2024.04.15 Weekly

Captain Dollar: Vanquisher of Mediocrity

Since Q4 earnings season came to an end in late February, the journaling of my weekly views have been centred around 2 themes: 1) fed policy expectations and the macro data that influences it, and 2) valuations and earnings growth expectations which I’ve argued that it’s at levels where continued rallies would be difficult to justify.

Data review

CPI printed hotter than expected at 0.4% m/m vs 0.3% expected for both headline and core. Expectations seemed to be mostly below and rounded up to 0.3%, while the actual numbers came in at 0.36 and 0.35% rounded up to 0.4%.

The rounding was also reflected in the Cleveland Fed nowcast which shifted the March PCE higher by 7bps from this time last week.

Unless m/m inflation turns flatter in the coming months, and considering that base effects will skew y/y inflation higher further into the 2024, it is becoming near impossible to justify rate cuts as early as the June meeting at this current juncture.

PPI came in softer than expectations which had come as a surprise. But when looking at the unadjusted index changes, we see trends that is more consistent with the rebounding commodity prices as well as firms reporting higher cost pressures from Q1 PMI reports for example.

Lastly Univ. of Michigan survey showed weaker consumer sentiment/outlook on fresh inflation concerns.

11.5% earnings growth?

NTM EPS growth ramped back up to the highs from 11.24% last week. While I do think its possible that the strong expectations could be maintained for another quarter based on the trends of strong economic data, Q1 earnings would need to exceed expectations to drive further gains which is already at a very high bar of 11.5%, making a continued rally and extension of all-time-highs difficult to argue for.

Stocks rallied on improving earnings expectations that have in part priced in the narrative of inflation coming down and imminent fed cuts, and as reviewed above, it’s not been a good week of data for the Fed — inflation is reaccelerating, wage pressures are still strong even though the labour market is showing signs of loosening (as reviewed last week). So from a valuations perspective — holding earnings constant (i.e. Q1 earnings comes in roughly as expected), it would be difficult to see multiples expansion when that narrative is reversing and bond yields creeping higher again. To take things further, now that Israel-Iran conflict could be simmering down for the moment and ease safe-haven bids in bonds, yields may now have more free roam higher.

Given where earnings expectations are currently, I can easily see this 21x (SPX multiple at all-time-high) to current 20.5x (SPX @ 5123.4 / 250 EPS estimate = 20.49) levels serving as the highs for the near-term so long as Fed cuts are looking less likely this year.

Looking ahead this week…

Looking at the calendar, I see upside risks to yields. Hawkish risks from fed speakers — we’ll likely get more of the same message from the Fed that errs on the a lack of progress/evidence inflation is coming down sustainably to 2%; Upside risks to data — solid retail sales print expected with favourable seasaonal factors likely to skew risks to the upside and Industrial production should reflect the rebound in the US manfacturing sector.

NEWSFLOW

MARKETS

• Iran launches ‘unprecedented’ missile and drone attack on Israel (FT). Israel Fends Off Iran’s Missile and Drone Attack (WSJ). US Seeks UN Response to Iran Attacks; Markets on Edge — US and UK helped intercept drones targeting Israel, G-7 leaders condemn strike, urge restraint (BBG). Biden urges restraint on Israel after Iran’s drone and missile attack (FT). Be restrained or go ‘crazy’? Israel faces tough choices after Iran attack — Netanyahu must weigh US calls not to escalate against far-right allies’ demands for crushing retaliation (FT). The onus is now on Israel as Iran makes its move — Netanyahu’s sense he has prevailed in this round may make him less rather than more risk averse (FT). Israel Says Hamas Rejected Cease-fire Proposal After Iran Attack — Hamas leader Sinwar exploiting tension with Iran, says Israel
  Israeli officials were optimistic last week a deal was closer (BBG).
• Global investors pull back from equity funds amid inflation concerns — equity funds dumped for the second consecutive week amid persistent inflation worries and diminishing expectations for a U.S. Federal Reserve rate cut in June, US and Asian equity funds witnessing outflows worth $2.7 billion and $1.9 billion respectively (RTS). Investors wrongfooted as ‘higher for longer’ rates return to haunt markets — Analysts tear up interest rate forecasts as inflation proves more stubborn than most had expected (FT). Bond Traders Are Preparing for a 5% Yield, No-Rate-Cut World — Schroders is shorting 2, 5, 10-year Treasuries on higher rates, Ten-year yield has topped 4.5% for first time since November (BBG). Bridgewater’s Prince Says US Rate-Cut Plans Are ‘Off Track’ — no reason to buy longer-term bonds, ‘It is clear the Fed is off-track now (BBG). Dollar Caps Best Run in 18 Months on Fed Rethink, Haven Bid (BBG). Dollar has strongest week since 2022 as investors reverse bets on rate cuts (FT). Funds selling options help temper US stock swings — There’s been tremendous growth in these ETFs, definitely has a pronounced impact on the market; one of the reasons why you have seen volatility so low over the last few years, Every jump in volatility has been met with a “massive wave of supply of index volatility (RTS).
• The No-Landing US Economy Is Too Hot to Cool Inflation (BBG). Powell’s Soft-Landing Dream In Danger as Traders Hedge Inflation (BBG). Fed Rate Cuts Are Now a Matter of If, Not Just When (WSJ). Fed rate cut expectations for 2024 fall to lowest since October (RTS). One Cut, Then Five, Then Two: Goldman’s Calls Roiled by CPI (BBG). Williams: recent “bumps” in inflation readings have not been unexpected, and that if there had been surprises it was over how fast price pressures eased last year, “There’s no clear need to adjust monetary policy in the very near term”; Collins: “Recent data suggest it may take more time than I had previously thought to gain greater confidence in inflation’s downward trajectory, before beginning to ease policy”, eyes about two rate cuts this year, “I am still expecting that we’re going to see some slowing in demand start and continue into 2024, and that will help to bring inflation down later in the year”; Barkin: breadth of inflation being hard to “reconcile” with a near-term shift to rate cuts, “did not increase my confidence” that price pressures were easing on a broader basis throughout the economy; Bowman: if inflation doesn’t fall or gets worse the Fed may have to hike rates again; Bostic: “one cut toward the end of the year, and I expect that the economy’s going to continue to grow”; Daly: absolutely no urgency to adjust the policy rate, “Policy is in a good place right now, and I need to be fully confident that inflation is on track to come down to 2% — which is our definition of price stability — before we would consider a rate cut”. FOMC minutes: “vast majority of participants judged it would be prudent to begin slowing the pace of run-off fairly soon”.
• Rate Cut Odds Wane in Emerging Asia as US Inflation Speeds (BBG). Global Rates Repricing Puts ECB on Track to Cut Rates Before Fed (BBG). Japan repeats warning against excessively weak yen — Suzuki: “If there are excessive moves, we will respond appropriately without ruling out any options”, did not escalate his warning to take “decisive action”, yen slide complicates BOJ’s rate hike path (RTS). Ueda Says BOJ Won’t Alter Policy to Respond Directly to Weak Yen (BBG). Japan’s Five-Year Yield Rises to Highest Since 2011 on BOJ Bets — OIS signaling expectations that BoJ target rate will rise to 0.3% by the year-end (BBG). China Maintains Yuan Defense After Currency Nears Red Line (BBG).
• Gold slips from record levels after hot US inflation data (RTS). Copper Hits Fresh 14-Month High on Supply Fears, China Optimism (BBG). US, UK take action targeting Russian aluminum, copper and nickel (RTS). Investors bet on further rise in US gasoline prices (RTS). OPEC sees robust summer oil demand, economic upside potential (RTS).

AMERICAS

• US consumer prices heat up in March; seen delaying Fed rate cut — CPI increases 0.4% in March, CPI rises 3.5% year-on-year, biggest gain in six months, Core CPI advances 0.4%; increases 3.8% year-on-year (RTS). Tame US producer price data soothes inflation concerns — rise in the cost of services was softened by a fall in goods prices (RTS). US consumer sentiment slips; inflation expectations increase — UoM Consumer sentiment index falls to 77.9, One-year inflation expectations rise to 3.1% from 2.9% (RTS). US small-business sentiment slides to lowest level in more than 11 years (RTS). NY Fed finds mixed outlook for inflation expectations in March — Survey of Consumer Expectations sees inflation a year from now at 3%, unchanged from prior month, inflation three years from now rose to 2.9% from 2.7%, five years from now inflation is seen at 2.6% from 2.9% (RTS). US Consumer Perceptions of Credit Access Remain Pessimistic — Net 68% of respondents in Fed survey say credit harder to get, Majority in Fannie Mae poll say difficult to get home mortgage (BBG). Credit-Card Delinquency Rates Were Worst on Record in Fed Study (BBG). Manhattan Apartment Rents Dip in Sign Market Is Stabilizing (BBG).
• Biden Cancels $7 Billion in Student Debt in Election-Year Push — President seeks to draw voters to polls with loan relief, Effort comes days after Biden detailed broader ‘Plan B’ (BBG).Biden Surpasses Trump’s Record for Blacklisting Chinese Entities (BBG).
• Bank of Canada says June rate cut possible if inflation keeps easing — June rate cut within the realm of possibilities, BoC said economic growth in 2024 would be 1.5%, Traders dialed back their expectations for the first 25-basis-point rate cut in June to 56%, from 84% before the announcement, rate cut in July is fully priced in after slipping below 100% for sometime after the rates decision (RTS). Young Canadians Squeezed by Housing Turn Away From Trudeau — Group that helped elect Trudeau increasingly skews right, Conservative leader has mobilized outrage over cost of living (BBG). Canada to lease government land in plan to add millions of homes — The Liberal government has announced a series of measures to address the housing crisis over the past two weeks, and the issue is expected to dominate next week’s federal budget. The flurry of activity follows a surge in housing and rental prices that has caused Trudeau’s Liberals to lag the Conservatives in opinion polls before an election that must be held by October 2025. (RTS) Canada to allow some first-time home buyers to pay off mortgage in 30 years — instead of 25 years for newly built homes. Home loans comes with an interest rate that is subject to a renewal of terms every three or five years within the set amortization period, unlike in the US where a fixed-rate mortgage carries an interest rate that applies to the entire life of the original loan. With sharp hikes in interest rates since 2022 adding to debt burdens, Canadian mortgage holders have had to either extend their mortgage period to keep payments steady or increase the amount of monthly payments. (RTS)
• Mexico Inflation Undershoots Forecasts, Putting Rate Cut in Play — Annual inflation hit 4.42% in March, core inflation at 4.55%, After quarter-point rate cut, bank is cautious on more easing (BBG). Mexico to cut at least 330,000 bpd of crude exports in May — leaving customers in the United States, Europe and Asia with a third less supply (RTS). US imports of Mexican crude fall to lowest on record, EIA says (RTS).

EUROPE

• European Central Bank holds interest rates at 4% in contested decision — Some policymakers backed cut at Thursday’s meeting as bank signals it will consider such a step in June (FT). ECB Set to Cut Interest Rates in June, Villeroy Says (BBG). ECB’s Kazaks Says on Track to Cut Interest Rates in June (BBG). It’s Time for the ECB to Diverge From Fed, Stournaras Says — Four rate cuts still possible in 2024, even if Fed moves later (BBG). ECB puts June rate cut into view, asserts independence from Fed (RTS). ECB Survey Shows Inflation to Slow to 2% Target in 2025 (BBG). Euro-Zone Companies Expect Wage Growth to Moderate, ECB Says (BBG). German inflation eases to lowest in almost three years (RTS). German Corporate Distress Rises as Economy Stalls — Real estate remains the most distressed sector in Europe (BBG). This will hurt: France braces for budget cuts — France must in coming weeks show how it will avoid a budget crunch that is putting its credit ratings at risk and could even lead to the downfall of President Macron’s government (RTS).
• UK economy’s growth points to exit from recession — GDP rises 0.1% month-on-month in February, Economy still looking broadly flat, output down on a year ago, Services and manufacturing drive growth, construction plunges (RTS). Traders scale back bets to two BoE rate cuts this year (FT). Ben Bernanke says BoE must revamp main economic model (FT). Bernanke Urges BOE to Give Market Clearer Guidance on Rates (BBG). UK Surveyors Most Upbeat on Home Buyer Demand in 13 Months (BBG).
• Norway CPI Slows More Than Forecast, Backing September Cut — March core inflation slowed to 4.5%, versus 4.7% forecast, Data suggests central bank may not need to delay planned cut (BBG). Swedish Inflation Surprise Spurs Bets on Rate Cut Next Month — March core price growth well below forecasts on food cost drop, The Riksbank has said it expects to cut rates in May or June (BBG). Sweden’s Economy Unexpectedly Ekes Out Growth in February (BBG). Swedish Home Prices Extend Gains as Market Shows Signs of Thaw (BBG). Most Swedes Are Bullish on House Prices as Riksbank Signals Cut (BBG).

ASIA

• BOJ’s Ueda signals scope to reduce monetary stimulus — BOJ must keep easy policy for time being, must reduce stimulus if trend inflation rises, BOJ expect trend inflation to converge towards 2% in 1.5–2 years (RTS). Japan households’ inflation expectations rise, open room for rate hike — More households see higher prices a year from now, Ratio of households seeing prices rise 5 years from now also up, Households spending more on food, less on discretionary items (RTS). Investment Plans for Japan’s Insurers Will Likely Favor JGBs — Yield approaching 2% seems a good level for insurers: SMTB, Life insurers bought Japan bonds, sold foreign debt in FY23 (BBG). Tokyo Office Vacancies Hit Three-Year Low, Bucking Global Slump (BBG).
• China’s March exports and imports shrink, miss forecasts by big margins — Falling export prices weigh on nominal GDP: analyst (RTS). Weak China inflation data fuels concern over consumer demand (FT). China’s Credit Expansion Keeps Slowing as Loans Disappoint (BBG). Fitch cuts China’s ratings outlook on growth risks — double whammy of decelerating growth and more debt, provincial governments see weaker fiscal health (RTS). Chinese spending jumps over long holiday weekend, tops pre-COVID level (RTS). Yellen Says Nothing Off Table in Response to China Overcapacity — “We’re concerned about the possibility of surges in Chinese exports to our markets in areas where they have a great deal of overcapacity” (BBG). Scholz Arrives in China on a Mission to Dial Down Tensions (BBG). German companies’ dependence on China will last decades, warns Siemens (FT). Chinese Executives See US-China Rivalry as ‘Biggest Uncertainty’ (BBG). US Buys More Taiwan Exports Than China for First Time Since 2003 (BBG).
• Surging Oil Prices Seen Dragging Down Won to 1,400 Per Dollar (BBG). Big Loss Turns Pro-Business Yoon Into Lame Duck in South Korea — President’s investor-friendly agenda set to be derailed (BBG).

EQUITIES

Global equities is breaking down with All-Countries World index (ACWI), Developed markets (EFA) and Emerging ex-China (EMXC) seeing its worst week since October last year. Fairly convincing signs that broad risk have taken a corrective stance.

Once again, looking at the 2 indices I’m closely watching:

OMX is slowly fading from the measured technical zone, still needing another lower close to confirm down side.

NIKKEI is also reacting well to channel resistance and in need of a lower close below the 39k handle to provide some confirmation of a pullback leg. Still short this one.

SPX breaking down from its rising wedge rally and bearish divergence, finding support at 5110 which is the initial breakout target level and trendline that price action has well-observed. Another lower close this week should open the door to a larger pullback.

SPX relative to their 20 50 100 and 200dmas — far less stretched now but still slightly extreme against the 200.

SPX is sitting at key levels and a continuation lower could trigger some unwinding in CTA positioning.

Looking at this chart from GS, it does appear as though CTAs + RP + VC funds are at max length and vulnerable to unwinds...

while CTA’s already appear to be dialing back SPX exposure.

Solid trend reversals looking at US indexes by market-cap.

Breadth gone negative, short-term momentum has turned sharply lower with the majority of US stocks now below their 20 and 50dmas…

About half of all US stocks are above their 100dmas which larger-caps holding up better — mean reversion underway?

NYFANG+ has found some upward momentum post PPI, I continue to expect resistance with the bounce in bond yields to challenge valuations.

Small/Mid-caps index PRFZ broken down decisively from key pivot zone.

MSCI US cyclicals index rolling over from a structurally weak top, while cyclicals-defensives spread is holding the tight consolidation range. I’d imagine that spread to look different after earnings season as a result of the Fed staying pat for much longer or doing more i.e. to induce some cyclical weakness to cool the economy.

Most-short stocks index (a decent proxy for market sentiment) is looking the most bearish its been so far this year. It’s attempted to hold the channel abc-projection but was unable to do so on Friday perhaps due to the threat of Iran attacks. Now that Israel has completely soaked up the onslaught of projectiles from Iran and their allies, I suppose this is one to watch…

European equities also showing some cracks with the cyclicals index breakdown below the trendline. It’s consolidating after the break below and we shall see whether it holds it’s bearish bias.

Volatility indexes is becoming more elevated, front 2-month VIX futures spread has been narrowing and was close to going into backwardation last Friday. Skew and Taildex (chart) showing put premiums are rallying. Is the setting the scene for more vol selling, or for vol to stay more elevated from than to revert to low extremes?

COMMODITIES

Commodity indices looks to be entering some consolidation, weighing up the Israel-Iran risks after the weekend skirmish.

I’m waiting to lean into some WTI crude longs in the lower 80s, and picked up some NatGas last Friday. I’ve posted some seasonal charts in my late-Feb and early-March notes and with that in mind along with ongoing newsflow in the sector, I remain constructive.

I’m tempted to short-gold in the aftermath of the Iranian retaliatory strikes especially in view of stronger US yields and Dollar. I have very little conviction however as I’ve been burned a few times before, but it does look ripe now than fading the upward moves outright as I have done before.

RATES

Yields moved higher across the board last week, shifting up approx 30bps since the start of the month (Green).

December fed funds sold off to new lows last week on the hot CPI print, now at 4.96% implied, pricing in about 37bps of cuts by year end.

1yr and 2y inflation swaps are now the highest in just over a year.

Strong upward momentum in 10yr yields that reversed on some safe-haven bids heading into the weekend. A colleague mentioned that Geopol risks simmering down could give yields more free roam to push higher, and that sounds very plausible to me.

10yr real yields pushed to new highs since this post and now sitting at 2.16%. If bonds continue to stay under pressure, I expect that to have meaningful impact across assets.

The rise in real yields has been meaningful — chart shows real yields less their respective breakevens as a spread. A rising trend doesn’t bode well for risk assets and currencies (think back to the Aug-Oct period of last year), and the 30yr is only just 1bps from inverting…

Also the 10yr term premium has gone back positive again. The last data point is marked for Friday Apr-5th and given the very weak auction last week, I’d imagine it to be higher than what’s on that chart.

CURRENCIES

King-dollah!

Not only is the widening US macro divergence with the RoW problematic, heightened geopolitical risks will also keep USD supported on safe-haven flows — playing on both sides of the ‘Dollar Smile’ only exacerbates capital flight to the Dollar and we should see more evidence of this when looking at EMFX, as we are in this chart (JPM EMFX index):

EUR and AUD was the weakest in G8 last week:

Bullish USD — I think its quite possible DXY could revisit 110 especially if US10yr yields ventures towards the 5% mark:

Maintaining the same views as noted over previous weeks:

Bullish USD for reasons mentioned above, tactically bullish CAD on USD and strong Energy/commodity crosswinds; bearish EUR (ECB looks next in line to cut), NZD (continued trend of weak data), CHF JPY (low yielders). I’m also short cable but GBP seems a little trickier given the recent uptick in data that has the market paring back on BoE cuts.

That’s all for now. Good luck trading!