Where Are We Headed?
This weekly is on the early side and I am wary of what Friday brings, especially as the debt ceiling saga gives rise to further bond market volatility.
US Rates: As expected, the Fed raised rates +0.25% to a band of 5.00% to 5.25%. It was always about the wording that followed – and this too largely confirmed what was expected: a pause is in sight. It ruled out rate cuts any time soon as inflation remains too high. However, it believes it has done enough, for now, to bring it (inflation) back down. Critically, their statement referenced, again, regional banks. Overall, the Fed believes the banking system is both sound and resilient but expressed concerns the supply of credit to households and Small and Medium Enterprises (SMEs) may slow. If it does, it will have an impact on economic growth thereby lessening the need for further rate hikes. At the time of writing, the latest futures pricing has a 91.5% expectation the rate stays unchanged at the next sitting (14th June) and an 8.50% expectation it will rise another 0.25% to a range of 5.25% to 5.50%. How have we suddenly moved to a possible (albeit low) rate hike probability…..?
US Non-Farm Payrolls: …..Because on Friday 5th May we had the April employment release, and it showed a healthy +253,000 gain (way ahead of expectations). Average hourly earnings rose +0.50% m/m to 4.4% y/y, both higher than expected. Professional & Business services gained +43,000, Healthcare +40,000, Leisure & Hospitality +31,000, and social assistance +25,000. Despite all the concerns in Banking, that gained +25,000 while Government hiring rose +23,000. As with all these things, the devil is in the detail and markets seem to have overlooked the sharp, downward revision to March of -71,000 to +165,000 while February was revised down by -78,000 to 248,000. When you average the last three months, there has actually been a moderation…..but of course no one remembers as far back as yesterday! Interestingly – and a useful guide – Powell said a 2% inflation rate is commensurate with wages rising at +3%. Currently, they are rising far in excess – even more when you take into account bonuses and the dispersion by sectors and status. This spooked bond markets which has seen wild swings all along the yield curve. FYI, the front-end 1-month Treasury is yielding 5.50%. At one point today, it jumped to 5.60%. That’s an impressive yield for a AAA security with great liquidity!
EZ Rates: The ECB raised rates +0.25% too which was also expected. However, unlike the Fed, there was no indication of a pause ahead as it doesn’t see current rates as restrictive enough but remains flexible in its approach.
Australia Rates: The Central Bank (RBA) raised rates +0.25% to 3.85% in a move that wasn’t expected. In its wording, it went on to say, “some further tightening may be required to ensure inflation returns to target in a reasonable timeframe”.
Global Rates: In general, there is a slowing down – even pause – in rate action. This interactive chart demonstrates recent Developed Market Central Bank action (https://www.reuters.com/graphics/GLOBAL-MARKETS/znvnbqxjrvl/G10CEN230502.gif) and Emerging Market Central Bank action (https://www.reuters.com/graphics/GLOBAL-MARKETS/jnpwykalqpw/EM18CEN230502.gif). April witnessed just two rate hikes across the ten most heavily traded currencies. Emerging Markets also witnessed further slowdown in rate hikes.
China Activity: The April Caixin services activity stood at 56.4 and, at over 50, continues its expansion. The Caixin manufacturing activity index remains sluggish at 49.5 (contraction) on the back of sluggish demand (home and overseas) and high inventories (forcing manufacturers to wind down output). However, despite facing several headwinds at the same time, it’s worth noting inbound tourism has exceeded 2019 levels while HK Q1 GDP jumped 5.3% q/q boosted by private consumption.
India Activity: Also picked up steam with April Manufacturing rising to 57.2 (March: 56.4). Both the new orders & output components rose strongly. April services (=60% of GDP) soared to 62.0 (March: 57.8) driven by the strongest rise in new business and output in 13 years. Between India and China, there is a big lift coming.
US Banks: Short sellers have been incredibly active betting against Regional banks and it has netted them some significant gains (US$7bn in unrealised profits). One key name is PacWest bank which, despite seeing its stock price rally 88% today, is still down -75% YTD. Its dividend yield is nearly 18%! The KBW Regional bank index is down over -27% YTD despite a rise of over 4% today. We’ve seen it before - at some point short covering kicks in and when (not if) that happens, there will be a sharp, upward correction in the Banking sector. That’s NOT the same as saying Banks have turned the corner – just a technical correction and, like a wave, will carry many other sectors upwards. Meanwhile, FDIC is planning to hit lumber big banks with big fees to replenish its deposit insurance fund. SMID banks (less than $10bn in assets) will be exempt (Bloomberg). The cost of SVB, to FDIC, was some $20bn.
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