pocapital.com.au

Overnight Recap

16th August 2022

UKraine

Ukraine plans to reintroduce an excise tax on fuel, including diesel and gasoline, to boost revenue. Parliament also extended martial law by 90 days. Vladimir Putin said that Russia is "step by step liberating" Donbas.

JPMorgan and BofA are among several US banks that have offered to facilitate transactions in Russian corporate and sovereign debt on behalf of clients, after the Treasury said it's not a violation of sanctions for individuals to wind down their positions.

OVERNIGHT

AUD/USD 0.7024

Dow Jones 33908.94 +0.4% Nasdaq Composite 13134.69 +0.7% S&P 500 4298.13 +0.4%

Australia's ASX 200 7064.34 +0.5% Aussie 10-Year Yield 3.36% -6.4 bps

Stocks gained, with megacaps catching bids as investors digested weak US and China data. Treasuries and the dollar gained, while commodities tumbled. The S&P 500 gained 0.4%, with the Nasdaq outperforming. Asian equity futures are flat to mixed.

Treasury yields ended Monday lower, off session lows reached after August Empire Manufacturing fell much more than expected to -31.3, a two-year low. Rally was sustained over US afternoon as swap spreads tightened, indicating support from receiving flows. Stock benchmarks exceeded Friday’s highs, led by Nasdaq 100.

Treasury yields ended richer by 4bp-5bp across front-end and belly of the curve, steepening 2s10s spread by 1bp, 5s30s by ~4bp; flattener positions, profitable until recently, faced additional pressure
Profit Squeeze on Flattener Positions Now Underway in Treasuries
Most of the move in Treasuries occurred after the weak Empire Manufacturing print, while cash flows and receiving flows in swaps also appeared to support the rally
By the end of the day both 10- and 30-year swap spreads had tightened more than 1bp
Fed-dated swaps adjusted only slightly, continuing to price in around 60bp of hikes for the September meeting
Rate options activity featured selling of put flies, including an apparent profit-take of around $4.5 million on a bet initiated back in June
Block Trade Points to a $4.5 Million Profit-Take on Hawkish Bet
Treasury futures flows included a large steepener position via 5- and 2-year note futures

WTI touched a six-month low on a potential breakthrough in talks with Iran and after China's softer economic data and surprise rate cut, signaling both a potential rise in crude supply and a drop in demand. Tehran's foreign minister pledged a response to the EU's draft nuclear deal Monday evening, with a spokesman adding there could be the basis for a signed pact "in the very near future."

SEC vs ESG. US regulators are expanding their scrutiny of firms offering ESG funds, querying how they lend out their shares and whether they recall them before corporate elections. The practice lets asset managers earn fees that benefit investors, but it can also impact the ability to cast ballots. The SEC's investigation delves into whether asset managers are making proper disclosures to clients.

New York manufacturing activity plunged in August by the second-most in data back to 2001, with sharp declines in orders and shipments indicating an abrupt downturn in demand. The Fed's Empire gauge slumped to -31.3 from 11.1 prior. Consensus was for 5.

Economist Nouriel Roubini said there are two options for the US economy: an economic hard landing or inflation at a persistently elevated level. "The fed funds rate should be going well above 4% — 4.5%-5% in my view — to really push inflation towards 2%," he said.

US homebuilder confidence declined by 6 points to 49 in August, marking the worst stretch since the housing market collapsed in 2007. The reading was worse than the lowest estimate and below the breakeven measure of 50 for the first time since May 2020.

CHINA

Joe Biden is being forced to test Beijing's red lines on Taiwan by Congress, at the cost of worsening ties. Lawmakers are visiting the island to virtue signal, without considering the fallout, the East-West Center's Denny Roy said. The president's next battle is over the proposed Taiwan Policy Act, which his officials say contradicts US One China policy. Meanwhile, the delegation to Taipei led by Senator Ed Markey met President Tsai Ing-wen and representatives of TSMC.

China's sovereign bonds received foreign inflows in July for the first time since January as falling Treasury yields and greater yuan stability boosted their attractiveness. Overseas funds bought 3.3 billion yuan ($487 million), after offloading 199.3 billion yuan over the five prior months. The bet may pay off as weak new lending leaves Chinese banks with excess funds to park in bonds. Other onshore debt remained unpopular with global investors.

China is likely to cut its policy rate again by the end of October after Monday's surprise easing, Standard Chartered said. Meanwhile, the Communist Party's Qiushi magazine republished Xi Jinping's speech on his "new development" concept.

Paul Krakes Comment

"Of all the pithy cliches designed to spark market conversations, the one I truly despise is “where is the pain trade?”. If you're accurately defining a pain trade, it will be the market's direction that inflicts the most harm to investment portfolios. Conventionally, however, it is used by pundits and financial media to describe lost opportunities either for benchmark managers or discretionary tactical traders, generally when markets rally. Given that over 95% of asset pools are long only or long biased, the true pain trade is when asset values fall. The majority of investors are negatively impacted by falling equity valuations, wider credit spreads, or declines in house prices. The notion that a pain trade exists when under-exposed speculative investors make less money than they should in a rising market does lose sight of the big picture. While relative performance is important in many circles, it is difficult to digest that making less money is more harmful than losing it. It depends on where you sit, but for tens of millions of investors across the globe, relative underperformance can't be compared to capital destruction.

The pain trade phrase has been bandied around recently as market participants debate whether this recent bounce in risky assets is a bear market rally or the commencement of something more sustainable. Growing evidence of peak inflation driven by softer energy prices, a resilient US labour market despite two negative GDP quarters, and a self-reinforcing narrative driven by a 25% rally in US high yield spreads and a 20% rally in the NASDAQ have seen the consensus framework migrate. Eight weeks ago, the conventional thinking was a near-term recession. Today, the Goldilocks scenario of a soft landing despite the Fed raising rates by 150bps cumulative at two consecutive meetings appears to be the base case for many. This has prompted a slew of commentary discussing whether the pain trade is a continuation of rising asset values at a point in time when many portfolios are extremely defensive. For me, this is less about financial pain and more about the mental anguish which lies at the heart of every bear market rally."

Report - The true pain trade is coming

ESG AND CARBON

China is the biggest spender on energy transition in combined public and private investment, according to data. China spent $297.5 billion last year; European member states devoted $155.7 billion and the US $119.7 billion.

Bill Gates-backed TerraPower raised at least $750 million to advance efforts to develop small-scale nuclear reactors, including a major investment from SK Group. It will also use the proceeds on using nuclear isotopes to develop new cancer drugs.

Ola Electric aims to launch its first EV in summer 2024, founder Bhavish Aggarwal said. The cars will cost less than $50,000, compared with the global price tag of about $70,000, building its own battery technologies to bring down costs.

S&P 500 ESG Index 374.50 +1.7% MSCI World ESG Leaders Index 173.17 +1.1% ICE EU Carbon €90.48 +2.1%

Main Economic Data (Sydney time)

9:00 a.m.: Australia July CBA Household Spending
11:30 a.m.: Australia Aug. RBA Policy Meeting Minutes
1:00 p.m.: New Zealand July Non-Resident Bond Holdings
2:30 p.m.: Japan June Tertiary Industry Index
4:30 p.m.: India July Wholesale Prices

WEEK AHEAD

Fed minutes on Wednesday may help reset expectations around the path of rate hikes, Bloomberg Economics said. It expects the release to reinforce the message that there's still a long road ahead in the tightening cycle, with cuts off the table. The account may also offer clues as to what kind of data officials need see to determine the size of their next move. On the data front: US retail sales — both the headline and ex-auto and gas — may eke out a gain.

UK inflation is the key highlight in Europe. Data mid-week may show price gains hit 9.8% in July, the latest step on a march higher that the BOE predicts will reach more than 13% by October. There are also reports covering unemployment, wage growth, retail sales and public finances, and the euro-area issues follow-up readings on GDP and inflation.

Walmart, Home Depot Report
RBNZ May Hike Again Mid-Week
Germany's ZEW Survey on Tap

In commodities, BHP will bring down the curtain on a very mixed reporting season for miners. Expect CEO Mike Henry to be quizzed on what's next for the industry and the company after its spurned bid for copper miner Oz Minerals. Also this week: China releases commodities output data.

Asia: The RBNZ will probably hike by another 50 bps on Wednesday to quell inflation. Philippine central bank Governor Felipe Medalla has signaled an increase of 25-50 bps is on the table the next day. Japan CPI on Friday may show core inflation moving further past the BOJ’s target.
EMEA: Germany's ZEW survey on Tuesday may show the index of current conditions deteriorated, while the expectations gauge improved slightly. Turkey may ignore soaring inflation and keep rates unchanged when it meets on Thursday. Egypt, Zambia and Namibia also set policy.
Americas: US industrial production, due on Tuesday, may rebound amid higher auto and utility output, BE said. Canada CPI is also on tap that day. Colombia and Chile release GDP data.