary policy conditions loose, inflation soared above target and stimulus was everywhere to be seen. Figure 4 puts in perspective how elevated home prices are relative to the median income within the Uk. Historically, the Uk house price/ average annual income ratio within the Uk has floated between 4 and 5; except for the Barber Boom and Lawson Boom . Just for some context the Barber boom was named after Uk’s Chancellor Anthony Barber back in the 1970’s, whose budget, designed to return the Conservatives to power, led to a brief period of growth known as “ The Barber Boom ” that unfortunately pushed the economy into a recession. With inflation in the double figures rates had to be increased having a detrimentally negative affect on housing affordability. Some analysts think we’re returning to the 1970’s inflationary period, as we already breached double digits early this year topping 10.1% to be exact. Now the Lawson Boom was also another macroeconomic storm caused by who? You guessed it, the Chancellor of the Uk during Margaret Thatcher’s reign in the 1980’s, seems like Kwasi Kwarteng is only following the footsteps of his predecessor’s in making huge policy changes which force the markets to say otherwise. Simple Put, Nigel Lawson, the man the boom was named after cut the standard income tax rate from 29p to 25p per £1 of income. History lesson over. The ratio between Uk house price and average annual income is sitting at 9, during the 08' housing bubble the ratio was 8.5. What’s worse is that the Bank of England will have to increase rates to keep the fight against inflation going but with rates on mortgages set to be recalculated the bubble I see is a large amount of defaults on mortgage payments. For those on variable mortgages or tracker mortgage, which simply tracks the BoE’s rate changes; things will be getting tighter much quicker. Yields, Credit Spreads & Mortgages in the U.S I hope the picture is clear for you. Rising rates, rising mortgages, defaults, leading to a probable housing crash. Sounds about right to me. Looking at this chart realises the drastic change in credit within the U.S economy. Starting with mortgages, as of today a 30-year fixed rate mortgage would set you back 7% !! It’s the same story all over again but in a different part of the world, markets may not repeat itself but they sure do leave clues. The point to note with bonds, is they both predict future interest rates within an economy and also the underlying risk associated with the issuer defaulting/falling behind on payments; so what we’re seeing today is simply the yield investors are demanding to take on the inherit credit risk associated with the debt instrument and duration. For the private sector, widening credit spreads means only one thing, tougher times. Here’s a reason as to why, as access to credit tightens within an economy, companies looking to borrow funds through new issuance of bonds have to have their credit worthiness tested by global rating agencies such as Moody’s or S&P Global . Now according to the LCR (liquidity coverage ratio), a regulation put in place to prevent banks/large financial institutions from liquidity runs, allowing them to survive a period of significant liquidity stress over a period of a month; they must allocate a specific amount of their portfolio to high grade bonds, upper medium grade and lower medium grade, there’s no room for junk bonds however. The catch is, the lower investment grade the bond is, the less allocation the institution is allowed to make, due to risk levels associated with the investment. So for corporations a simple downgrade from AA- to A+ (S&P rating)significantly decreases the liquidity and capital they can raise as banks/pensions funds/insitution’s have to rethink their portfolio allocation due to the credit worthiness and rating changing. Credit spreads are obviously affected by the degree of borrower’s creditworthiness , but as you can see the regulatory and institutional constraints affecting the decision making progress of huge fixed income buyers play an important role too. So higher rates cause trouble within the private sector when it comes to credit worthiness. Tying this back to more recent events you can see why the Uk is under soo much stress as the credit market faced this hit. Explains the massive amount of selling in gilt markets and the pound as Uk’s debt market was recently downgraded to AA-. A rating that is still high grade but screams to investors “greater risk, I’m going to need a bigger risk premia” - hence why yields are up on every gilt and also why the Bank of England have had to set in to salvage the bond market from tearing apart. Hey guys, thanks for reading! I know it didn’t come out on Tuesday, this was a longer piece so I needed to get it right for you! We’re back on Friday; as always stay tuned and please share, re-post and send to someone Twitter - @JoeOlashugba Instagram - @Joe.olashugba Until next time, Joe
Oct 12, 2022 · 7 min read
Two Negative Quarters, Recession Finally Here?
Is it official, that the U.S is in a recession…or is there more to the story? According to widely accepted knowledge, a recession is defined as two consecutive quarters of negative declines in GDP, which we have seen in the U.S after Thursday’s reading. That was until Jay Powell decided to change the definition across the web; problem solved right? No. In Q1 the U.S economy's GDP figure declined at an annual rate of 1.6%, and over the last three months declined by another 0.9% . However, that is not an official definition of a recession, let me explain what is; A non-profit organisation called the National Bureau of Economic Research defines a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months”. Ok, so now that we know what an actual recession (officially) is, let’s look at what Jerome Powell had to say in response to comments about the U.S sliding straight into one. Typical Powell, to boast about the state of the labour market which we both know is a lagging economic indicator and as we have been seeing across the news prominent corporations like Robinhood , Netflix and Shopify are just a few of the many Technology firms being forced to fire/cut employee numbers due to economic conditions tightening up. So the question to ask is when will we begin to see job layoffs impacting the wider Non-farm Payroll data figure we’re seeing? Now that we’ve opened up the floor let’s take a look at the Fed hike and the message perceived by the markets. We saw the Fed hike rates by 75bps which was pretty much priced in by markets, what wasn’t priced in was the dovish comments made by Powell which sent risk assets rallying. So if your equities or crypto holdings are up, thank Jay Powell :) After reading the transcript of Jay Powell’s conference this week here’s what stood out to me: Powell acknowledged the fact that the unemployment rate is currently sitting near a “50-year low” , which although that sounds good from the outside looking in, we have to understand that his goal and overall purpose is to deliver his speech with the utmost confidence in the labour market further backing the actions the Fed take; however, the markets picked up on the dovish comments made by Powell which I’ll highlight later in this piece. Starting with the labour market I’m seeing a consistent increase in the initial jobless claims, showing more people filling for unemployment on a weekly basis which could be a sign of cracks appearing within the perfect labour market Powell keeps rambling on about. Not only is the outlook looking weak in employment, but a look into pending home sales provides a leading insight into how consumers are pricing up the market for purchasing new homes. If both the housing price and mortgage rates are looking attractive then you can expect a higher number of pending home sales across the U.S and the exact opposite for unpleasant conditions. The latest reading came in at -8.6% , the worst reading we have seen since early March ‘21. It’s clear to say we are already experiencing demand destruction across the U.S with pending home sales declining rapidly as well as new home sales. This shouldn’t come as a surprise considering where 30y Treasuries are at, taking a mortgage out in this environment would be crushing to your pockets. I said I would cover it so here it is, bare with me… Post the Fed Interest rate hike you would expect equities to shift lower and borrowing costs in yields to steepen right? That wasn’t the case and the reason why is statements such as these from Jay Powell: Both statements have indirectly told market participants that we will no longer be looking to hike aggressively above the neutral rate into the restrictive territory; so you can start buying up risk assets since the bad days are over. So in this hiking cycle, Powell has given equities, crypto and other higher-risk assets room to rally with such comments; if there’s one thing we know about inflation is that it’s like a helium balloon, easy and quick to go up but painfully slow to go down. Moving forward I’ll be watching closely how leading/lagging indicators line up giving me a clue on how conditions are shaping up and what that means for the Fed meeting in September. As always, thanks for reading this! Share with your macro heads in your group— much appreciated.
Jul 30, 2022 · 5 min read
The Current Macro Picture (Pt.1)
Hi guys! - Welcome back to Market Macro Hub. There’s a tonne to talk about, especially in this climate. So much so, this will be a trilogy breaking down the current global macro picture. In this piece, we will dissect the following: Global Growth, U.S Labour Market & The Tech Meltdown The IMF’s recent global outlook shows that global growth is expected to slow from 6.0% in 2021 to 3.2% in 2022 and 2.7% in 2023. Keep in mind that this is the weakest growth profile recorded since Covid-19, the GFC (Global Financial Crisis in 2008) & 2001. When observing growth I tend to focus on leading indicators as supposed to lagging indicators/hard data such as GDP, CPI & employment. Surveys are the most common form of leading indicators; readings such as ISM, PMI & consumer confidence provide a forward-looking viewpoint of current conditions. Let’s rewind and explain what this really means for those who may not fully understand. The manufacturing PMI index is a survey that simply measures the month-on-month change in economic activity within the manufacturing sector. Why this sector in particular? Well, it’s the most sensitive to changes in the economy from commodity prices to interest rates and usually, the manufacturing sector is the first to blow up in a recession. A great proxy for judging the cycle of an economy/ the global economy. When the readings are above 50 this is expansionary and vice versa for below 50 being contractionary. Across major economies exporting goods the overall trend has been bearish since July 2021 but remained above 50 which meant managers within the manufacturing industry saw signs of expansion and development within the economy. However, since April, there was an overall acceleration of the downward trend in PMI most likely caused by the uproar in inflation globally, succeeded by the most aggressive hike in interest rates by central banks globally. So what does this mean for equities? Take a look at Figure 2&3. YTD U.S equities have returned anywhere between (-20%) and (-33%) on capital deployed. Sure, you could blame the worsening macro picture, the rising of interest rates and the portfolio rebalance away from riskier assets and into safety but those aren’t the only factors at play. ISM, otherwise known as the Institute for Supply Management is a heavily overlooked survey showing comparable data points to the PMI index. Now, with a correlation near or even over 80% the ISM index is the best indicator of the U.S economy but moreover the direction of the S&P500. Simple business cycles leading the direction of U.S equity markets. As we’re focused on global macro we now need to employ second-order thinking; if the U.S, UK and Europe’s manufacturing industries are signalling signs of a slowdown, what is the source? Where is this coming from? The source of this contraction must also be the source of expansion , so we now need to look beneath the layer and ask. Who drives synchronised global growth? Bingo! China. So rewinding back to February when China enforced strict lockdown measures across Shanghai, affecting goods stuck at trade ports we saw the effect this had on supply chains globally. Consequently, if China slows down that has implications for Germany (a major manufacturer of goods & GDP contributor for Europe), the U.S, Uk and India. So forth and so forth. As a result, you see the chain and domino effect caused by one discrepancy within the global financial system. Yesterday, China's exports YoY came out negative (0.3%) against expectations of a 4.3% increase. Using second-order as a framework we can now put a picture together of the domino effect the markets may have. Add to that cocktail multi-decade-high inflation and numerous cracks within the global economy from a levered pension fund industry, to fragmentation risk in the Euro Area, to Canadian private sector debt, which currently sits at over 280% relative to GDP, a figure that is higher than the peak of the Japanese housing bubble in the 1980s! The moral of the story, we’re cooking up an already overheated economy and screws are starting to come to lose in different places within the global financial mechanism. I broke down on my last note how housing across the Uk, Canada and Australia are on the brink of cracking due to rapid rate increases. Labour As the global financial world enters the next phase of the downturn cycle we’re about to foresee, layoffs have been in the eye of major tech companies in hopes to preserve cash flow & earnings outlooks. It’s a bloodbath out there, with the most notable names Twitter and Meta being forced to cut thousands of employees from their workforce. Total nonfarm payroll employment increased by 261k in October whilst the unemployment rate rose to 3.7% . I’m not going to focus too heavily on the unemployment rate in the U.S as this is a lagging indicator which at the moment is only clarifying the fact that the U.S has bottomed out on the subject of unemployment; I expect to see this particular number increase as companies begin to feel the squeeze of conditions whilst the Fed continue to raise rates all the way until 5%. This is it for pt.1, but we’re back on Friday with an insight into: Thanks for reading! Finally, if you’re gaining knowledge from this could I ask you to share this with someone like you? It’s free game — why not ;) Until next time
Nov 8, 2022 · 5 min read
The "Super Bowl" Central Bank Week
Firstly, what a week, right? Let’s dive into the meat, and as usual, lend me your attention from here onwards. Successive 75bps Hikes, Enough To Solve Inflation? It’s set in stone, if you were anticipating a Fed Pivot, i.e a diversion from their aggressive monetary policy stance, you can say goodbye to that dream. Rates are up 75bs to 3.25% in the U.S , and it’s about to get hotter. Let’s dissect the newly released Summary of Economic Projections (SEP) from the Fed. Now, what’s the first thing you notice when comparing some of the projections to the previous June release? It’s the change in expectations for real GDP growth this year and in 2023. Initially, in June ‘22 the Fed projected real GDP growth to be at 1.7% whereas projections now are showing revisions for real GDP growth to be subdued at 0.2% a whole (1.5%) cut! Fed Jay Powell pointed toward “high-interest rates” as the reason we’re seeing such low revisions for economic growth. The question is, how did markets perceive the initial release and what is the market pricing for the future? To answer that, let’s take another look at the Federal funds rate projections vs the June figures. What markets instantly would have seen is that now interest rates in the U.S are expected to rise higher than previous projections and stay elevated/ in restrictive territory for a longer period of time. And if you’re judging how restrictive rates will be, the neutral rate is 2.50%, and we’re expected to see interest rates climb 200bps above neutral rates. That just goes to show how serious the Fed is about getting to its inflation target. You might be thinking, why does that matter? Here’s why. What affects the wider scale economy isn’t just what interest rates are, whether restrictive or accommodative, it is the duration , the length of time financial conditions are either loose or tight . So, if we experience a tightening in financial conditions only up until mid-2024, a shorter time window as seen in the June SEP revision, you would expect asset markets to take a relatively small downturn as seen, in anticipation that the Fed will have to pivot from their aggressive stance at some point to support the economy, eventually boosting risk assets once again. However, what we’re seeing now with the recent SEP revision, is that the Fed will now maintain a tightly restrictive monetary policy for much longer with rates expected to reach highs of up to 4.75% as shown in the dot plot below. The main point, I want you to take away from this dot plot which simply shows all 19 FOMC member’s projections of interest rates for the years 2022 - 2025, is the level at which members expect rates to be in order to get inflation under control. That being between 4.50% and 5.00% by 2023 vs the June expectation of 3.50% and 4.25% by 2023. That shift only signals more hawkish behaviour from the Fed and further pain for stocks, crypto, EM & G-7 currency valuations which have already taken a hit YTD. In short, I think the Fed has made the correct step in its monetary policy stance which is to bring back inflation to 2% , through successive rate hikes and balance sheet reductions (something we’ll look at later). My central focus will be on how equities price in tighter financial conditions for longer as well as how leading economic indicators will react. Bank Of England Join The Party: 50bps Very similar to what we have going on in the U.S; the BoE stepped up its interest rate expectations after raising its base rate to 2.50% from 1.75% on Thursday . I must say, the narrative in the Uk in regard to where we are headed as a nation is a forever dwindling picture. Amidst all of the rate hikes, cost of living remains the biggest soreness within the economy. A testimony to the current weakness is the rate at which the BoE stepped up interest rates. Remember, at the end of the day what really matters most to central banks, is their credibility . Now onto an even bigger focal point, when assessing the relative strength of a currency relative to the G-7 basket one of the first things you would look at would be the IRD (interest rate differentials). With the Fed recently hiking rates by 75bps, the ECB by 75bps and even the SNB (Swiss National Bank) hiking rates by 75bps , you have to ask. How is the strength of the UK’s economy perceived by the world against other major economies? Especially when the BoE is only able to deliver a 50bps hike unlike its G7 counterparts. Yes, you may be thinking we are ahead on the hiking cycle, having a positive rate differential vs ECB & SNB, but the important factor at play is the ‘rate of change’ and monetary policy stance. Even though rates may be higher in the Uk economy, if the future economic picture is looking weaker, that will translate through to monetary policy conditions materially softening resulting in lower rate hike increases like the one we just saw. That is the ebb and flow of where the Uk is positioned. I know we saw some really interesting action from the BoJ this week as they intervened to stop the Yen from sliding! I will save that for a detailed piece coming out on Tuesday; as for now - thanks for reading and supporting as always. I’m getting heavily active on Twitter and Instagram for Macro-related purposes so be sure to give me a follow and connect! Appreciate the feedback and the love you guys show Twitter - @JoeOlashugba Instagram - @Joe.olashugba Until next time. MMH
Sep 23, 2022 · 5 min read