April 12, 2023
An Easter-shortened week was not short on macro events to occupy our markets. Weekend news that OPEC+ agreed to voluntarily cut production a further 1.16mio barrels per day saw oil prices spike 8% on the open and rates markets sell-off (yields higher) as the consequences of higher oil re-ignited inflation fears.
10yr yields initially jumped 7bps to 3.55%, but the move was short-lived, perhaps as markets realized that OPEC is cutting to stabilize oil prices because global growth is weak and artificially higher oil prices only act to weigh on growth even more. In fact, cutting oil supply in response to a negative demand shock is often counterproductive, and as pointed out by @marcopabst on Twitter, on average, the Brent price in the month following an OPEC cut announcement was $4.45/bbl lower than the month preceding the announcement and $5.59 lower in the third month following the announcement 👇.
A week in numbers
Recession fears gained traction as the week progressed, with the US data flow showing a sharp economic deterioration. We’ve suggested in the Macro Pulse that the Feb data looked like a “blip to trend,” and certainly, data this past week indicates that the lagged impact of the Fed’s aggressive rate hike cycle is starting to bite 😬.
First up came US Manufacturing ISM, which fell deeper into contraction territory at 46.3, down from 47.7. Manufacturing new orders also fell to a recessionary 44.3 from 47 (and against 49 exp.) Ouch!
For the first time, the “resilient” labor market also started to show signs of weakness. The number of job openings on the JOLTS survey fell below 10mio for the first time in 2 years, dropping a massive 632k to 9.93mio (Vs. 10.4mio exp).
Next came the ISM services, which fell to 51.2 from 55.1 prior (and against 54.5 exp.) Post the covid re-opening, the service sector, which accounts for just under 80% of US GDP, has been the key driver of growth and inflation. Whilst a reading above 50 is not an outright contraction, this suggests a sharp slowing. New orders also fell to 52.2, down from 62.6. Additionally, ISM service prices clocked in at 59.5 down from 65.6. So the slowing in services inflation is perhaps underway 👀.
Back to the jobs market and on Thursday, initial jobless claims soared to 228k Vs. 200k expected and perhaps more significantly, back-dated revisions were huuuge. Last week's claims were revised from 198k to 246k; the week before that, 247k revised up from 191k. The week before that, 230k revised up from 192k. These are significant revisions. In fact, during growth slowdowns/recessions, jobs numbers are frequently overestimated given the assumptions made when making adjustments, and we’re perhaps starting to see the true state of the labor market in these revisions.
The week however, finished with Non-Farm Payrolls, which bucked the trend and came in with a solid headline print of 236k (230k exp), with the unemployment rate dipping to 3.5% from 3.6%. Giving a “goldilocks” glow was average hourly earnings continuing to slow at 4.2% down from 4.6%.
Yields reversed some of the early week losses with 10yr closing at 3.41%, 2yr at 3.99% and odds of a 25bp hike in May rising to 70bps. However, the veil of labor market strength is starting to slip and “catch down” to a reality that is more in keeping with the activity data. NFP feels like an outlier and the last shoe to drop.
Calm before the banking storm?
Elsewhere, the Fed balance sheet contracted $74bn in the past week as a sign perhaps that banking stress is moderating and counters the favorable tailwind of lower rates for Crypto. That said, with front end rates still too high, deposit outflows will continue and, notably, bank stocks remain under pressure, with the KRE Regional Banks Index still trading precariously near its March lows.
Latest data also shows that US bank lending contracted by a record $105bn in the last two weeks of March, pointing to a significant tightening of credit conditions. Over the coming few weeks, we also get bank earnings results which may shed more light on the state of regional bank balance sheets and is a potential source of continued banking sector volatility. This story isn’t over yet, and the Fed must continue providing a liquidity backstop.
Overall, the macro backdrop continues to play out in line with our peak inflation, peak rates, peak Fed narrative and with the tightening of credit conditions on top of the lagged impact of Fed tightening, this dynamic should accelerate throughout Q2.
“Long duration” will continue to perform into a slowing US economy and the end of the Fed hike cycle, which will support the long duration high beta proxies of Nasdaq and of course, Bitcoin and the broader crypto complex. This bull has only just started to run 💪.
Flows over the past week at Paradigm have been somewhat muted, although positioning focused on the upcoming CPI release and the Shanghai upgrade. In BTC, dominant flows have seen some downside protection buying. Interesting to see more bullish leaning trades for ETH, with 28-April-23 1600/2100 bull risk reversals bought and 10.5k ETH of 14-April 2100 Calls and 10k ETH of 28-April 2200/2300 Call spreads bought, all notable trades.
ETH vols have underperformed BTC in 2023 with BTC the “cleanest” play on the shift in monetary policy regime. Lots of different scenarios in terms of how ETH performs post the Shanghai unlock, although I lean towards the view that “stakers are hodlers” and there won’t be significant selling post the unlock. With the risk event out of the way, ETH may well look to play catch up with BTC in more of a “sell the rumor, buy the news” redux.
Q2 has started slowly, taking a breath after the March madness 🤪 .Yet with the positive macro tailwinds and the Shanghai upgrade around the corner, we expect Crypto to spring back to action this week. Lessgo 🚀!
David Brickell 💜