State Of Shock

January 24, 2022 — Mitul Kotecha

Equity markets are in a state of shock.  After a stellar year last year equities have started the year in terrible shape. The rout extended further at the end of last week, capping off the worst week in over a year for US stocks.  Tech continued to lead losses, with the Nasdaq down 7.6% over the week.  Notably global equities were impacted less than the US, reflecting the fact that most equity markets outside of the US are less tech orientated.  Anything with leverage and consisting of highly speculative investment such as Crypto are bearing the brunt of the pressure.  Volumes of equity put options on the S&P 500 have also risen sharply as investors try to hedge further losses on US stocks. 

The main cause of market pressure remains the build-up of expectations of Fed tightening, with Fed officials sounding increasingly hawkish and speculation growing of a 50 basis point Fed rate hike in March as well as several more hikes over the course of this year, with four hikes already priced in for this year.   It’s hard to see such pressure abating soon. Indeed, technical indicators on the S&P 500 look poor, with the index having closed below its 200 day moving average level.  However, with market pricing for US rate hikes already so aggressive, a lot of the pain may already have been inflicted unless the Fed really does hike at every meeting this year.  

Wednesday’s Federal Reserve FOMC meeting will give further clues US interest rate policy, with the Fed likely to give signals that a March rate hike is in the offing.  However, this should not be surprising given that Fed officials have over recent weeks already strongly hinted at a March rate hike.  What will be scrutinised is any clues on Fed balance sheet reduction (quantitative tightening) as well as the path of the funds rate after March.  It’s unlikely that the Fed provides any firm indications, but nonetheless the press conference could prove more interesting.

Other policy meetings this week include the Bank of Canada meeting (Wednesday). It’s a close call but strong domestic data points to a 25-basis points policy rate hike, kicking off a likely cycle of hikes in the months ahead.  Separately, rate hikes in Hungary (tomorrow) and South Africa (Thursday) are also likely.   Following unchanged outcomes from Malaysia and Indonesia and a policy cut in China last week, there is little on the data and events front in Asia this week.  

Political and geopolitical developments will garner plenty of attention this week.  In the UK the Sue Gray report on “Partygate” will be released.  In Italy, the path for Draghi to be elected President appears to have become easier, with Berlusconi pulling out of the running though it is by no means a clear cut process.  Meanwhile, the situation with regard to Ukraine is on tenterhooks, with Russia reportedly continuing to build up troops on the border, and risks of “significant military action” rising.

Currency markets have been largely spared the carnage seen in equity markets. Speculative positioning data suggests the market remains heavily long the dollar index (DXY). Higher US real rates and continued tightening of Fed rate expectations suggests any pull back in the USD will be limited and the currency remains a buy on dips. Notably, GBP positioning has remained firm, ignoring the potential for a no-confidence motion on Prime Minister Boris Johnson. Asian currencies also remain relatively resilient, with the Chinese currency likely to continue outperforming.

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Testing The Fed’s Resolve, China Data Gives Some Relief

November 15, 2021 — Mitul Kotecha

In the aftermath of the surge in US consumer prices in October which reached the highest since 1990 at 6.2% year-on-year, the Fed’s stance is under intense scrutiny.  While tapering is beginning soon, the biggest question mark is on the timing of interest rate hikes, with markets having increasingly brought forward expectations of the first Fed hike to mid next year even as Chair Powell & Co keep telling us that inflation pressures are “transitory”.  Front end rates have reacted sharply and the US dollar is following rates US rates higher.  The flatter yield curve also suggests the market is struggling to believe the Fed.  Meanwhile, liquidity in interest rates market remains thin, and smaller Fed purchases going forward will not help.  In contrast, equities are hardly flinching, with the FOMO rally persisting. US equities closed the week higher despite a drop in the Michigan sentiment index, which fell to a new 10-year low of 66.8 in early November (consensus 72.5), with inflation being largely to blame. 

There was a bit of relief for markets on the China data front today.  The October data slate revealed less sharp softening compared to the previous month, but momentum continues to be downwards. Industrial production increased by 3.5% (consensus 3.0% y/y). A host of regulatory, and environmental pressures are leading to policy led weakness in manufacturing.  While there has been some easing in such pressures, there is unlikely to be much of a let up in the months ahead.  While retail sales also increased by more than expected up 4.9% (consensus 3.7% y/y) sales have been impacted by China’s “zero-tolerance” COVID policy, which has led to lockdowns across many provinces.  Fixed assets and property investment slowed more than expected reflect the growing pressure on the property sector. Also, in focus today will be the virtual summit between President’s Biden and Xi. I don’t expect any easing in tariffs from the US side.  

Over the rest of the week, US retail sales data will be take prominence (Tue). Sales likely rose by a strong 1.3% month on month in October, but the data are nominal and goods prices rose 1.5% in the October CPI, implying real good spending was far more restrained.  Central bank decisions among a number of emerging markets including in Hungary (Tue), South Africa (Thu), Turkey (Thu), Indonesia (Thu) and Philippines (Thu) will also be in focus.  The divergence between most Asian central banks and elsewhere is becoming increasingly apparent, with expectations for policy rate hikes in Hungary and South Africa, and a likely cut in Turkey contrasting with likely no changes from Indonesia and Philippines.   Also watch for any traction on the passage of the $1.75bn “build back better” fiscal package in the US, with a possible House vote this week.  Separately, markets are still awaiting news on whether Fed Chair Powell will remain for another term or whether Brainard takes his seat, with a decision possible this week.

As noted, sharply higher than expected inflation readings in the US and China will play havoc with the narrative that inflation pressures are “transitory” while highlighting the depth of supply side pressures.  Higher US market rates, with the US yield curve shifting higher in the wake of the CPI, bodes badly for emerging market carry trades in the near term as it reduces the relative yield gap.  At the same time a tightening in global liquidity conditions via Fed tapering may also raise some obstacles for EM carry.  That said, there is still plenty of juice left in carry trades in the months ahead.  Markets are already aggressively pricing in Fed rates hikes and there is limited room for a further hawkish shift i.e a lot is already in the price.  Meanwhile FX volatility remains relatively low even as volatility in rate markets is elevated.  Many EM central banks are also hiking rates. As such carry and volatility adjusted expected returns in most EM FX remain positive.

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Setting Up For A More Volatile Q4

October 4, 2021 — Mitul Kotecha

After a disappointing September for risk assets, markets at least found some relief at the end of last week, with the S&P 500 ending up over a 1% while US Treasury yields fell and the US dollar also lost ground.  However, sentiment in Asia to kick of the week has been poor, with Evergrande concerns coming back to the forefront.

There was positive news on the US data front, with the Institute of Supply Management (ISM) manufacturing index surprising to the upside in September, rising modestly to 61.1 from an already strong level at 59.9 in August (consensus: 59.5) though the details were less positive.  In particular, the rise in supplier delivery times and prices paid reflects a re-emergence of supply chain issues. 

Separately, the infrastructure can was kicked down the road as infighting within the Democratic party on the passage of the bipartisan $1.2 trillion infrastructure bill and larger $3.5tn package, led to a further delay of up to one more month. It is likely that the eventual size of the proposed $3.5tn spending plan will end up being smaller, but there still seems to be some distance between the progressives in the Democratic party want and what the moderates want. Separately, the debt ceiling issue is likely to go down to the wire too.

China’s Evergrande remains in focus, with the company reportedly suspended from trading in Hong Kong pending “information on a major transaction”. According to China’s Cailian news platform another developer plans to acquire a 51% stake in the property services unit. The sale is likely a further step towards restructuring the entity and preventing a wider contagion to China’s property sector and economy.

Over the rest of the week attention will turn to the US September jobs report, which will as usual likely be closely eyed by Federal Reserve policymakers.   A pickup in hiring relative to the 235,000 rise in August is expected, with the consensus looking for a 470,000 increase. It would likely take a very poor outcome to derail the Federal Reserve’s tapering plans in my view.  

Several central banks including in Australia (Tue), New Zealand (Wed), Poland (Wed) and India (Fri) will deliberate on policy.  Among these the most eventful will likely be the RBNZ, with a 25 basis points rate hike likely while the others are all set to remain on hold.  Other data includes the European Central bank (ECB) meeting accounts of the September meeting (Thu), US ISM Sep services index (Tue) and Turkey September CPI (today). 

Overall, going into the fourth quarter investors will have to contend with host of concerns including weakening global activity especially in the US and China, supply chain pressures, persistent inflation risks, Evergrande contagion and related China property developer woes, China’s regulatory crackdown, raising the debt ceiling, difficulties in passing the US infrastructure bills, Fed tapering, and ongoing COVID concerns.  This may set up for a much rockier and more volatile quarter ahead for markets especially amid a growing wave of more hawkish G10 central banks.

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Busy Week Ahead For Central Banks

September 20, 2021 — Mitul Kotecha

US equities came under more pressure at the end of last week, with the S&P 500 falling to its lowest in four weeks, down around 2% month to data.  The drop will test the buy on dips mentality as the S&P is once again resting just above its pivotal 55-day moving average, a level that has seen strong buying interest in the past. 

Economic data gave little help to market sentiment, with the University of Michigan confidence index improving a little to 71.0 in early September but falling slightly below consensus expectations at 72.0.  Separately, the inflation expectations measures were broadly unchanged, with the most relevant series for Fed officials (the 5-10y) remaining steady at 2.9%, which is still consistent with the Fed’s 2% goal.

This week is all about central bank meetings, with an array of policy meetings including in Indonesia (Tue), Sweden (Tue), Hungary (Tue), China (Wed), Japan (Wed), US (Wed), Brazil (Thu), Philippines (Thu), UK (Thu), Norway (Thu), Switzerland (Thu), South Africa (Thu), and Taiwan (Fri), all on tap. 

Most focus will obviously be on the Federal Reserve FOMC meeting, during which officials will likely signal that they are almost ready to taper. A formal announcement is likely in December or possibly November.  Most other central banks are likely to stay on hold except a likely 25bp hike in Norway, 25bp in Hungary, and 100bp in Brazil.

Politics will also be in focus, with Canada’s Federal election and the results of Russia’s parliamentary elections today.  Polls suggest the incumbent Liberals ahead though the most likely outcome is a minority government in Canada while in Russia the ruling pro Kremlin United Russia party is likely to renew its supermajority. 

Other issues in focus this week are frictions over the US debt ceiling, with the House voting soon on raising the ceiling.  US Treasury Secretary Yellen renewed her calls for Congress to raise of suspend the debt ceiling stating in a Wall Street Journal op-ed that failing to do so “would produce widespread economic catastrophe”. 

In China, Evergrande’s travails will be in the spotlight on Thursday when interest payments on two of its notes come due amid growing default risks.  Indeed, China related stocks slid on Monday morning as Evergrande concerns spread through the market.  Property developer stocks are under most pressure and whether there is wider contagion will depend on events on Thursday.

The US dollar has continued to strengthen, edging towards its 20 Aug high around 92.729 (DXY) and looks likely to remain firm heading into the Fed FOMC meeting especially as it will hard for Fed Chair Powell to sound too dovish and given risks of a hawkish shift in the dot plot.  Positioning data is showing increasingly positive sentiment towards the dollar, with speculative positioning (CFTC IMM net non-commercial futures) data showing the highest net long DXY position since May 2020. 

Conversely, speculative positioning in Australian dollar has hit a record low likely undermined by weaker iron ore prices.  Similarly, positioning in Canadian dollar is at its lowest since Dec 2020 while Swiss franc positioning is at its lowest since Dec 2019. Asian currencies have been hit, with the ADXY sliding over recent days.  The Chinese currency, CNY has been undermined by weaker data and concerns over Evergrande while high virus cases in some countries are hurting the likes of Thai baht. 

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Inflation Angst

September 13, 2021 — Mitul Kotecha

US equities fell for a fifth straight day on Friday enduring their worst week since June.  Asian markets faced a tough start to the week after US losses and amid further Chinese regulatory measures, with Alipay in focus as regulators are reportedly (FT) looking to break it up while the Biden administration is reported to be looking at starting a new probe into Chinese industrial subsidies.  Worries about the persistent impact of the Delta variant on the services and tourism sector globally are adding to the sense of malaise in markets. 

Data wise, US Aug Producer Price Index (PPI) data dented confidence following a bigger than expected 0.7% m/m, 8.3% y/y increase, with yet more evidence of the impact of supply pressures impacting the data even as the core measure slowed.  It is worth noting that China’s outsized increase in PPI inflation in August released last week sent a similar message.  Such fears may have been attributable to the move in bonds, with US Treasury yields rising on Friday, giving back the gains in the wake of the strong 30- year auction, despite the fall in equities. 

Following the US PPI, there will be a number of other releases this week which could potentially add to nervousness over lingering inflation pressures.  The plethora of inflation data kicks off with India’s August consumer price index (CPI) today for which a 5.6% y/y increase is expected, a level which will likely continue to make India’s central bank (RBI) uncomfortable.  US August CPI scheduled for tomorrow is likely to show another strong rise in food and energy prices though core CPI likely rose at its slowest pace since February.  Canada August CPI (Wed) is likely to drift higher while UK August inflation (Wed) is likely to reveal a jump after a sharp decline last month.  On balance, the inflation releases this week will do little to calm market’s inflation fears.

Other key data this week will likely show weakening activity.  The slate includes US August retail sales (Thu). The data is likely to add to evidence that the boost to goods spending in the US from fiscal stimulus has peaked.  China activity data including August retail sales and industrial production (Wed) will likely show further moderation especially to retail sales which was likely impacted by lockdowns in various provinces.  Australia employment data (Thu) is likely to have revealed a decline while NZ GDP (Thu) is likely to show firmer economic momentum than the RBNZ’s forecast.

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