(USTs lower, slightly steeper on light volumes)while WE slept; 5y breaks breakin'; equities mea culpas; steepner; GDI; like bonds then BUY STOCKS
Good morning … Rates have been grinding higher since I left (Wed) and that was NOT viewed as ‘concession’ with regards to yesterday’s 2yr auction.
ZeroHedge: Tailing 2Y Auction Prices At Highest Yield Since 2007
… The internals were also above average, if hardly spectacular, with Indirects taking down 65.5%, below last month's 68.5% but above the 63.0% recent average; and with Directs taking down 20.8%, or the most since March, and just above the six-auction average of 19.9%, Dealers were left with an award of 13.8%, the most since May.
Overall, a solid if hardly spectacular auction, one which benefited from the modest concession today as 10Y yields rose to 3.86%.
That in mind — and despite whatever MY view MAY (or may NOT) be, we’ve got to bare witness TO a 5yr auction today, as the FOMC meeting gets underway,
Couple things strike ME as the very first chart I pull up this morning, after a few days away … NOTE the momentum (bottom RIGHT) has crossed BEARISHLY and while I’d like to say we’ve got enough of a ‘concession’ here and now (after approx 15-20bps selloff), it may just NOT be enough given uncertainties in the hours / days just ahead. I’m NOT technical analyst but rather a more casual observer now, once removed, and so it is something I’m watching, making a mental note, if you will …
Moving on … here is a snapshot OF USTs as of 705a:
… HERE is what this shop says be behind the price action overnight…
… WHILE YOU SLEPT
Treasuries are lower with the curve slightly steeper this morning. China's stimulus (Hang Seng China Enterprises index +5.3% today) and sovereign supply weigh though the just-released ECB lending data and the German IFO seemed bond price supportive (links above). DXY is modestly higher (+0.1%) while front WTI futures are little changed (see attachments). Asian stocks were higher on China stimulus hopes, EU and UK share markets are a hair higher (save for Spain's Ibex after their jump-ball election there) while ES futures are little changed here at 6:45am. Our overnight US rates flows saw a bid for Treasuries during Asian hours amid a pick-up in volume (low bar to leap!) with buying seen from the front-end out to intermediates. In London hours, prices sagged and yields rose ~4.5bp on light flows and few observable catalysts. Our London desk saw front-end selling (2's to 3's) from fast$ before real$ lifted paper in the long-end on the dip, flattening the curve. Overnight Treasury volume was ~80% of average overall.… the already rebound-ready 5y TIPS breakeven charts look as good as one can imagine right now with 5y breaks finally leaving their 2.235, multi-month range high behind. Importantly, the next chart zooms out and shows that medium-term momentum (guides for the next 1-4 months, roughly) has now gone 'hockey-stick' (lower panel) as buy-side demand presumably picks up and selling pressures abates. The wind is definitely now at the back of 5y breaks and after some minor resistance near 2.34, we think 5y breaks could be aimed to at least 2.40, over time.
… and for some MORE of the news you can use » IGMs Press Picks for today (25 July) 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’ …
How could I NOT lead with this note off a large German bank strategists desk,
DBs Mapping Markets: Beware complacency about falling inflation
The last couple of weeks have seen some very positive news on global inflation. That’s raised hopes that a soft landing might be possible after all, despite the most aggressive cycle of rate hikes in decades.
But we’re not out of the woods yet, and growing complacency on inflation risks creating surprises down the tracks.
This is creating both short- and long-term risks. For instance, markets risk underestimating how hawkish central banks will be at upcoming meetings, and then being taken by surprise. Remember as well that several positive inflation trends are set to fade over the months ahead, such as the rapid decline in global energy prices since last year. And over the longer term, structural forces like demographics and waning globalisation are still set to create more upward inflationary pressures.
…Conclusion
It's clear that we still have some road to travel on the inflation story. The historical evidence shows that the last part of returning inflation to target is normally the most difficult, so there's the risk that markets are taken by surprise if inflation does prove more resilient. In fact, US 2yr breakevens are currently at 1.96%, so markets are expecting a fairly benign path ahead on the inflation side.But recent experience has shown that central banks are very willing to pivot hawkishly if the data demands it, and there's a risk that markets are taken by surprise once again. Furthermore, tight labour markets and accommodative financial conditions mean there are plenty of reasons that could happen.
As we attempt to NOT ‘see what we want to see’ (ie falling inflation), another note which would seem to be a good ‘fit’ here,
Goldilocks: Real GDI Is Understating Economic Growth
… In general, we think both indicators are valuable. While GDP is less prone to revision than GDI, we find that the average of the initial estimates of GDP growth and GDI growth provides the best prediction of true activity growth, defined as either the average of the final revised estimates of the two indicators or our Current Activity Indicator based on hard data.
However, we think that GDP has sent the more realistic signal recently and that GDI will be revised upward, for two reasons. First, we estimate that a planned revision to corporate net interest payments will boost quarterly annualized GDI growth by 0.8pp on average in 2022Q4-2023Q1. Second, the BEA’s effort to adjust depreciation for the impact of tax policy changes is probably causing corporate profits to be understated, and history suggests that revisions could boost GDI growth by another 1.5pp in 2023Q1.
Although the ultimate size of the revisions to GDI is uncertain, our estimates suggest that real GDI actually grew by 0.2% annualized in 2023Q1 (vs. -1.8% currently reported) and declined by 2.1% in 2022Q4 (vs. -3.3%). Using these estimates, the average of real GDP growth and real GDI growth adjusted for likely revisions was 0.3% annualized in 2022Q4 and 1.1% annualized in 2023Q1, suggesting that growth remained positive but below potential in the last two quarters.
From falling inflation AND concept of GDI I’m going to try and get back TO things more DIRECTLY rates related and on that, a weekly note with a new IDEA
BNPs Quant Trades of the Week: Trade ideas amid eventful week
… Initiating tactical US 2s10s steepener: The US curve continued to bear-flatten in the past two weeks, resulting in US 2s10s looking 8.4bp too low (−2.1 z-scores) according to MarFA™ Trading and 9.6bp too low (−0.8 zscores) vs MarFA™ Macro. Going into a FOMC week, we view the risk-reward perspective and current levels as attractive to enter a US 2s10s steepening position.
Same shop who now sports an entire desk FROM Bloomberg econ department offers this preview,
BNP US Q2 GDP preview: Resilient top-line to mask stiffening headwinds
KEY MESSAGES
We revise up our projection for US Q2 GDP growth to 2.0% from 1.5%, due to firmer data on retail sales, investment and government hiring.
We estimate the details to show a sharp slowdown in underlying growth, and forecast final sales to domestic purchasers (GDP ex. inventories and trade) being roughly cut in half compared to a robust gain in Q1.
Points of strength will come from services spending amid pent-up demand for leisure activity, high-tech investment and a construction rebound, while weakness will be concentrated in falling goods purchases and slumping exports, we think.
Fresh off trip TO the Grand Canyon, this next one caught my eye and not just because the author was traveling, too
MSs Global Economic Briefing: The Weekly Worldview: The Edge of the Plateau
We discuss catalysts for downside risks, as the Fed is expected to hold peak rates. We think an increase of high yield defaults and a wave of refinancings could pose risks, but do not yet see it at a tipping point.
I spent the last two weeks marketing in Europe, and in most meetings, the first question was whether there will be a hard landing or a soft landing in the US. Since the beginning of the Fed’s hiking cycle, we have called for a soft landing. Typically, to get a recession in the US, you need two components: a “shock” that slows the economy down, and an amplification mechanism to turn that slowdown into an outright recession…
…Our forecast points to a further slow down in the economy from here, as the rest of the standard lags of policy are felt. Subpar growth could cause a re-examination of the lower-end of the credit spectrum. And the slowly building wave of lower-quality debt refinancing will eventually become clearer and clearer. We should expect an uptick in defaults, but not a full blown credit crisis. But of the list of risks to the US economy, this is an important one.
AND for our inner stock jockey’s, first up a mea culpa of sorts,
MSs US Equity Strategy: Weekly Warm-up: Is Disinflation Now a Headwind?
2023 has been a story of higher valuations than we expected amid falling inflation and cost cutting. However, disinflation is now eating into sales growth, which means investor focus is likely to shift toward top line growers rather than just companies exhibiting cost efficiencies.
… March's bank depositor programs added close to $400B to the Fed's balance sheet in a matter of weeks. While we wrote at the time that this was not equivalent to QE, we do think it had a positive impact on asset prices, particularly as the Treasury was draining its general account and unable to issue supply due to the debt ceiling constraint. With the regional banking system stable and the Fed’s quantitative tightening ongoing, the liquidity backdrop should now be less constructive for equities. Furthermore, with the Treasury issuing significant supply for the rest of this year, the Treasury General Account will likely no longer serve as a positive offset to QT. In other words, the liquidity tailwind has likely also faded ( Exhibit 4 ).
… This leaves us with what we think has been another key driver of the rally in US equities —falling inflation. Last October, we based our tactically bullish call on the view that inflation was peaking along with back-end rates and the US Dollar. However, the upside move in equity multiples on the back of this theme (and the others discussed above) has gone further and persisted longer than we anticipated—i.e., we were wrong…
You just don’t see that too often on Global Wall Street. But then again, when it rains it pours?
WisdomTree’s Prof Siegel: When the Facts Change
John Maynard Keynes was asked in the 1930s about his view on the British economy and he gave a forecast that differed from his past comments. One follower said to Lord Keynes, “you've changed your opinion on this, why?” And Keynes responded, “Well, Sir, when the facts change, I may change my opinion. What do you do, Sir?”
I’ve held the opinion the Fed has tightened too much and have believed the risks that this tightening will push us into a recession are higher than necessary. But as I look at the cumulative weight of evidence and recent data, I now believe the Fed is not as tight as I feared. This will not give the Fed a full reprieve from my criticism: the Fed still kept interest rates far too low in 2020 and 2021 and I do not believe it needs to hike any more at this point. But let’s look at what facts are changing my mind on forward economic risks.
Forward-looking indicators are the key: the money supply, housing and commodity prices. The dramatic increase in the money supply during 2020-2021 spurred my warnings of rapid inflation from the pandemic. The Fed should have identified inflation pressures earlier and removed their accommodation much earlier…
… I am thus revising my estimate of where I believe real rates will settle. I previously thought the 10-year TIPS would go from current levels of 1.5% back towards zero. My new estimate is the 10-year TIPS yields may only revert down to 1% and the neutral Fed Funds rate to 2.5%-3%, also a point higher than my previous estimate.
This week the Fed will hike rates another 25 basis points. I would still say the downside risks to the economy of this action outweigh the upside growth risks, but not by as much as before.
My view on TIPS yields settling higher are because bonds are not quite as attractive portfolio diversifiers. The real rate on bonds staying more elevated is good for coupon clippers of yield, but fears of sticky inflation risk are making bonds a less attractive hedge assets for portfolios. With bonds losing this extra diversification appeal, the required compensation to own bonds (and the starting yield) is going up.
Supporting my view is better economic growth and productivity looks to be coming from the new AI technology spillovers. There is a lot of hype at the moment and that many of these stocks have been driven too high, but I do think an upgrade in the economic growth potential is warranted from the latest technology advances.
All this is generally good news for equities because the probability of recession risk is now down in my view…
… My shift in view is not set in stone. If the forward indicators reverse and deteriorate, I am willing to revert to my previous forecast that the Fed will have to reduce rates rapidly. However, at this moment the indicators show a firm economy.
AND … a large British shop asking,
Barcap U.S. Equity Insights: Can Earnings Beat the Heat?
Valuations are up and earnings are in the hot seat as we enter the busiest weeks of summer reporting season. Estimates are heading lower for most sectors, while uncertainty is high for Big Tech. Two potential sources of downside: negative operating leverage worsened by faster disinflation, and China exposure.
AND here are a few OTHER links which I found funTERtaining …
Goldilocks: Rates and Spreads Are Again Negatively Correlated: A Positive for Total Returns
In most paradigms, corporate credit spreads and treasury yields are negatively correlated. The chief exception to this negative correlation has been the current hiking cycle where the Fed’s reaction function has generally been more sensitive to upside risks in inflation than downside risks to growth. Over the last few months, the rates/spreads correlation has, however, moved back to negative territory as the market has embraced our US economists' soft landing view.
Last year’s large move in Treasury yields also created plenty of upside convexity in corporate bond price returns, despite current tight spread levels. For most of the last two decades, the pull-to-par dynamic has been a headwind to corporate bond total returns. That said, in the current environment, we think it is accretive. We continue to forecast USD IG and HY full-year total returns to reach 6% and 10%, respectively, both above the annual average of the post-GFC period.
AND on that — CORP BOND related — note,
AllStarCharts: Here’s Why Bonds Just Got a Lot Cooler
Bonds are breaking out!
Yes… Bonds!
No, I’m not talking about US Treasuries. Those “risk-free” assets have plenty of work to do before I can take an informed long position.
I’m referring to corporate bonds. Remember, companies have numerous ways to raise capital besides selling shares – bonds being one of them.
But they’re not your run-of-the-mill corporate bonds flashing a buy signal…
They’re the issues investors can convert into equity.
Check out the Convertible Bond ETF $CWB:
CWB has traced a classic bullish reversal in price as it completes a yearlong basing formation.
A similar bearish-to-bullish reversal in momentum suggests bulls have taken control, confirming the upside resolution.
More importantly, the breakout in CWB represents a bullish data point for equities.
Yes, equities. Not bonds!
The only bonds breaking out are the ones that, one day, with a little luck, could become stocks.
If you have an itch to buy bonds, skip the hassle and go straight to the stock market…
… If you must own bonds, CWB is the best-looking vehicle.
But it’s not for me. I laid out last week what I need to witness before getting long US Treasuries, mainly bullish data in the form of price…
Ultimately, nobody’s foolin’ anybody thinking it’s about MORE than … The Fed.
On THAT note, John Authers’ latest,
What to expect from central banking's Big Three this week
… Powell and the Fed
Kicking it off is the Fed, which meets in the midst of a surge of earnings results from 165 companies in the S&P 500 — amounting to nearly $15 trillion in market cap. What the central bank will do Wednesday is almost a certainty. Traders and economists have a near-unanimous agreement that Powell & Co. will hike by 25 basis points — their 11th such increase since early last year — and bring the benchmark rate to a range of 5.25% to 5.5%. The question is what it says about the future.Many are expecting a unanimous decision by the Federal Open Market Committee. George Mateyo, chief investment officer at Key Private Bank, sees the the outcome as “preordained… The Federal Reserve is not done and I think what they’ve been trying to signal this year is that a pause might be likely, but a pivot is not. So the Fed is not going be taking off the brakes anytime soon and potentially, they might actually have to raise rates even further this year.” As Bloomberg’s model of fed funds expectations shows, markets are still positioned for a gradual loosening that doesn’t get going in earnest until next year, with a slight possibility of one more hike after this one:
Guiding on the future could be difficult, given the absence of a dot plot at this meeting. After the unanimous decision to leave policy unchanged in June, the minutes revealed disunity, with some favoring interest-rate increases. Mixed economic data in the last month, largely supporting the doves on the committee, has further blurred the picture. In the US, inflation has since cooled but remains persistent. For Bloomberg Economics, the central bank still has room for one more quarter-point hike this year, though “June’s soft inflation data may have weakened their conviction.” Further, the doves may soon strengthen their position.
“The internal dynamics on the FOMC may be changing in favor of the doves,” Anna Wong of Bloomberg Economics wrote, referring to the plans of St. Louis Fed President James Bullard to resign effective Aug. 15. Their latest sentiment spectrometer, she said, “shows that many FOMC members have moved away from the hawkish end of the spectrum since last year, with many now clustered around the center.”
The Fed is clear that its goal is reining in inflation even at the expense of kneecapping the economy. The 2% target is still a long way off, but it certainly helps that recession fears have started to abate. Wall Street shops have pushed back their calls for a downturn, or changed tone altogether. Barclays is the latest. The firm pushed back its projected mild recession to 2024 and forecasts a shallower downturn than before, which would probably qualify as a “soft landing.” It expects the Fed’s rate hikes to have limited traction in slowing the still-strong labor market and expects core inflation to remain in a “stubbornly elevated range” of around 2.7% year-on-year at the end of 2024. Thus, even though more confident about economic growth, Barclays thinks the Fed needs to keep a hawkish stance:
We expect the FOMC and Powell to signal a tightening bias for future meetings. Softer-than-expected June CPI prints reduce the urgency for an additional hike, but the FOMC will remain skeptical that conditions are in place for a sustained return to the 2% inflation target absent appreciable slowing in the labor market and wages.
As there are hopes that the Fed will instead signal an indefinite hiatus, or even that its hiking campaign is over, such an outcome might not go down well. It’s not where the market is positioned. After some exceptional switchbacks over the last 12 months, the fed funds futures market has for the last month settled with some confidence at 5.33% for the effective rate expected for the end of the year:
In theory, this should make the market more vulnerable to a “hawkish” surprise on Wednesday. However, if recent FOMC days are anything to go by, traders will be able to persuade themselves that Powell is dovish once he starts his press conference, no matter what he says.
AND … the wait for tomorrow’s FOMC begins in earnest. Get those bids in for 5yy early and often? As things return to normal here this side, likely NO update Thursday morning for biz travel and … THAT is all for now. Off to the day job…