Insights, Perspectives & Trends
Skeptical; the devil is in the details…
FX | Rates | Credit
Equities | Alternatives
Skeptical; the devil is in the details…
Week #33 is here and with it, another edition of the Global Macro/Markets Notes. As you know, here we try to make sense of short-term financial markets movements in the context of hard data, facts, and reason to help us Navigate Global Macro/Markets.
Last week, US investors welcomed better than expected inflation data, as it took the first steps in the right direction; July CPI headline decelerated to 8.5% on a year vs. an expected 8.7% and 9.1% year over year change in June. I dislike with a passion having to say that we (with an immense help from our research partners), have been suggesting inflation deceleration for a while now. Thankfully, we timestamp our comments and opinions to avoid the typical #hindsightbias that permeates the financial industry. Said that, we remain SKEPTICAL of the current market behavior and still believe this to be a #bearmarketrally and a #bulltrap.
In this week Insights, Perspectives and Trends, we dig a little deeper on what we would like to see to have a change of heart. Read on and please let us know if you think differently or have any questions, comments, opinions… those are always welcomed, as I truly believe that investing is a "team sport".
Best Regards, LeoC.
Insights, Perspectives & Trends
Last week, even if you wanted you could not have missed the noise about inflation turning into deflation. Media outlets and financial market tourists were shouting the word deflation with vengeance, not only here in the US, but also in Brazil and China, but not in Europe.
As we have been mentioning since early summer, inflationary pressures have started to move in the right direction, but let's not confuse disinflation, which relates to a deceleration in inflation with deflation, which is a GENERAL decrease in price levels mostly caused by a shift in supply and demand.
But why am I being so technical? Why am I being, potentially defined by some people, "a pain in the butt"?
Simple answer. Because of a key word - GENERAL. As the saying goes, "the devil is in the details…". So, let's look under the hood.
#clickbait of the week = DEFLATION
To recap: consumer inflation through June showed energy prices raising close to 42% in one year, of which 7.5% was in that month alone, pushing the headline CPI index to a 9.1% increase year over year (YoY). For the sake of full information, we also identified that energy was not the only problem; the price for food and all other items, which include the price for services, have also been increasing significantly. Fast forward a month and last week the Bureau of Labor Statistics reported that US consumer inflation in July was down to 8.5% for the YoY period vs. an expected 8.7% year over year change (figure 1).
Needless to say, the USD basked (BBDXY) fell 1.1% during the week, on the expectations that the Fed will not have to continue raising rates aggressively (figure 2). The broad US equity markets welcomed the news and soared on the week; the S&P500 Index (SPX) jumped 3.8%, the NASDAQ Composite Index (CCMP) increased 4.4% and the Russel 2000 Index (RTY) leaped 5.4%, since the report was released on the morning of Wednesday, August 10th.
On the surface, it seems that everything is all sunshine and rainbows. Not only in the US, but also in certain countries like Brazil where consumer inflation also decelerated in July. The social media channels, and to some extent the traditional media as well, were quick to use DEFLATION as #clickbait. For the record, core European countries have yet to experience deceleration in inflationary pressures.
Victims of click bait, usually the occasional headline reader or a market tourist, would not have noticed that in fact, interest rates continued to raise over the week; albeit, less so in the US and Japan, but more so among core European countries. The 2yrUST increased 1.65bps to 3.24% and the 10yUST inched 0.44bps higher to 2.83%. Core-European countries France and Germany ended the week with 2yr sovereign yield up more than 10bps and 10yr yields up around 5bps (figure 3). More importantly, not only core DM yields increased, but the #10_2USTspread, despite bouncing from -0.50% mid-week, continued to decline on a weekly basis to end Friday at -0.4213%, levels not seeing since the early 2000s.
What do I make out of this?
For me, global economic deceleration still on the horizon. Maybe, we won ONE battle, but we are far from wining the [inflation] war.
Now, let me tell you why we have not won the war yet…
It was mostly energy
Don't be fooled by clickbait DEFLATION. Please remember that US midterm elections are around the corner and touting a 0% inflation over one month is a pill much easier to swallow than 8.5% inflation over one year.
Furthermore, with oil prices falling close to 30% since early June (figure 4), an energy driven decline in consumer inflation was pretty much inevitable since energy items represent close to 8% of the weight in the index. As such, the deceleration of CPI headline index for July is mainly explained by the collapse in oil prices (figure 5).
Yes, core inflation, which removes the volatile food and energy items, was "better than expected", but still unchanged from June at 5.90% YoY. With services prices ex-energy, which represents about 58.2% of the CPI index increasing and shelter not budging (a sub-category of it with a 32.8% weight of the CPI index), there is no reason to think that Fed officials will do a #fedpivot or introduce any kind of quantitative easing to save the market if things start to derail. With that said, based on the positioning of market participants in the fed funds futures market, the Fed will not come remotely close to implement its own guidance; they are currently expecting rates at the end of 2023 to be at 3.22% vs. the Fed guidance of 3.75% (figure 6).
What would I like to see to start having a change of heart?
First and foremost, the information I’m about to share is not static. In other words, today those are the most relevant items I believe will help determine the direction of economic conditions; tomorrow could be others due to the dynamics of the current market environment.
With that out of the way, I’m following closely data on the conditions of the housing market (activity such as permits, construction, sales of new/existing houses, mortgage rates and applications), an unsettling divergence in the US employment report between the household survey (people that say they do have or do not have a job) and the establishment survey (companies disclosing number of people in their payroll), and the spread for various maturities in the US Treasury yield curve. We also believe that consumers are on a path that could prove to be disastrous if the economy derails, unemployment rises, and inflation doesn’t go away. It is simply unsustainable for credit to increase approximately 1.0% monthly (figure 6).
Lastly, we have an eye on the prices of commodities. Since mid-July, the BCOM aggregate index has been increasing with help from the energy and industrial metals space (figure 7).
Week #33 is upon us and we are back at the #mondaygrind by looking what has and is happening in #globalmacromarkets. For the "new kids on the block", our goal is to simply try to understand the “message”, if any, that financial markets are sending through their short-term movements and dynamics. Let’s begin…
FX | Rates |Credit
From our #bzcFXmonitor, the US Dollar Index (BBDXY) finished down 1.1% and is now up 7.4% on the year. Technically, 1,260’s represents a short-term support for the #USDuptrend that began around mid-summer 2021 and gained strength towards the beginning of April 2022. The support was briefly tested after the CPI surprise, but it was regained by Friday's close (figure 9).
Looking at the FX pairs:
The Euro added 0.75% against the USD to close the week at EURUSD 1.0259. The #EURdowntrend still intact; we are looking around the 1.0146 level for an immediate-term show of strength; we penciled a line in the sand around a multi-day close at or above 1.0363 for a possible change in trend.
The British Pound gained 0.54% to GBPUSD 1.2138 and continues a #GBPdowntrend. GBPUSD 1.20 is an immediate-term soft line in the sand.
The Canadian Dollar closed the week 1.17% higher to USDCAD1.2782. The #CADneutraltrend still at play and range bound between USDCAD 1.31 and 1.28.
The Japanese Yen extended to a third week of a counter #JPYdowntrend move with a 1.19% gain on the week. Still, the JPY remains at a multi-decade low. The last time the JPY was this weak was around November 1998. The current trend is expected to continue if the Bank of Japan (BoJ) maintains its ultra-loose monetary policy, to support the country's still-fragile economic recovery, and continues to diverge from other major central banks' tightening policies.
The Chinese Renminbi ended the week pretty much unchanged at USDCNY 6.7428 and remains on a #CNYdowntrend since the first leg of the break in April 2022.
The Brazilian Real rallied 1.76% on the week to end at USDBRL 5.0745. Lately, the #BRLdowntrend has been challenged by better-than-expected inflation data and a central bank rate hike that took the base rate to 13.75%. We are looking for a possible change to a #BRLuptrend once the currency closes below USDBRL 5.1026 for multiple days.
Bitcoin jumped 5.46% to end close on Friday at XBTUSD 24.241. Ethereum finished the week at XETUSD 1,933.
In our #bzcFImonitor, the better than expected US CPI inflation did little to sustain a decline in UST yields. Immediately after the report was released on Wednesday, expectations for the number of 0.25% Fed fund hikes decreased from 2.78x to 2.3X. Nevertheless, Fed officials reiterated that the central bank still had work to do in taming inflation; Mary Daly, president of the Federal Reserve Bank of San Francisco, told Bloomberg Television that the latest inflation data, while an improvement, are still high and should not be construed as “victory. Meanwhile, Chicago Fed President Charles Evans remarked at an event hosted by Drake University in Iowa, that the central bank may need to raise rates to as high as 4% by the end of 2023.
The yield on the 2-, 5-, 10- and 30-year UST inched higher to end the week at 3.24%, 2.96%, 2.83% and 3.11%, respectively. The #10_2USTspread declined another1.8bps to end the week at -0.4213%, the most negative spread since early 2000s. The narrative that inflation may have peaked fueled a tightening in IG bonds credit spreads.
Core eurozone government bond yields ended the week higher, with UK yield following the lead of European core markets.
In Japan, JGB yields were mainly unchanged - the yield curve is negative all the way to 5yr terms.
Equities | Alternatives
For the #bzcEQmonitor, the large-cap S&P 500 Index advanced but did not gain as much ground as the mid- and small-cap indices (+4.4% for the S&P400 index and +4.9% for the Russell 2000 Index). Led by energy stocks, all the sectors in the S&P 500 advanced.
Core European equities rose less than its American counterparties, but still ended the week higher as concerns over further rate hikes eased. The aggregate STOXX 600 gained 1.2%; major individual country indices also advanced: France's CAC 40 climbed 1.3%, Germany’s DAX gained 1.6%, Italy’s FTSE MIB added 1.7% and the UK’s FTSE 100 increased 0.82%.
In Asia, the Japanese and Australian stock markets also rose, with the Nikkei 225 and the TOPIX index gaining 1.3%, with the AS30 increased 0.5%. Investors’ risk appetite was supported by the US inflation data positive surprise, which, tamed expectations that the Fed would continue raising interest rates aggressively. The Chinese stock markets ended the week on a mixed note as new cases of coronavirus offset news of a record trade surplus in July. The Shanghai and Shenzhen Composite Index added 1.5% and 1.90%, respectively.
Our #bzcCMDmonitor showed significant bounces in aggregate commodities. Energy, industrial metals and agricultural commodities all rose during the week. WTI and Brent traded 3.4% higher and ended the week at $92.09 and 98.15, respectively. Gold increased 1.5% to $1,802.