2023.07.31 Weekly Notes

Bullish, but Vulnerable.

Despite what my views are, market is still not showing signs of letting up and goldilocks-ish data is yet to offer reason for investors to get worried.

He’s been wrong on a lot of these posts but there’s a lot behind the surface of this rally that points to ‘technical’ vulnerability as seen in the charts below: short-term stretched via 50dma %deviation around key supply area, Vol and Put-premiums ridiculously low for a market that is pricing for the absolute best-case scenario.

FOMC & POWELL

FOMC’s and market’s assessment of how ‘restrictive enough’ policy is going forward is one purely of data dependence, and to this, Powell had put particular emphasis on inflation data while they were not explicitly targeting wage inflation, though it remains an important consideration. On whether policy is ’restrictive enough?

monetary policy we believe is restrictive and is putting downward pressure on economic activity and inflation.

we’re trying to achieve a stance of policy that’s sufficiently restrictive; stance has become more restrictive as inflation moderates; we think we’re going to need to hold, certainly hold policy at restrictive levels for some time

what our eyes are telling us is that policy has not been restrictive enough for long enough to have its full desired effects; policy is restrictive, more so after today’s decision; we’ll keep monetary policy restrictive until we think it’s not appropriate to do so

people are cutting rates next year because you know, the Federal Funds Rate is at a restrictive level now. So, if we see inflation coming down credibly, sustainably, then we don’t need to be at a restrictive level anymore, we can you know, we can move back to a neutral level and then below a neutral level at a certain point.

To add comments from my buddy Hugo Devere from the Presser:

Powell’s stance was hawkish, retaining a tightening bias.

Responding to initial questions about the September meeting, he pointed to labor, ECI, and CPI reports as the key determinants of the policy decision. He stated that hawkish data would lead to a hike and dovish data would result in a hold.

POV AND PAM COMING TO AN END?

Samuel Rines (one of just a few economists I respect and admire and who seemingly pours over every single company report and earnings call), still sees POV going while PAM is just beginning. But seeing that headline inflation is rolling over and, policy impacts/lags could soon be felt, I am working with the theory of POV and PAM soon ending since what is likely next, is demand to moderate, and therefore company pricing power which is fundamental to the maintenance of POV and PAM.

Travel and Leisure for example has seen strong pricing power due to the extremely strong demand to eat out and travel in the post-pandemic world.

Travellers take to the skies even as ticket prices and temperatures soar (FT).

If Energy prices are to keep going higher, that is going to squeeze margins at a point where demand gets most elastic to further price rises and costs can no longer be passed on:

Overseas holiday costs soar as inflation rises in Europe — Biggest price rises in Turkey and Bulgaria, though they remain cheapest overall but are we seeing some early signs that could be ending? (FT).

Some signs of price driven revenue expansion also starting to surface:

McDonald’s revenue growth to moderate as menu prices ease — as inflation begins to come down, I would certainly expect our pricing levels to also start to come down”. Major U.S. restaurants have had to raise prices to offset a hit to profit from higher costs tied to labor as well as commodities like beef and dairy, helping propel their revenue over the past several months (RTS). Heineken cuts profit growth forecast as higher prices put off consumers — World’s second-largest brewer reports slowdown in Asian markets and weaker demand elsewhere (FT).

Bottom line is if revenue inflation and margin preservation is peaking, so is earnings. That has been happening at the expense of contracting volumes where if pricing power is lost, prices need to be lowered in an effort to maintain sales volume.

SHIFT TO GROWTH FOCUS

Money markets have been focused on rates, and as we are soon to be reaching terminal levels, that focus is likely to shift increasingly towards Growth from rising Rates, particularly in terms of RV.

@NicolasGoetzman: “Both the Fed and the ECB want to fight inflation by curbing domestic demand. But there is a difference.”

This divergence makes the US exceptionalism -short Europe theme I’ve been discussing over many weeks even more compelling with US much less sensitive to policy rates than Europe, as well as being far more economically resilient. And it’s not even close.

WRONG-FOOTED MARKET RISKS

heatwaves are said to get more frequent and more intense, it affects productivity — construction and agriculture are most affected; as well as productivity, building materials don’t work as well in extreme heat while agriculture will be affected by drought (FT climate correspondent)

As I’ve been discussing over prior weeks, I am paying particular attention to developments to weather and commodities as I think this the biggest risk to markets that is priced for the (best-case) no-landing scenario. A reason I’ve dedicated a commodities section to the newsflow journal:

NEWSFLOW

MARKETS

• World shares rise, US yields weaken after inflation data, BOJ rate tweak (RTS). Confidence grows that Federal Reserve can deliver a soft landing for US economy (FT). Capitulating recession calls meet market restraint — Even as fears of a 2023 U.S. recession recede and stock market bears concede defeat, there’s scant sign of party mode (RTS). Economists counter market bets of soft landing — Analysts say investors’ expectations that rates are close to their peak are likely to prove over optimistic (FT). IMF edges 2023 global economic growth forecast higher, sees persistent challenges — inflation was coming down and acute stress in the banking sector had receded, but the balance of risks facing the global economy remained tilted to the downside and credit was tight (RTS). Stocks Are Doing So Well That It May Be Time to Start Worrying — Protection cost is lowest since at least 2008, per one measure, S&P 500 is on track for the fifth straight month in the green (BBG). Morgan Stanley Strategists Say US Stocks Are in a 2019-Like Rally — Wiilson: “The data we have today suggests to us that we are in a policy-driven, late-cycle rally. These developments fostered a robust rally in equities that was driven almost exclusively by multiple and not earnings, as has been the case this year” (BBG).
• Fed lifts rates, Powell leaves door open to another hike in September- Fed raises policy rate to 5.25%-5.50% range. “My base case is that we will be able to achieve inflation moving back down to our target without a really significant downturn that results in high levels of job losses. But it’s a long way to be sure and we have a lot left … Reducing inflation is likely to require a period of below-trend growth and some softening of labor market conditions” (RTS). Fed staff drop US recession forecast, Powell says — “we do have a shot” for inflation to return to target without high levels of job losses (RTS). Endgame for Fed’s tightening cycle challenged by easing financial conditions — Less tight financial conditions as exhibited by the red-hot stock market may increase the chances that the Federal Reserve hikes rates again before the end of the year, some economists reckon, even as financial markets put little odds on that happening (RTS).
• Traders Brace for $102 Billion Wave of Treasury Bond Sales — Cabana: “There’s just a lot of supply coming. We’ve been surprised by the deficit numbers, which are sobering” (BBG). Auction sizes set to increase at US Treasury refunding — Some market participants had worried that a surge in Treasury bill issuance after the debt ceiling was temporarily lifted could adversely impact bank reserves and lead to tighter credit conditions, but these negative impacts have not materialized. The bills have seen strong demand from money fund investors (RTS). SEC asked Coinbase to halt trading in everything except bitcoin, CEO says — Request would have meant ‘the end of the crypto industry in the US’, according to Brian Armstrong (FT).

COMMODITIES

• July 2023 set to be world’s hottest month on record — Breaks previous record set in July 2019 by 0.2C, Heatwaves searing Europe North America and China, Earth may not have been this hot in 120,000 years (RTS). South America braced for economic hit from return of El Niño — Extreme weather phenomenon could spark inflationary surge due to food and energy shortages (FT). Heatwave bakes US as heat index soars past 100 degrees (RTS). Scorching heat stresses US power grids, prices soar (RTS). Extreme Heat and Aging Power Grids Are a Deadly Combination (BBG). Wildfires bring death and destruction to sun-scorched Mediterranean — Wildfires hit Portugal, Spain, Greece, Algeria, Croatia, Italy; Firefighting plane crashes in Greece, Tunisia suffers heatwave, power cuts hit Malta (RTS). Europe’s Most Important Trade Route Is at Risk Due to Climate Change (BBG).
• Oil posts fifth week of gains on signals of tighter supply (RTS). US drillers cut oil rigs for eighth month in a row, Baker Hughes says (RTS). US oilfield service providers expect rig count recovery later this year on high prices (RTS). Shell and TotalEnergies profits slump as oil and gas prices cool — Q2 profits slump 56% at Shell, 49% at TotalEnergies y/y, TotalEnergies sees LNG prices recover somewhat in winter, Shell slows pace of share buyback programme (RTS). Chevron expects annual production at low end of guidance (RTS). Exxon profits slump 56%, joins global peers in energy price hit (RTS). Brazil’s Petrobras oil output dips slightly in second quarter (RTS). BHP expects Indian steelmaking boom to drive its coal business — Chinese sanctions on Australian products have redirected miner’s focus to the subcontinent’s rapidly expanding sector (FT).
• EU to squeeze carbon market cap in 2024 as new climate policies kick in (RTS). Hot rocks: German cities dig deep for green energy — — Geothermal technology has ‘enormous potential’ as renewable heating source, say industry experts (FT). Germany’s updated hydrogen strategy sees heavy reliance on imported fuel in future — German cabinet approved a new hydrogen strategy, setting guidelines for hydrogen production, transport infrastructure and market plans (RTS).
• Copper Set for Monthly Gain as Optimism Returns on China Demand (BBG). Analysts mark down copper forecasts and other industrial metals as supply expands while demand in top metals consumer China remains muted (RTS). Analysts trim gold outlook in absence of fresh spur — Gold seen averaging $1,944.5/oz in 2023, $1,988 in 2024, Silver seen averaging $23.52/oz in 2023, $25.00 in 2024 (RTS).
• Russia hits port infrastructure in Ukraine’s Odesa region (RTS). Ukraine: 26 port infrastructure facilities damaged in nine days of Russian strikes (RTS). Brussels thrashes out plan to move Ukrainian grain through EU ports — Bloc could provide alternative routes as Russia blocks exports via Black Sea, says agriculture commissioner (FT). Russia has not offered UN World Food Programme free grain (RTS).

AMERICAS

• US economy defies recession fears with strong second-quarter performance — Second-quarter GDP increases at 2.4% rate, Consumer spending slows, but pace still solid, Business investment picks up on equipment rebound, Weekly jobless claims fall 7,000 to 221,000 (RTS). US consumer confidence hits two-year high; recession fears linger — Consumer confidence index increases to 117.0 in July, Labor market differential rises to 37.2 from 32.5 in June, House prices continue upward trend in May. “We seem to be in an unusual eddy in this expansion, with consumer confidence up but consumer spending clearly leveled off” (RTS). US business activity growth slows as services soften — flash Composite PMI fell to 52 in July from 53.2 in June dragged down by decelerating service-sector growth, falling input prices and slowed hiring indicate the Federal Reserve could be making progress (RTS).
• Lots of US Homeowners Want to Move. They Just Have Nowhere to Go — Locked into cheaper borrowing costs and unable to find a new place that fits their budgets, countless people are opting to remain in their current homes, adding to an acute shortage of available properties (BBG). Heavy credit-card users are key in the Fed’s inflation battle — Demand for credit may be falling in some areas, but plastic is a different story (FT).
• Canada’s economy grew in May but likely contracted in June — 0.3% expansion in May was in line with expectations, and likely fell 0.2% in June in a flash estimate. (RTS). Is Canadian core inflation about to crack? July data could offer hope (RTS). Canadian dollar hits 2-week low as rate hikes ‘begin to bite’ (RTS).
• Brazil’s jobless rate hits lowest since 2014 for a quarter through June (RTS). Mexican peso hits 7–1/2 year high vs dollar, further gains eyed (RTS).

EUROPE

• Goldman Sachs cuts 2023 euro zone growth forecast following weaker economic data (RTS). Worsening euro zone business downturn reignites recession fears — HCOB’s flash Composite PMI dropped to an eight-month low of 48.9 from June’s 49.9 (RTS). EU stress test shows three banks falling short — In what the watchdog described as its toughest test yet, it examined the impact of a three-year scenario to 2025 of credit, market and operational risk losses on a bank’s mandatory core capital buffer. It included economic growth slumping by a cumulative 6%, and big falls in property prices (RTS).
• Eurozone returns to growth in second quarter as inflation falls — Price pressures fall to 5.3% in July but core inflation remains unchanged (FT). Euro zone sentiment and inflation expectations fall in July — Euro zone economic sentiment declined for a third consecutive month in July and by more than expected, while inflation expectations continued to fall (RTS). ECB fans talk of September pause after raising rates to 23-year high — September move up in the air after Lagarde comments, Markets still see September or October hike as possible, Inflation pressures strong, but recession risk rising (RTS).
• Falling German and French inflation feeds hopes of halt to ECB interest rate rises (FT). German consumer morale to stabilize in August, survey shows — GfK consumer sentiment index rose to -24.4 from a slightly revised -25.2 and expectations of -24.7 (RTS). German inflation resumes downward trend in July — Stronger declines expected starting in September, Core inflation eases (RTS).

UK

• Bank of England poised to raise rates to fresh 15-year high (FT). Bank of England rates set to peak at 5.75% by year-end: Reuters poll — median peak rate forecast was 5.75%, nearly half of respondents 29 of 61 still said 5.50% the same as a June 26 poll. Wage inflation will be the most stubborn driver of core inflation over the coming months, according to 17 of 18 respondents. “Company efforts to protect margins are a possible catalyst for inflation, but so are workers’ efforts to demand higher wages, offset the losses in real income and restore the distributional balance between wages and profits” (RTS). UK to run up highest debt interest bill in developed world — Treasury on course to spend 10% of government revenue on bond costs this year, according to forecast by Fitch (FT).
• IMF sticks with forecast for limited UK growth in 2023 (RTS). UK firms grow at slowest in six months as rate hikes weigh — UK composite flash PMI falls to 50.7 from 52.8, Manufacturing PMI weakest since May 2020 as orders slow, Inflation pressures lowest since February 2021, Sterling and gilt yields fall as markets trim BoE bets (RTS). Decline in UK manufacturing orders eases in July: CBI (RTS).
• Number in temporary housing in England hits 25-year high — Homelessness rising sharply as rental and mortgage costs soar, official figures show (FT). UK homebuilders under pressure as lofty mortgages deter first-time buyers (RTS).

ASIA

• Bank of Japan loosens grip on rates as prices rise, markets bet on bigger pivot — BOJ keeps bond yield targets, allowance band unchanged, BOJ decides to conduct YCC with ‘greater flexibility’, Yield band would be ‘references’ rather than ‘rigid limits’, BOJ will allow 10-year yield to rise by up to 1.0%, Ueda said BOJ pre-empted risks, ready to keep doing so (RTS). Investment flows poised for historic shift after ‘giant leap’ by Bank of Japan — Long-dated bond yields jump to 9-year high as analysts hail ‘de facto abolishment’ of trading cap (FT).
• Inflation in Japan’s capital slows in July, stays above BOJ target — Tokyo July core CPI rises 3.0% yr/yr vs f’cast +2.9%, Tokyo core inflation stays above BOJ’s 2% target, Inflation excluding energy accelerates in July (RTS). Japan govt sees inflation slowing next year, calls for BOJ coordination (RTS).
• Weak Chinese factory activity puts pressure on Beijing to support economy — Manufacturing activity in China contracted for a fourth straight month in July while growth in services and other sectors slipped. China Mfg PMI came in at 49.2 and 51.5 for Services (FT). White-collar wage cuts in China fuel deflation risks, hurt consumption — Finance workers, doctors, civil servants suffer wage cuts, Overall incomes are still growing but at suboptimal pace, New jobs come with lower salaries, China needs household income growth to outpace GDP, Wage worries could depress retail sales even more (RTS). China to step up policy adjustments amid tortuous recovery — says will focus on expanding domestic demand, Will adjust and optimise property policies in a timely manner, will implement its macro adjustments “in a precise and forceful manner” and strengthen counter-cyclical adjustments, as the government sticks with a prudent monetary policy and pro-active fiscal policy, (RTS).
• Everything China Is Doing to Juice Its Flagging Economy (BBG). Hopes Run High for Chinese Stocks as Beijing Targets Consumption (BBG). State-backed support puts renminbi on course for best monthly rise since January — increases 1.5% against dollar in July after months of falls (FT). China Property Stocks Set to Enter Bull Market on Policy Support — China property stocks gauge has jumped more than 20% from July 24 low (BBG).
• RBA Watchers Split as Policy Tightening Cycle Is Nearing End — Of 26 economists surveyed, 15 see hike and 11 predict a hold, Money markets are pricing no change to the cash rate at 4.1% (BBG). New Zealand Treasury Forecasts 2023 Recession as Rates Rise (BNN).
• South Korea consumer sentiment climbs for fifth month (RTS). South Korea’s Q2 GDP speeds up but weakness clouds outlook — grew by a seasonally adjusted 0.6% in April-June on a quarterly basis, according to preliminary estimates from the Bank of Korea, after a 0.3% increase in the preceding quarter (RTS).
• India’s food price inflation raises risks for Modi government (FT). India rate-cut bets pushed to mid-2024 amid inflation jump — Surging food prices accelerated India’s annual retail inflation rate in June to 4.81%, above the polled estimate of 4.58%, snapping four months of easing. “Rate cut bets are getting re-priced as markets are now expecting inflation to overshoot above 6% in July and upward pressure in the coming quarter” (RTS). India’s rice planting gathers pace as monsoon rains revive — crucial monsoon rains revived in July and helped farmers accelerate sowing for the world’s second biggest producer of the grain. This comes after India ordered a halt to its largest rice export category earlier in the month — a move that will roughly halve shipments by the world’s largest exporter of the grain (RTS). India’s economy to hold top spot for GDP but not so much for jobs growth: Reuters poll (RTS).

EQUITIES

A monthly look at the global benchmarks shows strong leadership by the US and developed markets retracing towards the 78.6fib of all-time-high, while ACWX is just short of the 61.8 and EMXC has just surpassed the 50fib in July.

Given how the market will react to more China stimulus measures, EM’s certainly could continue to catchup while US and Europe is starting to look expensive while priced for best-case scenarios.

Looking at US equities, strong weekly momentum while in and around key supply areas…

and daily shows rather interesting price action — ACWI doji, SPX and DJI showing a Friday inside bar following a large bearish outside bar on Thursday, and NDX showing the most strength rallying back a touch above the closing-basis trendline.

While the price action broadly speaks to potential exhaustion around key areas of supply, I look to see if NDX is able to keep up the Friday rebound or fails to point to a series of lower closes.

SPX IV has been ranging between 10 and 12 since June and Put-premiums remain at cheap extremes where I’m paying particular attention to bounces in Skewdex to further support short ideas.

MA %deviations from provide some colour on how strong breadth is and how overbought equities could be — looking at the points from which markets have put in local tops (vertical yellow lines during 2021 which I think is a good period to make comparisons against), SPX and OEX are certainly in the stretched region. Granted this could continue for some time, but I think there is some vulnerability of a pullback here particularly in view of the 50dma.

In view of sectoral themes, I like the weakness in Energy stocks from the weak earnings reports but with energy prices rebounding on a tightly supplied market (e.g. XOM) and also like Food suppliers (e.g. THS) for the micro book. XLB/XLI also looks like an interesting pair trade on theme with the commodities rebound, higher prices paid and strain on confidence. Generally thinking in terms of partial hedges on the upside risks to food and energy and broader disinflation narrative.

Over to European equities, we are still seeing a strong pro cyclical momentum since the AI mania has kicked in (dotted-vertical line) but we are also seeing the July rally being followed by a bounced back in Defensives and this has usually been a strong precursor of weakening appetite and extended rotation and broader sell-off. Something to watch as the ratio is beginning to look like it could roll downwards again.

COMMODITIES

Commodity indices are still pointing higher especially via the TR index.

Agricultural futures have been retracing last week while Energy has continued it’s grind higher. WTI continuing north of $80/bbl and RBOB break of $3/gal is likely to upset risk and consumer expectations which has offered strong support to equities.

RATES

Yields curve is saying risk-on. Higher across the curve since prior week (Purple, bottom panel) and 5 and 10yr real yields are lower since the beginning of July (Green).

BERT model also reflecting risk-on sentiment with breakevens moving higher and and real yields lower over from June. The key risk to the rates picture is the Treasury issuance announcements this week also mentioned by Nick Givanovic.

FX

Market extended net USD shorts, the most in over 2yrs in G10, and since pre-Covid crash vs EM’s.

Versus EUR and GBP, positioning is at extremes particularly for GBPUSD which is the most net long in almost a decade. Still like the short Europe theme as discussed over many weeks.

USD risk reversals looked like they could head further towards USD’s favour last week but no longer looking the case after the past couple sessions — most notable in USDJPY and USDCAD with 1mo skew becoming much more bearish on the pairs. EUR still on a bearish trend since mid-July and GBP flatlining. NZD looking the most bearish in view of commodity dollars and long AUDNZD (China stimmy optimism) and short NZDCAD (on commodity price bouncing back with the effect of some USD resilience) themes come to mind.

Equal weighted — Weekly

Equal weighted —Daily

I get the sense we are in for a tough week of trading, at least from the look of the charts initially and the themes I have in mind.

• EUR and GBP are showing signs of topping out but the strong bounce back last Friday does confuse signals. I suspect much of this is due to some month-end USD selling flows. In view of seeing stronger US relative value against Europe while risk sentiment stays positive, EUR and GBP funding higher beta’s like AUD and CAD are attractive themes to trade til risk convincingly turns.
• JPY longs is getting more interesting by the week but now that BoJ has made a little tweak as well as the no-landing positive growth optimism + upside risks to commodity prices, that is enough to put me off the JPY. OTOH, yields starting to get further stretched to the upside could entice me. Perhaps more interesting to me is CHF shorts (and possibly against JPY) which is looking much too strong for the SNB’s comfort and Swiss inflation delerating quickly.
• Of the Commodity-dollars, I favour AUD the most being closest to the pro-cyclical China and India story, then CAD with rising Oil prices as well as the tendency to act like a low-beta USD.

All for now. Have a good week trading! //