2023.05.15 Weekly Notes

Bobo wants to play

I’m becoming increasingly convinced that risk assets are ready to shed the bloat —2yr real rate is climbing higher to levels seen before the correction in SPX in Feb-Mar’23 and the momentum in equities has completely faded over the past month.

NEWSFLOW

MARKETS

• Wall Street Loads Up on Doom Hedges as Countdown to X-Day Begins — Open interest for VIX calls reaches highest level in 5 years, Parallels with 2011 spur hedging for extreme selloff (BBG). Investors predict ‘imminent’ US high-yield bond sell off — Tighter lending puts focus on spread between high yield and Treasuries (FT).
• Borrowers Pounce Before the Going Gets Rougher: Credit Weekly — Companies in US, Europe take advantage of window to raise debt, Recession risk, higher rates are incentives to move fast (BBG). Private Lenders Hire Restructuring Pros as Defaults Loom — Barings, HPS and Blackstone among firms bolstering teams, Around 76% of private credit executives expect higher defaults (BBG). Oaktree’s Howard Marks warns of crunch time for private credit — higher interest rates and slower growth are about to put $1.5tn market to the test. Big asset managers had competed aggressively to lend to the largest private equity groups as money poured into their coffers in 2020 and 2021, raising questions over the due diligence the funds conducted when they agreed to provide multibillion-dollar loans. “Now you have some meaningful interest rates and some scarcity of capital as banks are restrained,” Marks said. “This is a good climate . . . you can get equity returns from debt now, and when you invest in debt you have a much higher level of certainty of return relative to equity ownership” (FT).
• Stock Traders Who Nailed Last Year’s Earnings Season See Few Signs of Market Trouble — investors may not see any significant concerns in the future, leading to the calmness in the market, acknowledges the successful adjustment of share prices to reflect the potential profit decline in corporate America in 2022. Divergent views on future profits and potential recession risks, but the market’s current outlook appears more positive compared to the previous year (BBG). Algorithms prop up the market as fretful humans sit out the uncertainty — Quant funds have been piling into US equities in response to falling volatility (FT).
• Dip Buyers Scorched by Cratering Bank Stocks Rush for the Exits — Investors pull most from financial stocks in a year, BofA says, Little confidence that pressure on regional banks will stop (BBG). AI Frenzy Accounts for All of S&P 500 Gain in 2023, SocGen Says — Without ‘hype,’ S&P 500 would be down 2% this year, not up 8%. “The AI boom and hype is strong. So strong that without the AI-popular stocks, S&P 500 would be down 2% this year. Not +8%. Our update on the AI sentiment news indicator keeps rising exponentially and more extended than when we first talked about few weeks ago” (BBG).

• Dr Oil’s pessimistic mood — Harbinger or just temporarily unhappy? GS reiterates their view that prices are still heading higher once the current negative [US banking stress, China industrial weakness, falling diesel margins] drivers fade (FT).

• Lipper Fund flows — Global equity funds see 4th week of outflows on slowdown worries driven by outflows US which was modestly offset by inflows into Asia and Europe. Global bond and money market funds saw 3rd consecutive week of inflows. (RTS).

“equities looks more challenging, as a higher bar has been set for incremental performance at current elevated valuations. Risk-reward for high-quality bonds appears more attractive, and we believe the time is right to build up a diversified fixed income exposure to add stability to investment returns.”

“We suspect money market fund flows may remain strong until the US debt ceiling showdown is resolved, confidence in regional bank stability returns and uncertainty regarding a possible US recession and downward earnings revisions is reduced,” Data for 23,973 emerging market funds showed investors received a net $838 million worth of equity funds but exited a net $622 million worth of bond funds.

• EcoWeek Ahead: China’s Strong Data Likely to Mask Weakening Recovery — US numbers this week likely to show more economic weakness, Japan releases GDP, inflation; EU Commission forecasts due (BBG).

US

• US annual inflation slows to below 5%, price pressures still strong — Consumer price index increases 0.4% in April, CPI rises 4.9% y/y, Core CPI gains 0.4%; up 5.5% y/y (RTS). US Treasuries and tech stocks rally after inflation dips — Nasdaq closes at highest since June after data fuels investors’ hopes the Fed will cap rate rises (FT). Inflation may not be cooling fast enough to justify stock valuations — investors are growing concerned that the U.S. economy may not be cooling fast enough to justify bets that the Federal Reserve will cut interest rates this year, threatening a view that has helped boost stocks (RTS). Traders raise the chances for a Fed rate cut following April inflation report — chances of a September interest rate cut to close to 80%(CNBC).
• Fed policy on right track, but inflation still too high, officials say — Jefferson: “Is inflation still too high? Yes. Has the current disinflation been uneven and slower than any of us would like? Yes. But my reading of this evidence is that we are ‘doing what is necessary or expected’ of us, which is the dictionary definition of being “on track. The full effects of our rapid tightening are still likely ahead of us”. Bullard: “encouraging” the recent stablization of inflation expectations near the Fed’s 2% target. The prospects for continue disinflation are pretty good. Monetary policy is now at the low end of what is arguably sufficiently restrictive given current macroeconomic conditions. The bad news for the hawks in the room is, you are barely in the zone of restrictive-enough policy” (RTS). Bowman: there is no ‘consistent evidence’ that inflation is under control (FT). Williams: current problems in the banking industry and their impact will factor into policy outlook. “We haven’t said we’re done raising rates” (CNBC). Fed says banking sector looks set to weather recent turmoil (RTS). Brainard Says Budget Deal Talks Constructive, Bank System Sound — NEC director says staff-level talks on deal are ‘serious’, Brainard says failed banks didn’t manage risk, system is sound (BBG). Fed [SLOO] report shows banks worried about conditions ahead, with focus on slowing economy and deposit outflows (CNBC).
• UoM consumer sentiment plummets to 57.7 in May six-month low while 5yr inflation expectations rise to 3.2% from 3.0% the highest reading since 2011, Import prices rise 0.4% in April down 4.8% year-on-year. “This report has a bit of a stagflationary feel about it” (RTS). Outlook for household spending slumped in April, New York Fed survey shows — Survey of Consumer Expectations for April showed that the outlook for spending fell by half a percentage point to an annual rate of 5.2%, the lowest since September 2021. Respondents expect an inflation rate of about 4.4% in the next 12 months, down half a percentage point from March (CNBC).
• White House and Republicans start to shape debt ceiling deal — Scope of agreement begins to emerge as talks intensify in bid to avoid unprecedented national default (FT). Bond Traders Laser-Focused on Washington as Debt-Cap Risks Grow — Failure to resolve ceiling issues could upend entire market (BBG). Investors should brace for US debt ceiling turbulence — Even if a deal is done to avert a disastrous default, the process is likely to be chaotic with risks of shocks (FT).

EUROPE

• Bank of England raises interest rate to 4.5% and warns of delay to hitting inflation target (FT). BoE insists it is still winning the fight to control inflation — Inflation is now expected to stay higher for longer, BoE now thinks the UK will avoid a recession, Unemployment is expected to rise less steeply than previously thought (FT). Fresh Gilt-Sale Blockbuster Is Coming as UK Lures Pension Funds — Debt office is selling its longest conventional bond in a year, Sale to offer fresh insight into demand from UK pension funds (BBG).
• UK economy makes slow start to 2023 as inflation headwinds persist — UK GDP grows 0.1% in Q1 2023, matching forecasts, Economy unexpectedly shrank by 0.3% in March, Strikes and weak retail weigh on economy, GDP remains 0.5% below Q4 2019 level (RTS). British home-buyers, facing higher interest rates, retreat in April — measure of new buyer enquiries fell to a net balance of -37 in last month from -30 in March, the lowest since January (RTS). Swathes of UK households yet to face mortgage cost surge: think tank — 1.6 million British households are yet to face a 2,300 pound surge ($2,903) on average when their fixed-rate mortgages roll over this year and next. “Two thirds of the 12 billion pounds a year increase in mortgage costs that British households face as a result of rising rates is still to come” (RTS). UK sales growth holds steady in April, retailers hope for better summer — “While retail sales grew in April, overall inflation meant volumes were down for both food and non-food as customers continued to adjust spending habits” (RTS).
• ECB members sees more hikes but near peak: Future ECB rate moves will be “more marginal”, says Villeroy (RTS), ECB’s Centeno says interest rates near peak, could ease in 2024 (RTS), ECB’s Schnabel sees more rate hikes until core inflation declines too (RTS). Eurozone consumers are more pessimistic on inflation, ECB survey shows (FT).
• Italy industry output falls unexpectedly in March — falling 0.6% from February to register a third consecutive month of contraction, analysts expected 0.3% monthly rise (RTS). German industrial output slumps, recession fears rise — Production decreased by 3.4% on the previous month following a slightly revised increase of 2.1% in February, analysts expected a 1.3$ decline (RTS). Swedish real estate sector rattled as refinancing worries surface — Analysts highlight country’s exposure to rising interest rates (FT).

ASIA

• Japanese firms hike wages by 3.89% this year -Nikkei — Small and mid-sized companies raised wages by an average 3.57%, the highest level since comparable data became available 22 years ago. BOJ Governor Kazuo Ueda has said the central bank would maintain ultra-loose policy until wage growh broadens, and becomes durable enough to heighten prospects of sustained achievement of 2% inflation (RTS). BOJ’s Ueda vows to communicate exit path once inflation sustainable — Too early to discuss specific exit strategy now — Ueda, If BOJ were to sell ETFs, it would do so at market price, Rising inflation, wage growth keeps BOJ under pressure (RTS). Japan’s spending downturn, wages decline heighten pressure on economy — “Rising prices, while somewhat moderated by the government’s energy subsidy programs, have put downward pressure on consumption by shaving households’ real purchasing power” (RTS).
• China’s shrinking imports, slower exports growth darken economic outlook — Fall in imports reinforces signs of feeble domestic demand, Highlights weakness in many of China’s trading partner economies, World economy won’t be able to count much on China as driver of growth, Slower exports growth show China’s post-COVID revival will take time (RTS). Consumer inflation eases further, suggests domestic demand still frail, Producer deflation deepens, highlights pressure on factories — More stimulus may be needed to lift the patchy recovery. China’s economy grew faster than expected in the first quarter thanks to the lifting of COVID curbs but the recovery has been uneven. Recent data showed factory activity contracted, while persistent weakness in the property market remains a concern. The reopening probably put some upward momentum on services inflation, but it was in large part offset by slowing growth in food and energy prices, analysts say (RTS).

• MSCI drops two Adani Group stocks from India benchmark — Move expected to trigger investor sales and hamper fundraising plans (FT). Gautam Adani retreats after short-seller attack — Indian tycoon has been trimming capital expenditure and buying back bonds to shore up confidence (FT).

EQUITIES

MSCI World equity index which broadly reflects the action in SPX and EUROSTOXX has been stuck in a range for weeks, but momentum is notably fading.

EFA Developed markets printed a bearish week for the first time since the Mar’23 lows, while EEM Emerging markets continue to struggle to make any headway higher.

Dax has seen some relentless bouncing but is also showing seller exhaustion with each with weekly gains going from going from +1.34% +0.47% +0.26% +0.24% to -0.30% printed last week. While I’ve turned bearish on Europe, DeMark weekly sequential suggests next week would be a more timely entry while it is currently on an 8 count.

While the VIX is sitting around the lows, there is clearly some nervousness in Skew and Taildex (put option premiums) rallying driven by demand for downside protection.

COMMODITIES

Bloomberg commodities index is sitting at 16month lows largely driven by the collapse in Energy prices of which is at odds with major equity markets.

With economic data continuing to point to stagflation risks, Energy and Industrial commodities is a theme to be keeping on the radar for the months ahead if risk continues to be steady.

Further to stagflation risks, the nervousness around the debt-ceiling impasse keeps precious metals on dips to be attractive for the weeks ahead. Would note however that I think it can be tricky holding out for extended moves given hints of imminent risk aversion in major equity markets, and USD setting up to rebound which could cause whipsaws.

RATES

UST yields were a touch higher last week while we are seeing some odd kinks in front end bills as we near x-date. But what appears to be more important is rising real rates as inflation cools which should be increasing headwind for risk asssets and tailwind for the turn in the USD.

CURRENCIES

In FX, I’m heavily focused on the crosses as I think we can see steadier trending moves with AUDNZD NOKSEK longs and EURGBP shorts. Turn in trend for AUDNZD and NOKSEK is on the charts and looks set to go higher.

AUDNZD sagged lower after the RBNZ delivered a surprise 50bp hike last month while market expected RBA to be on hold. But that trend has reversed after RBA’s surprise hike earlier in the month with charts providing some technical confirmation.

NOKSEK has been hammered along with Energy commodities but downside looks overextended while Swedish outlook is looking bleak with high interest rates showing signs of biting on the dometic economy.

EURGBP is on the back burner for now after last week’s reversal bar and with risk assets looking precariously perched, the pair looks set to pullback higher. GBP economic data has been surprising to the upside for some time, but with forecasts tending to anchor to prior data, bar for further upside surprises is likely be on the high side going forward.

EURUSD and GBPUSD charts are imo providing the most clarity than other major pairs with last week’s bearish impulse pointing to turn in trend.

TRADE VIEWS/IDEAS

A good curation of how things are setting up and I’m in full agreement the short Europe theme is looking ripe for the taking. This week I’m focuse on:

• Short EUROPE via DAX, EURUSD and GBPUSD
• Long AUDNZD and NOKSEK
• Long Crude and Precious Metals on a shorter-term tactical basis

Have a great week trading!