Weekly Note 2022.08.08
Tightening financial conditions… Hello?
Last week I looked at reasons for why the pivot trade may have gone too far and why the market may have got too dovish too soon, i.e. hit a floor in rate cut expectations for the time being…
- Bonds say yes…
- Commodities says yes…
- Equities says no, hm, maybe..?
I cover my thoughts on why I think US stocks could catch up to the re-tightening outlook of financial conditions below.
- The Jobs Market Just Won’t Quit. Hiring Is Super-Strong — “Markets will take today’s number as a timely reminder that there is significantly more Fed hiking still to come. Rates are going above 4% — today’s number should put to bed any doubters.” (Barrons). Treasury Yields Leap as Jobs Data Spur Bets on Bigger Fed Hikes — Two-year yield climbs as much as 22 basis points to 3.26%, Data mean Fed unlikely to stop hiking anytime soon: Goldman (Bloomberg).
- Daly Says Fed Is ‘Far From Done Yet’ on Bringing Inflation Down — ‘We need to leave our minds open’ for September meeting. Suggests 50 basis points isn’t only option on the table (Bloomberg). Fed Governor Bowman sees ‘similarly sized’ rate hikes ahead after three-quarter point moves — Markets are anticipating a third straight big increase when the central bank meets again in September. (CNBC).
- Danger ahead: The U.S. economy has yet to face its biggest recession challenge — There is no historical precedent to indicate that an economy in recession can produce 528,000 jobs in a month, as the U.S. did during July. But that doesn’t mean there isn’t a recession ahead, and, ironically enough, it is the labor market’s phenomenal resiliency that could pose the biggest danger (CNBC).
- Senate votes to advance Joe Biden’s tax and climate bill — Legislation includes $369bn in clean energy incentives and higher taxes on corporate America (FT). Biden, Democrats Look for Midterm Boost From Breakthrough Bill (Bloomberg).
- Ukraine power plant shelled again, Zelenskiy rails at Russian ‘nuclear terror’ — renewed Russian shelling had damaged three radiation sensors and hurt a worker at the Zaporizhzhia power plant, in the second hit in consecutive days on Europe’s largest nuclear facility (Reuters). First cargo vessel since the Russian invasion arrived in Ukraine for the loading of grain to international markets (Reuters). Prewar export levels are possible within two months, a government minister says, but others warn of significant challenges (WSJ)
- Europe battles water shortages as severe drought sweeps the continent (FT). Temperatures rise as France tackles its worst drought on record (Reuters), Acute drought leaves France short of drinking water (BBC), Drought-stricken waters of Italy’s River Po are running so low they revealed a previously submerged WWII bomb (Reuters).
- Nuclear Power Plants Could Stay Open, Says Germany — Berlin could reconsider its decision to shut down Germany’s nuclear plants in December (WSJ), Europe’s Energy Crisis Threatens to Slow Green Transition (WSJ).
- ECB Is Through a Third of Its Rate Hikes, Market Bets Show (Bloomberg). ECB injects billions of euros into weaker eurozone debt markets — Central bank utilises reinvestments from maturing bonds to soothe jitters in countries such as Italy (FT).
- Bank of England warns the UK will fall into recession this year (BBC). People are going back to cash to keep tighter control on their spending as living costs soar (BBC). Liz Truss Leads Race to Become Next U.K. Prime Minister — Longtime cabinet minister casts herself as a tax-cutting insurgent in bid to succeed Boris Johnson (WSJ).
- China Launches Live-Fire Drills, Missiles Around Taiwan — ship, plane and missile drills encircled the island and came close to key ports, with five missiles landing within Japan’s exclusive economic zone (WSJ). Ships Delay Sailing to Taiwan Port to Avoid China Drill Zone (Bloomberg); Chinese and Taiwanese warships shadow each other as drills due to end (Reuters). China touted its exercises around Taiwan as proof of its ability to blockade the island in the event of a war (WSJ)
- China’s imports of commodities in July offered some tentative signs of a demand recovery after the sharp slump earlier this year due to stringent Covid-19 restrictions and property woes — China’s Crude Oil Imports Climb From Lowest Level in Four Years; Inbound iron ore shipments edge higher despite steel headwinds (Bloomberg). China’s exports gain steam but outlook cloudy as global growth cools — China July exports grow at faster pace, beat forecast; Imports again disappoint, highlighting weak domestic demand; Trade balance hit record high in July; Weak foreign demand adds stress to trade, economic outlook (Reuters).
- China’s Hainan Starts Mass Covid Testing, Imposes More Lockdowns (Bloomberg), COVID lockdown turns Chinese tourist hotspot Sanya into nightmare for stranded tourists — number of cases has suddenly soared, prompting a lockdown in the city which had just two positive cases in the whole of last year (Reuters).
LAST WEEK’S ACTION
Equities had a strong week despite the selling in bonds and commodities and a stronger USD. Equity sentiment looks to have ridden on the resilience of US data that may have shrugged off of some recession fears.
Growth led the rally with RPG (SPX Pure Growth) up +1.75% last week, driven by smaller-cap IWO outperforming mid and large-cap Growth. RPV (SPX Pure Value) finished -1.58%, biggest loser XLE going down as low as -10% while XLB and XLRE also followed commodities sentiment lower.
SPX and NDX is overbought while hovering around the 50fib retracement of the recent cycle and 20wma…
and Daily charts are showing some exhaustion around that area…
and Further supported by the MTD trend in net volume and cumulative tick.
Options market, a huge driver while the underlying market trades on low liquidity, has seen some call gamma building up. SpotGamma has observed Call selling and Put buying since the end of July.
I’d imagine the calls sold were further OTM than the puts bought, resulting in the sharp rise in zero gamma line. Essentially, it appears to me that bearish bets have got a little over excited on the turn from the highs late July, got squeezed, and now coming back in again around some key technical levels.
Putting it altogether, we had large-caps lead the way, run out of steam, then ‘shitcos’ playing catchup in gamma squeeze styles — I think this could very well be a sign of the final push and, biased as I may be, could be the perfect storm to see some acceleration in downside with another 2 trading weeks til OPEX.
Big move in rates last week. 1yr moved 29.5bps higher, 2 and 3yr more than 35bps higher. Good portion of the move coming after some hawkish comments from Fed members signalling the possibility of delivering more than the 100bps priced til year end, and the hot jobs report pushing it further.
Big jump after 5yr real yields went negative and 10yr was about a point short.
ED Dec’22 is less than 20bps off the June ‘pivot trade’ lows.
FFF showing a ~70% probability of 75bps at the Sep meeting.
Bloomberg commodities index dragged lower by Energy (Red) while Food (Green), Precious (Yellow) and Industrial (Orange) metals finished the week to roughly flat MTD.
Long JPY was a popular trade but is now signalling the end of the pivot trade, but as JPY heads back into the shorter-term (20/50) moving averages, the anticipation of some bad economic data could does make it attractive to me — especially vs the drought stricken EUR or vs the increasing risks CAD.
EURUSD is leaning heavy on the 20dma with action into and above the trendline being lacklustre — more weakness awaits…
And the higher beta AUDUSD exhibits a similar picture…
ZAR and MXN also showing a bearish look.
Currencies — long USD, maybe JPY:
US Equities diverging against the major asset classes as suggests a turn in sentiment is likely to materialize, Metals to stay under pressure due to slowing manufacturing activity and lift in rates, and USD to keep smiling as a result while JPY is somewhat attractive on the anticipation of more ‘slowing growth’ data. On the flip side, EUR and GBP still remain high conviction shorts with markets punishing currencies with greatest recession risks. I continue to like AUDNZD short and turning increasingly bearish on CAD which has had a poor run of data on top of an aggressive BOC and while commodities have been in a downtrend.
Short Gold and NDX:
Referring to the 5yr TIP yields chart vs Gold (inverted) in the rates section above, I like trading around the short-side of assets most likely to be impacted by the lift in rates. Even if the move in yields may mostly done, I expect real yields to maintain upward pressure as the Fed comments will likely attempt to keep inflation expectations in check.
I was lucky to capture the big move in LABU (leveraged Biotech ETF) where the sector drew some appeal recently and benefited from decent results and guidance.
Still long a few names in stocks and scaling in the process of scaling out. Bought some SPXU (Leveraged 3x Bear SPX ETF) for my stock book for some downside exposure and will expand my position via SQQQ (leveraged short QQQ) if the smaller-cap growth stocks look ready to rollover.
Accumulated China stocks since a few months ago mostly in Alibaba via HSI:9988 where im averaged in the mid-$90s. A longer-term trade, betting on Xi’s resolve to get China’s recovery on track and misplaced de-listing fears; I am seriously questioning how wrong and for how long I could be about this recovery…
“Alibaba sheds nearly 10,000 employees in June quarter as the e-commerce giant cuts costs amid sluggish sales, slowing economy” (SCMP)
Ouch… and my good friends at Macrodesiac still seem to think it’s “Game Over for China” as David writes:
“Clearly, China won’t immediately disappear or become irrelevant. It’s more of an irreversible decline that’s picking up pace.”
And that was from back in May 2022!
Time is the definitely the biggest risk to my view — the longer China ‘muddles in the mud’, the longer the road to recovery, and the way global macro is shaping up certainly isn’t helping. Although I’m taking a 2/3 year view, I’ve decided to reduce my holding to half to be safe with a view to see how things pan out this week.
That’s all for the weekend’s thoughts and idea’s — have a great week!