March 28, 2022

Markets Today: Ditching bonds like they are going out of fashion

Economists outdo each other for Fed hikes with Citi calling four 50 basis point hikes back to back

Todays podcast


Overview Anything You Can Do (I Can Do Better)

  • Economists outdo each other for Fed hikes – Citi sees b2b 4 x 50bp hikes
  • Yields surge on the above headline with the US 2yr yield +14bp to 2.28%
  • Risk sentiment still amazingly resilient with equities up (S&P500 +0.5%)
  • USD barely moved despite lift in yields, AUD holds 75 handle at 0.7514
  • Russia nears the end of its first phase of operations, shifts back to Donbas
  • Coming up this week: AU Budget, US Payrolls & PCE, EZ CPI, CH PMIs, OPEC

“Anything you say; I can say faster; I can say anything; Faster than you; No, you can’t. (Fast); Yes, I can. (Faster) No, you can’t. (Faster); Yes, I can. (Faster) No you can’t. (Faster); Yes I can! (Fastest)”,   Irving Berlin 1946 for Annie Get Your Gun


Carnage is one word to describe Friday’s moves which saw bond yields surge as US economists tried to outdo each other with rate hike calls. This time it was Citi calling for the Fed to hike 50bps at the next four meetings (i.e. May, June, July, September) with a terminal rate of 3.75% in 2023; BofA also called for 2 x 50bps moves with a terminal rate of 3.25%. Yields surged with US 2yr yields +14bps to 2.28% (after briefly hitting an intra-day high of 2.3286%). 10yr yields were up by a slightly less by 10bps to 2.47%, meaning the 2/10s curve flattened further by 3bps to 19.7bps. Other segments of the yield curve are already inverted with 3s10s -3.6bps, 5s10s -7.4bps and 7s10s -8.5bps, while 5s30s are 3.8bps and near early 2006 levels. Interestingly nominals rose by more than real yields (10yr real yield +6.5bps to -0.5093%) with the implied 10yr inflation breakeven +3.6bps to 2.98%. Fed Funds Pricing has lifted materially with 8.2 rate hikes now priced for the remaining six meetings in 2022, from 7.7 hikes on Thursday. Consecutive 50bp moves in May and June is now almost fully priced at 87%. June/September 2023 is when markets see the peak and start to price cuts.

Risk assets so far are proving extremely resilient with the S&P500 +0.5% despite the surge in yields. Since the start of March the S&P500 has risen 3.9% at the same time as the US 10yr nominal yield has surged 64bps to 2.47% along with real yields by 36.5bps to -0.51%. One factor helping risk assets may be some indication by Russia of de-escalating. Moscow said on Friday it was nearing the end of the first phase of its military operation in Ukraine with one spokesperson stating “Our forces and resources will focus on the primary objective: full liberation of Donbas”. The UK has also given the first tentative roadmap to easing sanctions on Russia with British foreign minister Liz Truss on Saturday stating sanctions imposed on Russian individuals and companies could be lifted if Russia withdraws from Ukraine. The comments are the first official confirmation sanctions could be lifted in a peace deal (see The Telegraph: ‘Crippling’ sanctions could be lifted if Russia withdraws from Ukraine, says Liz Truss for details). President Biden’s comments on the weekend of Putin “cannot remain in power” should not be seen as an obstacle and were quickly walked back by the White House.

Another factor behind recent strength may be short covering by institutional investors of speculative tech given the 23% lift in the ARK Innovation ETF since mid-March – one summary of the performance of long duration unprofitable tech. Goldmans noted leveraged investors had participated in the recent selloff by aggressively reducing their equity exposure and their own prime data showed a sharp reduction to hedge fund leverage in 2022. Flows data supports a lift in retail buying the dip, reinforcing the likely short covering. The other factor though not a driver of the recent strength in equities is the ongoing strength in corporate equity buybacks with $1 trillion of buybacks expected in 2022, up from an earlier estimate of $870bn. The other factors cited by commentators are optimism around a soft landing in the US and there being no alternative to equities in an inflationary environment. Your scribe is more sceptical and key to the resilience in equities and the assumption of earnings resilience to inflation pressures will be the upcoming earnings season for Q1 which kicks off in earnest during the second week of April, led by the banks.

Economic data continues to take a backseat, but also sends an amber signal to those getting too carried away with the hawkish narrative. US Pending Home Sales fell -4.1% m/m, well below the consensus for +1.0% m/m, and is its fourth straight month of declines. It is clear the US housing market is cooling rapidly in the face of higher rates with the benchmark 30yr fixed rate lending rate having increased 132bps since the beginning of the year to 4.56%, its highest rate since January 2019. Lumber prices are falling again (down some 32% from the beginning of March), along with homebuilders with the S&P 500 Homebuilding Subindex -26.6% from its peak, compared to -5.2% for the broader S&P500. The sharp deterioration in consumer sentiment since late last year remains with the University of Michigan Consumer Sentiment at 59.4 and at its lowest since August 2011. The housing sector should be watched closely with Fed Governor Waller noting on Thursday “with housing costs gaining an ever-larger weight in the inflation Americans experience, I will be looking even more closely at real estate to judge the appropriate stance of monetary policy”.

The sharp deterioration in US consumer sentiment since late last year remains with the final University of Michigan Consumer Sentiment measure coming in at 59.4 from the prelim of 59.7 and is at its lowest level since August 2011. The write-up noted “ when asked to explain changes in their finances in their own words, more consumers mentioned reduced living standards due to rising inflation than any other time except during the two worst recessions in the past 50 years: from March 1979 to April 1981 and from May to October 2008”. For now the US consumer is acting very differently to where sentiment suggests given a pool of accumulated savings and a tight labour market. Nevertheless, consumer sentiment and the housing market are sending some amber signals that could challenge the rapid pace of hiking currently priced by markets. Meanwhile across the pond ECB President Christine Lagarde was quoted as saying on Saturday. “Incoming data don’t point to a material risk of stagflation,” with the Ukraine war unlikely to lead to stagflation. The Fed’s Williams also hit the wires on Friday, but mostly repeated the hawkish rhetoric seen from other officials.

The USD was unable to gain any further momentum from higher yields with the DXY little moved, while BBDXY was -0.1%. USD/JPY looks to be showing signs of consolidating after its recent run higher, tracking sideways around the 122 level on Friday despite the US bond sell-off. The Japanese 10yr yield currently trades at 0.24%, close to the top of the BoJ’s tolerance threshold and markets will be looking to see whether the BoJ enforces its YCC policy. There has been some speculation the BoJ might widen the allowable range around its 0% 10-year yield target, say up to 0.50%, in response to the recent sharp depreciation in the JPY. For the week the USD/JPY rose 2.48% and currently trades at 122.05. One story that may impact on markets as trade opens is China putting Shanghai into a staged four day lockdown to carry out COVID-19 testing over a nine-day period.  Shanghai will be divided into two the first area locked down from March 28 and April 1 for testing, and then the second area locked down between April 1 and 5. China’s zero-COVID policy is being tested with the Omicron variant with only a very mild pivot so far in terms of treating patients who test positive.

As for the rest of the FX basket, The best performing currency on Friday was the CAD – with the USD/CAD falling 0.40%. The CAD was supported by rising energy prices and hawkish comments from the Bank of Canada. WTI oil rose 1.4$ at 113.90 after reports of a missile attack on Aramco’s fuel distribution facility in Saudi Arabia. For the week WTI oil rose 8.89. For the week the USD/CAD fell 1.03%. BoC Deputy Governor Kozicki put 50bp hikes on the table, noting “I expect the pace and magnitude of interest rate increases and the start of QT to be active parts of our deliberations at our next decision in April, ”. Meanwhile EUR closed modestly lower -0.1% to 0.7515 after a weak German IFO (IFO Business Climate 90.8 against 94.2 expected). The AUD held ground at the 75 handle, and currently trades at 0.7515 and for the second week in a row it was the strongest major currency – gaining 1.34% for the week.

Finally in Australia, the press report a few more budget leaks ahead of Tuesday’s announcement. The AFR notes a fuel excise cut is now certain and will likely las for at least six months. While the size of the cut is still uncertain, it is noted a 5¢-a-litre cut for six months would cost about $1 billion. More infrastructure spending is likely with $17.9bn in addition with details to be announced on the campaign trail. An already announced cost-of-living one-off payment is also likely to see plans dropped to extend to 2022-23 the Low-and-Middle-Income Tax Offset, an end-of-year rebate of up to $1080 for those who earn up to $126,000 a year (see AFR: Fuel tax cut, $18b extra for roads, rail in pre-election budget for details).

Coming this week

  • Australia: The Federal Budget is on Tuesday night where consensus for the 2022-23 deficit stands at $77bn. NAB also expects a figure around $77bn (from $98.9bn)  and falling to $55b in 2023-24. There would have been a greater improvement in the deficit if it were not for likely spending announcements ahead of the next election that must be held by 21 May. Given the 33-day notice period between calling and holding the election, we expect the election to be called within two weeks of the Budget. There is also likely to be rhetoric around the next phase of the fiscal strategy to stabilising or reducing debt-to-GDP, but there will be no escaping the pre-election nature of the budget (see our recent AMW: Fiscal consolidation expected to be gradual. Election to be called in next few weeks, most likely for May 14th or 21st for details). Also out during the week is February Retail Sales on Tuesday with still strong growth of 1.0% m/m some recovery from the mild Omicron impacts in January. Other data out in the week includes Building Approvals, Housing Finance Approvals, Credit and Job Vacancies. There is nothing scheduled from the RBA this week.
  • Offshore: US Payrolls this week is likely to take a back seat given the Fed’s assessment of “the labor market is [it is] extremely tight ” according to Fed Chair Powell. Consensus sees unemployment falling a tenth to 3.7% and for 490k jobs to have been created. Focus will also be on average hourly earnings which is expected to tick-up to 0.4% m/m after being flat in February. Instead the emphasis is likely to be on the ISM Manufacturing (Friday) for whether supply chain pressures are increasing given Russia/Ukraine, and whether demand may start to moderate given inflation headwinds and the mooted pivot by consumers from goods to services. In the EZ inflation figures on Friday will be the focal point with the consensus seeing core at 3.1% y/y from 2.7%. Across the Channel in the UK the focus is on the BoE with Governor Bailey speaking tonight and deputy Broadbent on Wednesday. It is also an important week in China with the manufacturing/non-manufacturing PMIs out which should pick-up some of the impacts of recent lockdowns. Consensus sees Manufacturing at 50.0 and non-Manufacturing at 50.6 with likely downside risks.

Coming up today

Very quiet with no top-tier data scheduled for Australia, the rest of Asia and the US . In Europe, UK BoE Governor Bailey speaks on the economy. Details below:

  • UK: BoE Governor Bailey: Governor Bailey speaks on “macroeconomic and financial stability in changing times.” . The speech could be used to delve deeper into the dovish hike and how the BoE is balancing inflation risks against activity headwinds. Markets are still hawkish as far as the BoE is concerned with 5.6 further hikes priced for this year and a 50bp hike in May is 44% priced.
  • US: Goods Trade Balance/Inventories/Dallas Fed Manufacturing: Second-tier data in the US and unlikely to be market moving given the focus on inflation. For the record consensus sees the good trade balance at 106.3bn from 107.6bn, and wholesale inventories to rise 1.2%. The Dallas Fed Manufacturing Index is expected to tick lower to 11 from 14.

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