2023.03.13 Weekly Note

Cash is not trash

Firstly, there seems to be a tangible fear we are on the cusp of a major policy error after Powell kept the door open to a 50bps hike, a reacceleration of which is likely to induce a hard-landing recession sooner than was thought. Tuesday’s inflation report will be key on that note, and I do not see the Fed stepping off the gas so easily and would expect 25bps next week at the least.

Secondly, and more to the point of today’s heading ‘cash is not trash’, the SIBV contagion on the banking sector is not only confusing the hiking expectations, but it’s also showing cracks in the banking system which stems from a deeply inverted yield curve.

If banks are in the business of borrowing from depositors at short-term rates (cost) to then loan out of those funds to customers on longer-term rates (revenue), then they suffer from net interest margin loss pressures. And with T-bills offering around 5% yields, there is competition for those deposits and an inherent risk to their business.

This is the dynamic that creates a credit crunch — banks become reluctant to lend, and when banks aren’t lending, economic growth stagnates til it eventually goes into recession.

The NY Fed produces analysis that estimates the probability of a recession based on the term spread readings. At this point, their probability of a recession is rated higher than at any time since the early 1980s. In anyone’s language, the yield curve is at an extreme reading.

I recently saw a podcast with Brent Johnson and he said history has shown that there is a period that’s great for stocks when the yield curve inverts and I think that makes sense for various reasons, but the important thought is that we may just be at the end of that period when the yield curve finally proves to break the camels back and impact credit markets, where we typically see the onset of a drawn out recession.

Markets and the Fed now appear to be in a very vulnerable spot.

NEWSFLOW

US

• Dow closes more than 300 points lower, posts worst week since June as Silicon Valley Bank collapse sparks selloff (CNBC). Just like that: Market pricing swings back to quarter-point Fed rate hike (CNBC). Bond Yields Plunge Most Since 2008 as Traders Rethink Fed Path — US 2-year yield falls nearly 30bps on year-end rate-cut wager, Financial contagion fears outweigh strong February jobs data (BBG). Regulators close New York’s Signature Bank, citing systemic risk (CNBC). SVB, Signature Bank Depositors to Get All Their Money as Fed Moves to Stem Crisis (WSJ). Fed Discusses Easing Access to Discount Window to Help Banks — Such a move would help banks meet any demands for withdrawals, Some banks already tapped discount window after SVB collapse (BBG). Dow futures jump 250 points as regulators announce backstop of SVB depositors (CNBC). Markets at Risk of More Upheaval as Banking Uncertainty Persists (BBG). 20 banks that are sitting on huge potential securities losses — as was SVB — plenty of other banks that would face big losses if they were forced to dump securities to raise cash (MarketWatch). Bitcoin Has Worst Week Since FTX Crash as Headwinds Take Toll (BBG). Stablecoin USDC breaks dollar peg after firm reveals it has $3.3 billion in SVB exposure — The company revealed it has nearly 8% of its $40 billion in reserves tied up at the collapsed lender Silicon Valley Bank, fell below 87 cents on Saturday, according to data from CoinDesk (CNBC).
• How the second-biggest bank collapse in U.S. history happened in just 48 hours — company’s downward spiral began late Wednesday when it surprised investors with news that it needed to raise $2.25 billion to shore up its balance sheet. Customers withdrew a staggering $42 billion of deposits by the end of Thursday, according to a California regulatory filing. Now, those who remained with SVB face an uncertain timeline for retrieving their money (CNBC). Auction process is reportedly underway to find a buyer for Silicon Valley Bank — FDIC took control of the bank on Friday and started an auction process on Saturday night, It is still possible that no deal is reached (CNBC). Hundreds of venture capital firms vow to work with Silicon Valley Bank again if new owner is found (CNBC). Silicon Valley Bank employees received bonuses hours before government takeover (CNBC).Bank of England seeks to wind up Silicon Valley Bank’s UK arm (CNBC).
• Jerome Powell Says Fed Is Prepared to Speed Up Interest-Rate Rises — Chair says U.S. central bank likely to lift rates higher than previously thought to fight inflation (WSJ). Summers Sees Nearly 50–50 Odds Fed Must Hike to 6% or Higher — Ex-Treasury secretary sees CPI data as decisive for March move, Summers warns on long-term fiscal dangers as rates climb (BBG). Fed Flies Blind on Monetary Policy With Rising Risk of a 6% Rate — Powell cautions that ‘we don’t know’ where neutral rate is, Lack of a gauge raises risk of overshooting or undershooting (BBG). New York Fed model finds inflation pressures more persistent than thought (RTS).
• US Payrolls Top Estimates, Wages Cool in Mixed Signal for Fed (BBG). Payrolls rose 311,000 in February, more than expected, showing solid growth (CNBC). Private payrolls rose by 242,000 in February, better than expected, ADP says (CNBC). Job openings declined in January but still far outnumber available workers (CNBC). US Jobless Claims Jump but Remain Historically Low — Four-week claims average is below prepandemic levels, with most of the increase in New York and California Tech (WSJ). Finance Companies Continue to Cut Jobs Despite Strong Broader Labor Market — Retailers, hotels and restaurants hired briskly in February (WSJ). Dividend Stocks Have New Competition: Cash — Just 34 stocks in the S&P 500 have a dividend yield above that on the six-month Treasury bill (WSJ).
• Canada Feb job gains surprisingly strong, upping pressure for higher rates (RTS). Canada posts surprise January trade surplus of C$1.9 billion on export gains (RTS).

EUROPE

• ECB Seen Taking Rates to 3.75% Peak as Bond Exit to Quicken — conomists predict four more hikes, finishing in July, Pace of quantitative tightening to be increased, survey shows (BBG). Norway Inflation Slows More Than Expected, Cooling Rate Bets — Headline and core inflation rate both fell in February, Norges Bank has faced growing pressure to speed up tightening (BBG). As ECB Rates Play Catch-up, Nordic Currencies Risk Deeper Losses — Riksbank, Norges struggle to keep pace with Fed, ECB hikes, ‘It’s a bleak, hopeless situation,’ Nordea analyst says (BBG).
• Global Economy Gets Tailwind From Falling Energy Prices — Lower natural-gas prices could boost European output by 1.5%, economists estimate (WSJ). Germany Turns Page on Economic Abyss With Sign of Green Shoots — Median in Bloomberg survey no longer shows GDP drop for 2023, Production, confidence and DAX at highest since February 2022 (BBG). EU Strikes Watered Down Deal to Boost Energy Efficiency — EU parliament, countries agree to 11.7% target for end-decade, The deal lays out targets for scaling up yearly energy savings (BBG). Biden and EU’s Von Der Leyen Seek Trade Truce — Ukraine, sanctions and China are also likely to be on agenda, US, Europe have clashed over subsidies in Biden’s climate law (BBG). French Senate votes for Macron’s pension plan, despite new protests (CNBC). Macron Tells Protesting Unions Pension Reform Is Unavoidable (BBG).
• UK Economy Swings Back to Growth, Boosted by Premier League’s Return — Falling energy prices will give a longer boost to growth, but strikes are a drag (WSJ). 356,000 More Mortgage Borrowers Could Face Trouble by June 2024, FCA Says — FCA cut its forecast for struggling borrowers since September, Expecations of peak base rate have fallen to 4.5% from 5.5% (BBG). UK Plans £11 Billion Full Expensing Business Tax Break in Budget — Jeremy Hunt will hand business a three-year tax break worth about £11 billion by replacing the UK’s most generous ever investment allowance with a temporary measure in next week’s budget (BBG).
• Russian, Ukrainian Forces Pinned Down in Fight for Key City (WSJ). Turkey Blocks Sanctioned Goods on Way to Russia (BBG). US, EU Pledge Crackdown on Sanctions Evasion (BBG).

ASIA

• China’s Jan.-Feb. Economic Data Show Improvement, Minister Says (BBG). China Consumer Spending Shows Strong Rebound Signs — Spending on cars, restaurants, movies grew rapidly in Feb, Investors remain cautious due to lack of economic stimulus (BBG). China’s Credit Climbs, Led by Companies, Local Governments — mortgage demand from households remained subdued (BBG). Chinese Firms’ Hiring Intentions Hit Eight-Year High: S&P Survey (BBG).
• How China’s shifting growth picture could hit global markets — China’s economy will be forced to recalibrate because of a “fractured” global order, and the new drivers of growth will “disappoint” global markets, according to David Roche (CNBC). China Plans New Middle East Summit as Diplomatic Role Takes Shape — Beijing’s involvement in the details of dispute between Saudi Arabia and Iran led to a re-establishment of ties (WSJ). US Apparel Companies Can’t See a Future Without China — Brands are finding few factories outside the country that can produce the quality and quantity they require (BBG).
• Japan Consumption Rebounds by Most Since March Despite Inflation — Household spending rose for the first time in three months, Demand was robust despite price gains at a four-decade high (BBG). Haruhiko Kuroda sticks to his guns in last Bank of Japan meeting after ‘bazooka’ decade (FT). Japan’s real wages drop at fastest pace since 2014 as hot inflation takes toll (RTS). Japan’s workers eye bumper pay hike in closely watched union talks (RTS).
• Australia’s Central Bank Raises Rates, but a Pause Could Be Coming — Policy makers temper language surrounding plans for further monetary tightening (WSJ). Investors Call Time on Australian Rate Hikes in Wake of SVB (BBG).

EQUITIES

Massive bearish engulfing print on the MSCI World that does not point to an immediate recovery.

Developed and Emerging markets also with a strongly bearish weekly signal pivoting away from key pivot area.

European markets have been particularly strong and in my view has done much to maintain resilient in broader risk sentiment.

The Nikkei put in a major reversal bar last week and starts the week 1.61% lower (at time of writing) while the Shanghai composite is trading near the lows after a bearish engulfing bar last week.

SPX and NDX also showing major bearish signals away from key areas that does not point to any meaningful recovery.

Volatility has picked up significantly after being muted for so long, and Tail-risk premiums (Orange) is at the highest see so far this year.

COMMODITIES

Commodities put in a strong bullish reversal following the plunge in yields and USD, particularly precious metals as markets dial back on hawkish backs and price in risks of a recession hitting sooner.

An interesting pair trade based on weaker sentiment and elevated recession fears is long Gold against Crude and an idea I’m consider executing on the assets independently, rather than as executing both the long and short simultaneously.

RATES

Big move in rates last week with the bulk of the coming on Friday. I’m of the view that the market was caught very short STIR and therefore finding the moves questionable as to what they are now implying on the forward path of rates. Even though I agree that market is pricing in the risks of doing too much, I feel the moves are getting stretched, particularly if the Fed and FDIC manage to stem fears in the banking sector.

CURRENCIES

Safe haven CHF +2.28% was the strongest followed by JPY +1.24%, while USD saw heavy selling against non-commodity currencies though up +0.57% on the index. EUR +0.62% and GBP +0.49% benefited from the selling in high-beta FX while AUD -2.59% was the weakest followed by CAD -1.31% and NZD -1.04.

On daily view, the G8 indexes do look stretched and at a point where it could attempt to reverse in my view.

TRADE VIEWS

Latest newsflow on US authorities taking measures to restores confidence in regional banks appears to soothe fears but I think concerns will remain especially now that cracks are now showing as a result of the high cash yield and inverted long end problem. And while charts are looking extremely bearish, I therefore feel the trade is to be on the cautious risk-off side than it is to be bullish risk.

As far as trading is concerned, I will take ideas and levels as they come as I have very little conviction and clarity with so many conflicting narratives.Keeping an open mind, staying nimble, and taking profits will be the name of my game for the week.

Wish you good luck trading.

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