February 14, 2023
A quieter week in terms of top tier macro data left markets digesting the strong NFP and ISM prints and it caused indigestion in the bond market 😬.
Front end rates repriced aggressively with 35bps of additional hikes priced in for the Fed over the course of the week which rippled throughout the yield curve. 2yr yields climbing to 4.50%, 10yr yields at 3.75%, both back at levels last seen on 6th Jan.
Equities consequently repricing lower. Remember what we say: markets are a function of rates and liquidity. Good news is bad news in a market addicted to low rates and liquidity 🤪.
Fed speakers this week also continued to sound the hawkish rhetoric, with a general tone that the fight against inflation is not over and rates may need to go higher than currently expected.
The Reserve Bank of Australia also revised higher forecasts for inflation in the latest Statement on Monetary policy. The Bank of Canada, the first Central Bank to explicitly state the intention to pause, saw a blowout labor market report of their own on Friday, with 150k jobs added (vs. 15k exp) and markets rushed to price a hike, instead of a cut as the next move.
The peak inflation, peak rates narrative that I signaled as a precursor to a rally back in early December then coming under some scrutiny 🧐.
The disinflationary process has begun…
Counter to this re-pricing and fear that inflation might not yet have peaked, JPow speaking at the Economic Club of Washington, reiterated the statement from the FOMC presser that he believes “the disinflationary process has begun,” with all the usual caveats that it will take some time and that he will be prepared to hike more than is priced should the data continue strong.
Yet Jerome Powell is experienced enough to pick his words very carefully. In my view, stating “the disinflationary process has begun” is potentially as pivotal a comment as back in November 2021 when Powell relented that “it’s probably a good time to retire that word transitory.”
Back then, those words marked the peak of the bull market in crypto and equities. Similarly, I think those words reinforce the view that the sharp hike cycle that destroyed all asset classes in 2022 is now coming towards its eventual pause. Rates of change matter and in 2023, rate hikes, if they continue to come, will be at a slower, incremental pace.
The market reaction over the past week feels like a muscle memory reflex from a market psychologically scarred by the events of 2022.
Yet it’s far too early to expect that data is about to re-accelerate higher. In fact, with the re-opening of China contributing to the fear of more persistent inflation, Producer Price Inflation (PPI) for Jan in China shrank at an annualized pace of 0.8% (Vs -0.5% exp and worse than Dec’s -0.7%) as high covid cases and weaker global demand limit the impact from re-opening.
China PPI is typically a good lead on US CPI. As the world's manufacturing hub, declining PPI in China is not suggesting an imminent re-acceleration in goods prices around the world. Combined with the fact money supply growth in the US remains in negative territory, I still fully expect inflation to come sharply lower in the months ahead.
Let’s also not forget. The transmission of monetary policy typically acts with a 9-12 month lag. 12 months ago, the Fed were at zero rates and still doing QE. We’re still yet to fully feel the effects of last year's tightening and with real incomes getting squeezed and little sign of a “strong” labor market driving a wage spiral (earnings have continued to soften) there’s little to dissuade the view here that we remain peak inflation, peak rates, peak Fed!
Nonetheless, “narratives" are what drive markets and the narrative over the past week has been one of concern that inflation is beginning to percolate again and that the rate hike cycle is not done. Tuesday’s CPI print is a HUGE number to determine the short term narrative on “peak” Vs “re-accelerating” inflation.
Rates and the dollar are a concern in the short term for risk and crypto. In many respects, this feels like a healthy (albeit sharp) repricing of the down trend we’ve witnessed since November.
The dollar, having broken below May 2022 lows bouncing into some important resistant zones. The dollar was the “wrecking ball” that strangled all financial assets in 2022 and so one we keep a close eye on 👁️🗨️ So far, it’s a “correction” rather than a new uptrend to elicit greater concern.
Also, on the narrative front, Crypto has once again had to deal with more FUD as the US appears to step up the crackdown on innovation and crypto. Coinbase’s Brian Armstrong first alerting to rumors of a SEC crackdown on Staking.
This was shortly followed by news that Kraken had reached a $30mio settlement with the SEC for failing to register the offer and sale of their crypto asset staking-as-a-service program. Kraken will now stop offering staking services to US-based clients.
Nic Carter’s “Operation Choke Point” piece highlighting the coordinated efforts of the Biden administration to restrict bank access to crypto adding to the FUD.
All in, the positive narratives and sentiment driving the rally in 2023 taking a hit and crypto recoiling. For now, a correction, rather than a reversal of trend (tech support levels for BTC at 21,450 and ETH at 1500 pretty much holding still looks constructive) - We’ve been here many times before in Crypto and typically come out stronger 💪.
Liquidity and flows supportive…
Elsewhere, liquidity and flows remain supportive for our markets. The market came into 2023 “under weight” and whether in equities or crypto, are left chasing performance. Dips, therefore, will get bought and perhaps is why equities, relative to the move in rates, held in quite well last week (Nasdaq off circa 2% no cause for alarm) Money also continues to flow into crypto funds.
With much of the leverage now taken out of the system, there’s also not the same negative flow dynamic in crypto that we were forced to endure in 2022. Open interest has been building, but not at levels that we’d typically see at the top of a market to drive a liquidation cascade.
Flows at Paradigm meanwhile have seen some reduction of topside positioning and some downside “insurance" being put on into the CPI print, but no material change in the flow dynamic to suggest at this stage a 180 re-think away from the broadly constructive view.
PBOC also continues to pump liquidity to try and re-ignite a stalled Covid economy and along with the BOJ still running QE, the combined balance sheets of the G4 central banks are expanding again.
The Treasury General Account (TGA) which we mentioned last week will be a powerful offset to QT in the US whilst with still over $2trn parked overnight at the Fed’s Reserve Repo Facility, largely from swollen money market funds, there’s still plenty of liquidity to flow into “riskier” markets.
In summary, liquidity and flows remain hugely supportive to our markets and are a powerful off-set to the correction in the rates and dollar. Rates and the dollar have the potential to dominate IF they maintain the topside momentum post CPI.
For now, it feels like the market has adjusted cautiously into Tuesday which leaves me relatively comfortable that the downside will be supported even in the event of a stronger CPI print and I remain in BTFD mode 🚀.
Macro regimes typically adjust slowly, like a large tanker turning, and are interspersed with periods of volatility. This is one of those periods. The stakes here are indeed high.
David Brickell 💜