… S&P 500 and Nasdaq futures have swung to losses this morning, declining 0.1% and 0.2% respectively as of 5:24 a.m. in New York. Capital is flowing into Treasuries instead, driving yields lower across the curve. A measure of the dollar is weakening slightly while gold prices rise as investors look for havens. Oil is gaining slightly after the events in Russia over the weekend, while iron ore prices fall on China economic gloom…
That’s all well and good BUT with a 2yy auction a bit later on today, lets hope capital avoids flowing here before elsewhere, robbing the markets of it’s recent bit of concession,
Momentum here IS bullish input but as DataTrek notes as it takes a step back a bit,
… The second point we want to discuss with you is the recent trend in 2-year Treasury yields, shown in the chart below. After peaking on March 8th at 5.05 percent, they fell to around 4 percent and stayed there through mid-May as markets waited for the economic knock-on effects of the US banking mini crisis. As those failed to immediately materialize, 2-year yields have started to climb again. They are not yet back to 5 percent, but Thursday’s/Friday’s closes of 4.80/4.75 percent are the highest in over 3 months.
Takeaway: Markets are growing to accept the idea that not only will Fed Funds remain high this year, but any loosening of monetary policy in 2024/2025 will happen only very slowly. Thus far this has had almost no impact on stock prices because the US economy is still performing reasonably well. That gives companies the chance to deliver the earnings growth we outlined in the prior point. Yes, this is all a very fine balance but so far it is working.
AND … here is a snapshot OF USTs as of 705a:
… HEREis what this shop says be behind the price action overnight…
… WHILE YOU SLEPT Treasuries are higher (belly outperforming) and keeping pace with EGB's after Germany's latest IFO reading disappointed (link above). DXY is lower (-0.2%) while front WTI futures are modestly higher (+0.35%). Asian stocks were mostly lower (SHCOMP -1.48%), EU and UK share markets are little changed while Es futures are showing -0.15% here at 7:15am. Our overnight US rates flows saw a quiet Asian session with some fast$ selling in the long-end noted amid some bull-steepening during their hours. During London's AM hours there were below-average volumes in swaps and cash with better receiving of 2s5s10s noted by the swaps desk (fast$ a better buyer of TY futures on curve or fly too). Overnight Treasury volume was about average overall despite desk flows being limited…
… Treasury 5yr yields, daily: Daily momentum (lower panel) peaked with rates in late May and momentum has made steadily lower highs since then. And that's despite 5yr yields making consistently higher closing highs since the start of this month. This set-up (falling momentum + rising rates) shows evolving Bullish Divergence or is simply a hint that recent sellers may be joining an already large crowd of shorts. Meanwhile, at last night's close daily momentum flipped bullishly from 'oversold' readings- a sign that buyers may have finally wrested control from the sellers as 5yrs respected support near 4.00%. This is a locally bullish set-up, from the looks of it.
… and for some MORE of the news you can use » IGMs Press Picks for today (26 JUNE) to help weed thru the noise (some of which can be found over here at Finviz).
From some of the news to some of THE VIEWS you might be able to use… here’s what Global Wall St is sayin’ … in addition TO what narratives were noted / highlighted HERE yesterday …
On Russia,
DBs Jim (early morning)REID: Markets will start the week trying to work out what to make of the volatile situation in Russia that saw a remarkable turn late Friday and into Saturday. In truth perhaps the mutiny and then truce, all within 24-36 hours means more political instability longer-term than shorter-term. At one point on Saturday though, when the Wagner group's Prigozhin had his troops march towards Moscow, it felt that there was a lot of potential global market event risk over the next few days. That has perhaps died down but this whole episode probably increases both the positive and negative tail risks a bit. It could increase the risk of escalation by Mr Putin to reinstate an air of authority, or it could leave him vulnerable which could be seen as positive or negative for Europe, Ukraine and wider markets. It's just impossible to tell at this stage.
In Russia, the mercenary Wagner group’s march on Moscow, and subsequent retreat from the march on Moscow has occupied news headlines. Financial markets have bordered on indifference. Political and media attention may be diverted from other issues like the cost of living crisis, but this is not dramatic enough to concern investors. There are two obvious ways markets might be made to care.
If Russian domestic instability affects energy supplies (and thus energy prices), markets would respond. Alternatively, if a weakened Russian President Putin were to attempt a show of strength in the war in Ukraine, this may broaden and strengthen western sanctions against companies doing business with Russia. Markets are not pricing in either scenario at the moment….
On the OIL aspect, specifically,
Goldilocks: Risks to Oil Markets from Recent Developments in Russia
… Russian oil output rebounded quickly last summer after a brief drop during the spring. A broader review suggests that persistent and substantial shocks to oil supply have historically arisen because of significant domestic civil unrest or because of the destruction of key oil infrastructure in a military conflict.
While there is no disruption to oil flows at present, we note that the Baltic Sea and the Black Sea are Russia’s major export hubs for seaborne oil, and that the Wagner group also has some presence around oil facilities in Libya.
We don’t expect a very large impact on oil prices when the oil market opens on Sunday. Markets may price a moderately higher probability that domestic volatility in Russia leads to supply disruptions or has a sizable negative impact on oil supply at some point in the future. That said, the impact may be limited because oil markets are often focused on spot fundamentals, which have not changed, and because any hits to financial risk sentiment or to oil demand from increased uncertainty may provide an offset…
And one last note / thought / link to consider,
ZH: Ride Of The Valkyries: What Do The Latest Events In Russia Mean For Markets By Peter Tchir of Academy Securities
Rarely does a T-Report write itself, but this is one of those occasions! A paramilitary (or simply military) group named Wagner. A ride to Moscow. Almost impossible not to conjure up the iconic helicopter scene from Apocalypse Now.
Academy has published two brief SITREPS on the events of the past 48 hours in Russia. We are having multiple discussions on the subject attempting to sort through the possibilities and you should expect another SITREP on this “incredible” development. “Incredible” from the standpoint that virtually no one saw it coming, that it is the first real “challenge” to Putin and that somehow, Belarus apparently played the role of mediator.
For now, some key takeaways are:
General (ret.) Deptula – “a huge opportunity for the Ukrainians”
General (ret.) Marks – “definition of chaos and uncertainty” and “focusing on the control mechanisms of Russia’s vast nuclear arsenal”
General (ret.) Walsh – “fluid” and “Xi is tied to Putin”
General (ret.) Kearney – “For Prigozhin to live a long life..”
Fluid is probably the key word in all of this as the situation continues to develop.
What Does This Mean for Markets
At this stage, there is so much uncertainty around what happened, how it happened and what will happen next that it is difficult to predict anything for markets. But, I think we are in position to lay out several plausible scenarios and what it would likely mean.
Ukraine makes advances, the Wagner group removes itself from this conflict to focus on their other “business” initiatives and Putin is forced to the table (potentially literally forced by Xi).
From the perspective of Ukraine, NATO, Europe and even humanity, this would be the best outcome. It would pave the way to a truce while some final “treaty” is agreed to.
Europe benefits as refugees can start the process of returning to their homes and talk of rebuilding Ukraine will spark growth discussions.
A year ago, this would have been deflationary, but now, that is far from clear, as Russia has found new buyers of its commodities and seems unlikely (or even unable) to return to selling cheap fuel to Germany and the rest of Europe rather than to China (and India). A year ago, I would have expected oil to sell off significantly on any peace news, but oil was over $100 then, not $69 and these new buyer/seller arrangements were not as entrenched as they are now.
The rebuilding of Ukraine could be inflationary. Depending how quickly it starts, where the money comes from (possibly Russia’s dollar reserves) we could see another spurt of inflation as this reconstruction will be expensive and resource intensive.
I’d buy a commodity dip, favor European and Emerging Market stocks, overweight companies that benefit from “reconstruction” and would expect rates to initially rally (along with an initial commodity sell-off) only to reverse higher.
Some sort of “regime” change in Russia.
This seems highly unlikely. While Putin was at the very least, embarrassed, by the events of the past 48 hours, he remains firmly in charge. There were no mass defections from his base or the regular military.
If a regime change does occur, even though the new person in charge is likely to be a person of “questionable morals” (being polite) they would likely back down on the war in Ukraine and open negotiations. No point, even if you are a bad person, not to take a step back and consolidate the riches you would have won as the leader of Russia.
From markets standpoint, it probably plays out similarly to a peace deal.
Retribution and renewed focus from Putin.
The wildcard, all along in the fight for Ukraine has been Russia’s possession of nuclear weapons. We’ve known from the start his willingness to commit atrocities on a large scale and that he was largely indifferent to his own troops, but he has stopped at the nuclear option. If he feels threatened, does he escalate? We still see it as extremely unlikely that he resorts to nuclear weapons, and while his inclination may be to lash out even more viciously at the Ukrainians, he is likely getting pressure from Xi to restrain himself. Xi’s connection to Putin has not been a good look for Xi and some “cornered animal response” doesn’t seem to be in China’s interest. While Putin will do what Putin wants, we have to assume there is pressure from China for him to act with restraint.
Anything other than nuclear (which we don’t see as an option) isn’t likely to do much to markets. We’ve settled into the status quo and this would just be viewed as yet another escalation, likely to dissipate over time.
While it doesn’t seem likely, it isn’t entirely possible to dismiss the potential that this whole event was some sort of charade. Russia was reported to be moving nuclear weapons to Belarus. It is easier to reach Kiev from Belarus. And now, “suddenly” this splinter group, no longer taking orders from Moscow, is there. Could this be some shift in how Russia plans to continue its attacks on Ukraine? Seems unlikely, yet, the entirety of the last 48 hours seems and unlikely, and Russia does seem to be the master of “false flag” operations. This would trigger weakness in risk assets, if however unlikely it is, it turns out to be the reality of the situation.
Status quo.
Ukraine is able to take some advantage of this change in Russia, but the lack of air support, the unwillingness of NATO to let Ukraine take the fight to Russian soil, etc., leave us more or less where we’ve been – a slow grind, hurting both sides, with the rest of the world looking for signs that both sides will come up with the pretext to start realistic peace negotiations.
Bottom Line
We are probably the closest we’ve been to seeing a defined path to peace since the invasion occurred, but its impact on markets will be muted as the world has changed a lot in the past 18 months.
There is some small risk that this all gets worse before it gets better.
I will leave you with this quote “Russia is never as strong as she looks; Russia is never as weak as she looks” since it seems appropriate for the current fluid situation.
In as far as the Fed (and global CBs) goes, THE question on everyone’s mind,
Central banks are well on their way to restoring price stability, with inflation rates roughly halving from their peaks over the past year. Inflation is likely to be back near 2% over the coming year or so. However, we think the next stage of disinflation will not be as pain-free as the initial stage, and the normalisation in services inflation is likely to be slower and bumpier than the disinflation so far. A fall in services inflation will likely also require weaker labour markets and a rise in unemployment…
… We now expect a US economic downturn to begin in Q4 2023. We have upgraded our 2023 growth forecast, but significantly downgraded our 2024 forecast
More near-term resilience will now likely mean a later start to interest rate cuts - and therefore a more prolonged period of highly restrictive monetary policy
We now expect the Fed to hike once more in July, and to start cutting rates in March
… our highest conviction view remains our well below consensus forecast for earnings this year—our base case 2023 EPS for S&P 500 is $185 (Bear $170/Bull $210), which compares to bottom-up consensus at $220 and top-down/buyside forecasts near $210-215. While last year’s earnings misses were mostly a function of bloated cost structures as pandemic demand normalized, we believe the next leg will be about deteriorating pricing and top line disappointment
In addition to growth risks, the liquidity picture is starting to deteriorate due to record levels of Treasury issuance and QT. Morgan Stanley estimates bank reserves will contract by $500-800B over the next 6 months, which is likely to have a negative impact on equity valuations, which are back to cycle highs even though interest rates (both nominal and real) are also at cycle highs and unsupportive.
Fiscal support has been much higher over the past 12 months than most investors appreciate, based on our conversations. This is expected to peak and reverse next month and could amount to a 6ppt headwind to nominal GDP over the next 12 months.
Finally, the technical picture remains poor with recent breadth improvement failing yet again. If our view on earnings is wrong, breadth should be improving. Either way, we think equal weighted S&P 500 will begin to outperform market cap weighted S&P 500 as the average stock should do better in the more optimistic outcome—i.e. go up more, or the pessimistic one—i.e goes down less. Similarly, we believe value is likely to have a period of relative outperformance versus growth as defensives reassert their leadership from last year.
… Fed Recession Model has Never Been this High without Actual Recession
… Money Supply Growth is at Levels Not Witnessed Since the 1930s
… Our Liquidity Model is a Good Coincident Indicator of S&P 500—What’s Next?
And while many / most of the ‘easy money’ is being placed on RECESSION bets,
DB Mapping Markets: 5 upside risks - some ways a recession might be avoided
1. The nature of the pandemic shock and the massive stimulus makes this cycle different to those that came before. So there’s a risk that using past cycles as a comparison might be misleading.
2. There are several signs that inflation could ease over the months ahead. And if inflation did normalise, that would enable central banks to pivot away from restrictive policy
3. For several reasons, the case can be argued that rate hikes haven't been as damaging as originally feared, despite the most aggressive cycle of hikes since the 1980s
4. Consumer confidence and a few other indicators have actually been improving recently.
5. If commodity prices keep falling, that would continue the positive tailwind that consumers have had over the start of 2023, whilst also helping on inflation.
I’m done … It’s summertime and I hope you / yours have an excellent start to the day and week just ahead … it IS the final week of the month and QUARTER so don’t waste a moment as you prep those portfolios and PnLs for 4pm Friday … THAT is all for now. Off to the day job…
We now expect the Fed to hike once more in July, and to start cutting rates in March...
Good Call !!!!!!!!!!
Agree with the 2 yr analysis...higher for longer
Tchaikovsky & Wagner.............LOVE IT !!!!!!!!!!!
Fantastic letter!!!