2024.01.29 Weekly

Context matters!

A lot of ‘discussions’ on Fed policy rates already too restrictive and bordering on potential and unnecessary policy error that could be avoided by beginning rapid adjustment cuts, effectively justifying current rate pricing. The arguments are compelling when focusing on inflation trends alone, but inflation is highly lagging, and if we take into account the context of where the disinflationary forces have come from, and what underlying forces still exist, I think much of those ‘discussions’ are very short-sighted.

I’m by no means an economist by any stretch of imagination; just a technically-oriented trader trying to get the macro view right so I can get some added alpha to my performance by trading around the right themes. But my view is that cutting rates pre-emptively or too quickly in the context of full employment, strong GDP and strong Wage growth could result in an even costlier policy error and I believe the Fed recognises these risks, therefore, if anything, I believe the Fed would engage in a much slower pace of cuts than the market or many of these ‘discussions’ would suggest.

Jam-packed Calendar this week…

• Tuesday: Japan Unemployment Rate, Eurozone Q4 GDP, US Job Openings, US Consumer Confidence.
• Wednesday: BoJ Summary of Opinions, Japan Industrial Production and Retail Sales, Australia CPI, Chinese PMIs, Switzerland Retail Sales, UST Quarterly Refunding Announcement, US ADP, Canada GDP, US ECI, FOMC Policy Decision.
• Thursday: China Caixin Manufacturing PMI, Switzerland Manufacturing PMI, Eurozone CPI, Eurozone Unemployment Rate, BoE Policy Decision, US Challenger Job Cuts, US Jobless Claims, Canada Manufacturing PMI, US ISM Manufacturing PMI.
• Friday: Australia PPI, US NFP.

USA USA USA …

US equities are at record highs and complimented by a string of goldilocks data — Q4 GDP was exceptionally strong beating expectations by some way and PMIs point to further growth with a notable revival in the US manufacturing outlook. All the while, inflation continues to ease.

As a result we’ve seen a big jump in economic surprises while inflation surprises has been more or less stable. That’s all well and good for the current soft landing narrative but while the market is looking for cuts at almost every meeting from the March meeting onwards, I think the most salient point of any discussion should begin with real wage growth being roughly at 4% while forward indicators point to continued upside risks. That alone, should be enough to indicate that demand is strong enough to keep inflation pressures alive.

Upside risks?

WSJ’s Nick Timiraos has been strongly campaigning that rate cuts should some sooner than later citing 3 and 6month annualised core inflation.

Ok, so core PCE has trended back to 2%, but again, context matters.

In addition to the economic strength, Equities are at at all-time-highs and Financial conditions are around historical norms…

Supply chains, the loosening of which was the large driver for the disinflation we’ve seen, is tightening again…

Commodity prices are rebounding as result of geopolitical tensions and China stimulus headline to add fuel to the rebound …

Freight costs are ramping again…

FOMC

Jan meeting this week is likely to see subtle changes to the policy language that takes further rate hikes off the table. We may also get some hints of how then intend to reduce the balance sheet run-off but it will probably be more noise than signal for now. What’s more of note is the rotation of Fed members coming in for the new year:

• Barkin is focused on potential upside risks saying that he feared “more will have to happen on the demand side, whether organically or through Fed action, to convince price-setters that the inflation era is over”.
• Bostic has sounded a little more dovish at times but has pushed back on rate cuts citing the last median projection of 3 cuts in 2H2024. “I want to stress two things. First, we are still a ways from our 2 percent target. Second, there remains considerable uncertainty about how supply and demand in the economy will evolve in 2024 as we seek to promote a return to balance of these two fundamental forces”.
• Daly has titlted hawkish in her remarks calling for more patience and that there is still “a lot of work left to do” on inflation and that it’s “premature” to think rate cuts are around the corner.
• Mester has been fairly balanced in her comments saying she needed “more evidence” while she did say it is “probably too early” for a rate cut in March, but she does step down in June however for retirement.

Broadly, these members have been cautious about sooner rate hikes and I see this dominating discussions for the time being, and particuarly in light of potential upside risks outlined above.

Quarterly Refunding Announcment

Likely to be the most important event of all this will be the QRA at 3pm EST on Monday, with details to follow on Wednesday. Given the way the market is set up at the moment, the pain point for markets will be rates going higher which is likely to induce USD strength and weakness in risk assets given their higher than normal beta to rates and this QRA could be a huge market mover:

Not only did the last QRA of $776bln hugely miss expectations of $852bln, Yellen decided to weight issuance towards bills which helped to ease the term premium pressure on bonds, sending 10yr yields on a downtrend and fueling the risk rally into year-end. BofA’s Hartnett says “a number well above $1tn is needed to dent the risk rally” with consensus expectations at $960 bln.

Assuming for now that the QRA comes in roughly as expected — there could be some nuances if Yellen opts to weight issuance towards longer maturities given improved demand in the 5–10yr range for USTs. This would in effect, do the Fed a favour by helping to tighten financial conditions, stunt the rally in stocks, and limit the potential wealth effect from stocks pushing record highs — a risk that is not openly discussed or communicated by the Fed and seemingly ignored by the market.

Trading views in a nutshell

Likely to be a very volatile week given the event risks and unless QRA greatly disappoints, I will look to continue trading around these themes:

• Short equities — if there is to be a pullback, I expect the top Tech names to lead the correction which keeps me selling rallies on the Nasdaq to express that trade.
• Short USTs (pro-steepeners) and long USD — the continued exceptionalism of the US economy vs ROW will continue to be a theme putting upward pressure on bond yields and rate cut expectations being far too aggressive for reasons laid out above. USDJPY should remain a buy on dips and I see it taking out the 150 handle with ease as the BoJ moves toward an easy policy exit at a turtle’s pace and recent data (on top of the dovish minutes) does not highlight any sense of urgency for the BoJ pivot.
• Short Europe — still an obvious theme to trade around given the Europe’s weaker position to weather supply chain impacts while the slowdown is clearly visible. UK on the other hand looks far better than was feared months ago, and much like the US, I expect sticky inflation and labour market resilience to be reflected by slow BoE cuts, and GBP resilience.

Markets are quite choppy and not-so directionally clear for the moment, so small-targets and being content with nibbles and small gains will by my MO until there is more clarity.

NEWSFLOW

MARKETS

• The S&P 500 Rallied to Records on the Back of Just One Sector — Tech stocks keep climbing, while the other 10 sectors of the index are trading an average of 15% below their all-time highs (WSJ). European Stocks Rise After Strong US GDP Data, ECB Holds Rates (BBG). Goldman Says Momentum Traders to Sell Stocks in ‘Every Scenario’ — Notes extended positioning as CTAs built $129 billion in longs, Citi says bullish Nasdaq 100 bets now pose profit taking risk (BBG). AI-fuelled chip rally tested by semiconductor demand warnings — Earnings from Qualcomm and AMD next week will provide evidence of health of industry (FT). Deutsche Bank’s Nolting Says US Stocks Ripe for a 10% Drop (BBG). Hot Stock Rally Stirs Fears Over Wall Street’s Big Rate-Cut Bets — Wealth effect from equity boom seen risking inflation comeback (BBG). Ed Yardeni Is Getting Nervous About the Speed of S&P 500’s Rally — “Our main concern right now is that the S&P 500 may be starting a tech-led meltup similar to what happened during the second half of the 1990s; We are wondering whether a bout of irrational exuberance might push the multiple higher, inflating a speculative bubble in the stock market as occurred during the late 1990s” (BBG).
• 10-year yield is little changed near 4.14% after another encouraging inflation report (CNBC). Investors temper US rate cut bets as Fed meeting looms — “Given the strength of both economic growth and wage growth, the Fed still has to worry about the medium-term inflation outlook” (RTS). Cooler Inflation Keeps Door Open for Rate Cuts This Year (WSJ). Plummeting Inflation Raises New Risk for Fed: Rising Real Interest Rates (WSJ). Even with progress on inflation and solid growth, the Fed will want to see more before cutting rates (CNBC). The Fed Gets the Signal It Needs to Cut Rates, but It All Comes Down to the Job Market — If the January or February employment reports show a ratcheting down in job growth, a March cut seems likelier (WSJ).
• Traders Riding Long Treasury Positions Are Starting to Feel the Squeeze — Recent positioning drop seen in 10-year futures as yields rise, CTA buying likely peaked, longs now under pressure, BofA says (BBG). Bond Market Braces for Record Auction Sizes for Some Treasuries — US two- and five-year notes are already at peak levels, Treasury officials in November said further increases likely (BBG). US 30-Year Yield Reaches Year-to-Date High After Poor Auction (BBG).
• Metals Extend Gains as China’s Measures Sustain Market Rally (BBG). Oil Jumps to Two-Month High on US Stockpile Drop, China Stimulus — China hints that more economic support measures could follow, WTI rises above $77 a barrel in an algorithm-fueled rally (BBG). Hedge Funds Slash Bearish Bets on US Crude By Most Since April (BBG). OPEC+ Doesn’t Plan Any Changes to Oil-Output Policy Next Week, Delegates Say — JMMC set to gather on Feb1, Prices high enough to preclude further action (BBG). Russia Achieves Oil Export Cuts Pledged to OPEC+, Novak Says (BBG).
• Hostage deal deadlocked over Israel’s refusal to agree permanent ceasefire (FT). Houthi Hit on Russian Fuel Has Oil Traders Recalculating Risks (BBG). Fuel Tanker Rates Are Soaring on Red Sea Disruption (BBG). Saudi Keeps Sending Oil Through Houthi-Menaced Red Sea (BBG). Houthi Attacks Disrupt Shipping, Draw U.S. Into Direct Conflict — Houthi rebels are carrying out audacious attacks to disrupt global commerce and draw the U.S. military into direct conflict, using Israel’s war in Gaza to transform themselves from a marginal player among Iran-aligned forces into one of the Middle East’s most formidable militant groups (WSJ). Middle East conflict could fuel gas price volatility, warns IEA (FT). Europe’s Diesel Supply-Chain Threatened by Soaring Freight Costs (BBG). Red Sea reroutings to further disrupt car supply chains, warn shipping executives (FT). Middle East Crisis Is Starting to Weigh on the Economy — Surveys show the skirmishes in the Red Sea are affecting European supply chains, putting upward pressure on inflation (WSJ).

AMERICAS

• US economy defies recession fears with 3.3% growth in fourth quarter — Figure caps ‘standout’ performance in 2023, giving boost to Joe Biden’s re-election hopes (FT). US prices rise moderately in December; inflation trending lower — PCE price index increases 0.2% in December and 2.6% year-on-year, Core PCE price index gains 0.2% up 2.9% year-on-year, Consumer spending jumps 0.7%, income rises 0.3% (RTS). US business activity picks up in January; inflation cooling — S&P Global survey — flash Composite PMI Output Index increased to the highest since last June to 52.3, manufacturing rebounded to a 15-month high of 50.3 from 47.9. services climbed to highest since last June of 52.9 from 51.4 (RTS).
• US pending home sales rise by most in over 3 years (RTS). Brutal Winter Across America Is Keeping the Housing Market on Ice — Even as mortgage rates drop from record highs, storms and subzero, temperatures have kept a lot of potential buyers on the sideline (WSJ).

EUROPE

• Bank of England set to start on path towards interest rate cuts — Investors have rushed further ahead and are betting that the BoE will start cutting Bank Rate as early as May, with three more cuts over 2024 taking it to 4.25% from 5.25% now; “for that expectation to be realised, we think the BoE needs to at least seem open to the idea in February” (RTS). UK consumer confidence hits two-year high in January (FT). UK economy picks up speed but Red Sea crisis hits factories — S&P Global/CIPS UK Composite PMI rose to the highest in seven months to 52.5 from 52.1, “surprising strength of growth in January, which has exceeded forecasts, may deter the Bank of England from cutting interest rates as soon as many are expecting, especially as supply disruptions in the Red Sea are reigniting inflation in the manufacturing sector” (RTS).
• Christine Lagarde says ‘disinflation process is at work’ — ECB president says rapid wage growth is showing signs of slowing (FT). Traders step up ECB rate cut bets, sensing shift on inflation front — Traders raise ECB rate cut bets post-meeting, Expect more than 80% chance of April cut, ECB seen as less worried about labour market, inflation (RTS). ECB Cut in April Are ‘Too Aggressive’ for State Street — Investors should fade recent rally, strategist Tim Graf says, Bonds rally on rising bets for early cut, ECB pushes back (BBG). ECB’s Kazaks: March projection cut alone not enough for big policy easing — in my view we should not be reacting aggressively with rate cuts,” he said. “And the reason is very high uncertainty” (RTS). Bets on Goldman, JPMorgan See Euro Challenging Yen as Carry-Trade Funder — Yen was the best carry-trade funding currency for two years, Euro set to weaken as traders see a ECB rate cut before summer (BBG).
• Euro zone business downturn eases in January — Factory PMI boosted by statistical quirk from Red Sea tensions (RTS). German business activity deteriorates in Jan — Flash Composite PMI fell for the seventh consecutive month to 47.1 from 47.4, below the 47.8 forecast (RTS). German growth will at best stagnate in Q1, Bundesbank warns (RTS). Euro zone inflation falling quicker than thought, data show — ECB survey now sees inflation at 2.4% this year, down from 2.7% seen three months ago and well below the 2.7% projected by ECB staff (RTS).

ASIA

• Yen bulls stock up on options for any BOJ spring surprises (RTS). International investors fuel further growth in Japanese stock market (RTS). Inflation in Japan’s capital slows, missing central bank’s 2% target — Tokyo core CPI rises 1.6% yr/yr in Jan vs forecast +1.9%, corporate service inflation steady at nearly 9-year high in December (RTS). Japan Jan factory activity languishes, but service sector picks up — Mfg PMI little changed at 48.0 from 47.9, “Backlogs of work broadly stabilised in January, providing an early sign that output was starting to be supported by improved demand rather than the fulfilling of prior orders” , flash services PMI increased to 52.7 from 51.5 sustained by new business growth that was the strongest since September (RTS). Japan exports soar to record in Dec; China shipments make long-awaited rebound — exports to China — Japan’s biggest trading partner — climbed 9.6%, Shipments of semiconductor manufacturing equipment and cars led the expansion but exports of chip and other electronic components tumbled 22%; Exports to the United States surged 20.4%, marking 27 consecutive months of growth. Shipments of cars and auto parts as well as construction and mining equipment propelled the increase (RTS).
• South Korea’s economy grew faster than expected in Q4 — GDP +0.6% q/q versus +0.5% forecast, Exports lead, but outlook downbeat, Domestic demand slowing, construction investment slumps (RTS).
• China’s Premier Orders More Measures to Arrest Stock Rout (BBG). Chinese regulators curb short selling as market downturn deepens — Measures come into effect from Monday and are designed to ‘create a fairer market order’ (FT). China cuts bank reserves to defend markets, spur growth — China c.bank will cut reserve requirement ratio from Feb 5, Move will free up $140 bln in liquidity, Property measures expected, Stock markets rally from multi-year lows (RTS). China adds 12.44 mln urban jobs in 2023，says more effort needed this year (RTS). Evergrande Faces Renewed Liquidation Risk in Wind-Up Hearing — Uncertainty over status of petitioners before Monday session, Wind-up of developer would exacerbate China’s housing crisis (BBG). China to List Property Projects Eligible for Funding by Jan — First batch of projects able to obtain financing soon, Local governments given more power in real estate policymaking (BBG). Bridgewater Says China Stock Selloff Made Valuations Attractive (BBG).
• Global Funds Sell Most India Stocks Since 2022 Post Record Rally — Foreign investors sold $2.4 billion on a net basis last week, Trepidation on India comes as China market optimism builds (BBG). Sell Calls on the Rise for India’s Top Consumer Goods Company (BBG). India Nifty’s ‘Head and Shoulders’ Pattern Signals Further Slump (BBG).

EQUITIES

Global Equities ACWX pared back early month gains with a strong rebound in the prior 2 weeks while US equities SPX rallied to new ATH while the equal weighted index is trying very hard to keep up.

Tech names have led the rally, driven mostly by Semiconductors which are showing signs of trend exhaustion:

With SMH semiconductors and XLK technology printing reversal bars last week, a macro event trigger (like the QRA) should validate the sell signal.

High concentration into tech adds to the precarious setup for broad risk.

Cheap skew, or the extreme low cost of hedging downside could provide the ammunition for a market correction.

Peaking EPS growth suggests price returns could be more limited.

Making NDX 12m forward EPS growth of +97% seemingly difficult to justify.

Hedge funds (via GS Prime book flows) are turning increasingly bearish.

COMMODITIES

Bloomberg commodities is breaking higher.

Momentum is has turned bullish for Energy and Industrial metals in particular, Agricultural commodities does tend to pick up at the start of the year after the Q4 harvest, and Precious metals stays heavy on real yields is on the rebound.

I’ve been trading around the theme of higher Crude and lower Gold for many weeks and we’ve finally seen a convincing turn in the Crude/Gold ratio. WTI has put in a strong +6.5% rally last week, and while it has met it’s measured objective around the 78 handle, it is on a breakout and looks poised to push on. Gold continues to hold resiliently above the 2k handle, and I stay biased short as I think there could be quite a bit of pain there should yields find their way higher and the 2k handle gives out.

RATES

Very little change to the yield curve last week, but long-end is trading slightly heavier with a bear steepening in the curve. Real yields have been driving most of the move — 10yr TIP +5.6 bps while 10yr nominal was up only +1.4bps.

Looking at real yields relative to their breakevens, the rise in real yields has closed the gap and usually, this dynamic tends to positive for USD and unconfortable for risk assets. Ignoring the QRA for the moment, I think the Fed likely to stay adamant on being cautious and patient on rate cuts will see this trend continue.

US10yr has been consolidating between the 4.1 and 4.2% handle and my chart suggests a technical objective of 4.25–4.30%. Assuming QRA will be as expected, I think the path of least resistance would eventually take us there as long as US data continues come in strong.

Looking at Fed Funds rate expectations, the market has more or less priced out a cut for March and leans towards May for the first cut. We are still priced for roughly 6 cuts this year and based on strength of economic data we have been seeing and Fed staying pat on rate moves in the next 2 meetings, I suspect we could see the FFZ24 back to about 4.4% by the end of the quarter.

CURRENCIES

• CHF +0.63% was the strongest last week — I breifly entertained the idea of going long AUDCHF on the China news, but it did not come off as I hoped. CHF continues to trade like its marked to US tech stocks and I continue to have USDCHF longs on the radar, as well as CADCHF with Oil breaking out.
• USD +0.13% continues to flirt with a major pivot area. I continue to be positive dollar with a particularly preference for USDJPY longs and NZDUSD shorts, the latter of which has entered a seasonally weak period after a strong Q4.
• GBP +0.11% to me has a lot of similarities to the USD, inflation continues to be stickly along with wage growth, and I think BoE cuts will come later than other major CB’s. Depending on how risk sentiment unfolds this week, GBPCHF GBPNZD longs are on the radar.
• CAD -0.07 the strongest of the commodity dollars making a strong bounce out of the high end of the Dec/Jan range. Theres a lot of dovishness in the CAD, and Crude breaking out as well as it’s tendency to be a lower beta dollar should see it continue outperform the other commodity dollars.
• EUR -0.31% has been surprisingly resilient in the face of very weak data and growth outlook. Europe is likely to be the worst effected by the tightening of supply chains and is a clear sell on rallies imo. Short EURUSD or on the crosses depending on how markets trade this week is an obvious theme to trade around for the forseeable future.
• AUD -0.24% I expect to trade poorly if I’m right about risk assets trading lower from here. At the same time I do not expect much movement with China stimulus in the air while awaiting for the RBA next week.
• NZD -0.29% the weakest of commodity dollars remains my preferred choice for expressing my bearish risk view. It’s broken down from it’s highs and trading well below it’s moving averages with RSI just below the 50 level.
• JPY -1.44% weakest as I had expected. Dovish minutes and big miss in Tokyo core CPI has not given any reason for the BoJ to rush their hawkish pivot and has kept the Yen trading heavy. Meanwhile I expect global bond yields to inch higher as supply chain tightening puts upward pressure in G8 inflation and Yen differentials to widen the most of all G8 currencies as a result.

That’s all for now. Good luck trading! //