“Some volatility is unavoidable, and indeed is a necessary part of the process by which markets and the economy adjust to incoming information.”
-Jerome Powell, Federal Reserve Chair
So, yesterday was largely uneventful …. in that special, post-crisis sense that falling volatility and benign price action are a guise for the accumulation of latent risk.
The dollar and yields did nothing. Xi decided term limits should only apply to mortals. Draghi made some dovish commentary, expertly counterbalanced and couched in an equal dosing of hawkish innuendo. Fed Governor Quarles issued some equivocal mutterings about the domestic growth trajectory being both conspicuously positive, but also arguably uncertain. And former hawkish policy malcontent turned current giver of zero shits with respect to allowing the economy to run hot, James Bullard, cautioned against the restrictive implications of overaggressive tightening in the face of stagnant productivity and still unfavorable demographics.
Really, it was all just suspenseful pretext to today’s main event with Powell delivering his first address to Congress … and the collective investor hope he doesn’t inadvertently or explicitly sponsor a 4+ rate hike expectation and, in doing so, overturn the equity apple cart via overaggressive tightening just as global growth and domestic inflation are cresting and real yields continue to flirt with a potential phase transition.
God was in a waggish mood when he conjured the February macro storyline.
Back to the Global Macro Grind …..
Mid-month, prior to me leaving for vacation and subsequently getting the flu, all anyone really wanted to talk about was the dollar and yields.
Little has changed.
If you’re still drowning in that discussion, it basically distills down to two related and seemingly simple questions:
- Why does the dollar continue to slide when the Fed is hawkish, real yields are rising, and DM yield differentials are widening and
- What is driving the back up in yields and what does it mean for (fill in the asset class blank)?
Consensus has mostly coalesced around the notion that fiscal policy angst sits as the fulcrum, unifying factor.
As it stands, the prevailing bond bear narrative remains a cogent and congruous one: Strong growth and the prospect of higher inflation alongside expansionary, debt-financed fiscal policy at a time when the labor market is at/near full-employment and in concert with Fed balance sheet unwind and reduced foreign demand for treasuries remains the conceptual underpinning.
But, the spread between nominal Treasury and LIBOR yields to swaps continues to widen and while breakevens and inflation swaps have risen (i.e. inflation expectations ↑), real yields have risen by even more.
For context: 10Y yields are +80bps since the latest September low. TIPS yields are up +47 bps over the same period, implying that rising inflation expectations only represent ~33 bps of the +80 bps increase in nominal yields.
The rise in real yields can be viewed as some combination of higher real growth expectations, higher term premiums … or something else.
The current speculative fascination centers around diving that ‘something else’ and the probability of that ‘something’ being the prospects of rising twin deficits.
So, does concern around a material deterioration in the deficit position, the prospect for rising treasury supply and uncertainty around a large-scale shifting in debt supply-demand dynamics accompanying that increased issuance explain both the dollar weakness and the increase in nominal yields in excess of that implied by inflation expectations and/or policy rate expectations.
Sure. It’s as reasonable and compelling an explanation as any.
But we’d also caution: There are other short and medium-term dynamics at play. And anytime something is the only thing anyone wants to talk about and speculative positioning around the narrative has built to >2 standard deviations, searching for variant explanations and outcomes becomes an increasingly healthy exercise.
This discussion has been building and evolving since January. For additional context see, for example: Dollar Exhaustion and Stalking the Deuce!
Lastly, we got the New Home Sales data for January yesterday. It was decidedly underwhelming with sales retreating -7.8% sequentially and -1.0% Y/Y.
We’d take the print with a healthy serving of salt as the extreme weather conditions that characterized early January probably provided some measure of negative distortion. Regional weakness in the Northeast (-44.2% Y/Y) and the South (-10.9% Y/Y) are supportive of that notion.
A cleaner read of the underlying trend should re-emerge in February as any residual weather effects resolve out of the data and progressively harder comps and higher rates will test what has been some of the strongest rate-of-change data in domestic macro over the past 6-monhts.
On the supply side, New Homes for Sale made another new cycle high, rising +2% sequentially and +15.5% year-over-year.
Recall, new construction and sales remains the primary relief mechanism to tight and tightening supply conditions in the existing market – a reality that is unlikely to shift materially over the nearer-term. Indeed, areturn to average peak levels of SF construction could fill ~68% of the current supply deficit in the existing market .
And with NHS volumes only now reaching average historical levels and still carrying ~40% upside to average peak levels, the medium-term asymmetry in new construction activity remains favorable.
The transcript of Powell’s remarks is set for release at 8:30am, alongside the Durable and Capital Goods data for January (more on that tomorrow) and ahead of his 10am testimony.
Regardless of what he says, we’ll get to listen to other people say a bunch of stuff about what he said, didn’t say or should have said, and then continue saying stuff about what it may or may not mean for the dollar and yields.
Indeed, when all is said and done in global macro, more is always said than done.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.81-2.95% (bullish)
SPX 2 (bullish)
RUT 1 (bearish)
NASDAQ 7027-7446 (bullish)
Biotech (IBB) 106-112 (bullish)
Energy (XLE) 66.51-70.29 (bearish)
RMZ 1014-1061 (bearish)
Nikkei 21175-22437 (bearish)
DAX 125 (bearish)
VIX 14.43-25.37 (bullish)
USD 88.54-90.44 (bearish)
EUR/USD 1.22-1.25 (bullish)
YEN 105.79-108.43 (bullish)
GBP/USD 1.38-1.41 (bullish)
Oil (WTI) 59.02-64.59 (bullish)
Nat Gas 2.51-2.78 (bearish)
Gold 1 (bullish)
Copper 3.14-3.28 (neutral)
AAPL 167.80-179.97 (bullish)
AMZN 1411-1531 (bullish)
FB 172-186 (bullish)
GOOGL 1051-1153 (bullish)
NFLX 255-300 (bullish)
TSLA 314-361 (neutral)
Enjoy,
Christian B. Drake
U.S. Macro Analyst
