Newsletter - April 21, 2022
Oil / Commodities
- China’s cabinet has confirmed that the addition of an extra 300 million tons of coal mining capacity will happen this year, a blow to shippers already contending with weaker Chinese imports. The authorities had not previously given a timeline for the ramp up, which threatens to upend the global market for the dirtiest fossil fuel. China’s year-to-date imports are already running almost a quarter below the pace set in 2021 due to record domestic production and price controls that disfavour its main suppliers in Indonesia, Russia and Mongolia. China is by far the world’s biggest consumer and producer of coal, mining over 4 billion tons last year. The extra capacity looks calibrated to cover a typical year’s imports, although with Chinese demand set to grow until at least mid-decade, overseas purchases are unlikely to be cut out of the equation entirely. Citigroup calls China’s willingness to walk away from overseas coal supplies a potential game changer for the world market, which poses major downside risks to global fossil fuel prices over the next few years.
o https://www.bloomberg.com/news/articles/2022-04-21/china-confirms-it-will-build-extra-coal-mine-capacity-this-year?srnd=technology-vp
Tech
- Bill Ackman has ditched his stake in Netflix after losing more than $430 million on his investment in less than three months. Ackman’s Pershing Square Capital Management said Wednesday it has sold its Netflix holdings after the streaming TV pioneer reported an unexpected drop in subscribers in the first quarter and projected an even steeper decline in the current one. Netflix shares tumbled 35% to $226.19 at the close in New York, making it the worst performer in the S&P 500 this year. Ackman became one of Netflix’s 20 largest holders this year, buying after the stock had already begun to dip over concerns about its subscriber base. Netflix shares climbed as the pandemic took hold and peaked in November, more than doubling from the start of 2020. With Wednesday’s plunge, the stock Is now down 62% this year.
- Netflix’s investors punished the company for its shock loss in subscribers reported for the first quarter, and abrupt turnabout to embrace advertising after years of shunning it. Shares of the streaming leader plunged 35%, erasing $54 billion of market value in its biggest drop since 2004. Two consecutive quarters of estimate misses and falling subscription momentum has made Netflix the worst-performing stock of the year on both the benchmark S&P 500 and Nasdaq 100 indexes and sent shock waves across the media universe, sinking WBD, Roku and other peer stocks. Netflix is seeking ways to stop a loss of subscribers and combat investor fears that its best days are over. The company is diverting from its years of abstaining from ads and embracing password sharing after losing 200,000 customers in the first quarter – the first time it shed subscribers since 2011. Specifically, the company lost customers in three of its four regions in the first quarter, including more than 600,000 subscribers in the U.S. and Canada. Russia’s invasion of Ukraine also cost it another 700,000 customers when it had to pull its service in the end of February, resulting in a loss of 300,000 customers in the EMEA region. Netflix is also guiding subscription loss of 2 million in the current quarter, a huge setback for a company that regularly grew by 25 million subscribers or more a year. Netflix also will curb its spending on films and TV shows in response to customer losses. Netflix management pointed to four causes of its latest subscription decline, including the prevalence of password sharing and growing competition. The company said there are more than 100 million households that use its service and do not pay for it, on top of its 221.6 million subscribers. Password sharing will allow Netflix to bring in revenue for everyone who is viewing and who gets value from entertainment it is offering. Netflix’s troubles are a warning sign for its peers and competitors. After watching millions of customers abandon payTV for streaming, U.S. entertainment giants have merged and restructured to compete with Netflix. Investors encouraged this strategic shift, boosting shares of companies like Disney which demonstrated a commitment to streaming in recent years. But now, investors have begun to question whether some of these media companies will sign up enough customers to justify all the money they are spending on fresh programming. Disney, WBD and Roku all struggled as part of Netflix’s extended rout mid-week. All of these competitors currently offer ad-supported services, or are planning to do so in the near future. Allowing consumers who would like to have lower price and are ad-tolerant makes a lot of sense for Netflix. The company said it will explore the best way to offer ads over the next couple of years. However, cracking down on password sharing is a risk for a company that started by giving customers a cheaper, more convenient alternative to cable. By nudging customers to pay and inserting ads, Netflix begins to resemble what it replaced. For the current period, analysts were predicting gains of 2.43 million subscribers compared to management guidance of further losses. First quarter revenue grew 9.8% to $7.87 billion, missing analysts’ estimates. Profits of $3.53 a share topped projections of $2.91. For now, Asia is the lone bright spot for Netflix. The company added 1 million customers in the region, buoyed by popular new titles such as South Korean drama “All of Us are Dead”. Netflix remains well ahead of most of its competitors outside the U.S. and is the largest streaming service in the world. The company continues to believe it can execute its way out of the current predicament by luring new customers with better programs and finding more ways to charge its existing user base. The company still expects to add customers this year and will have a stronger slate of new shows in the back half of the year.
- Netflix’s loss of 600,000 subscribers in the U.S. and Canada may be hinting at price pressures eroding consumers’ wallets. Consumer spending is by far the biggest contributor to the U.S. economy and economists are keenly looking for any signs that higher prices are starting to chip away demand. And Netflix’s latest shortfall may be an early signal that consumers are looking to cut expenses as inflation bites. But for Netflix, there are a few other factors at play, which includes increasing competition as well as reopening headwinds where people are trading in streaming for outdoor time. The company’s loss of customers may also spell its loss of pricing power. In the meantime, the company is considering the introduction of ads, which has been met with a mix of shock, cheers and skepticism from investors. With TV viewership decline in recent years, advertisers are flocking to the growing number of streaming services that include commercials, such as HBO Max and Hulu. They are all catering to consumers who are willing to sit through a few ads in exchange for lower monthly subscription rates. But the feat will not be an easy overnight execution. Questions from advertisers include how much viewer data Netflix is willing to share, who the company measures its audience and how many people sign up for the ad-supported versions. Netflix’s practice of releasing all episodes of a season at once could also complicate its ad business. Advertisers typically secure TV commercials months in advance, but they can also buy spots mid-season if a show suddenly becomes popular. Netflix’s show launch strategy could cause the bulk of the viewing to have occurred before an advertiser decided to build a campaign around the program. However, for Netflix, an ad-supported tier could deflect some of the negative news on the company’s dismal outlook on subscriber counts. Hulu generated $3 billion in ads last year, with about 88% of subscribers choosing an ad-supported plan. Netflix could add $4 billion to profits by 2030 if it includes a commercial option.
o https://www.bloomberg.com/news/articles/2022-04-20/netflix-subscriber-woes-hint-at-u-s-consumer-pushback-on-prices?srnd=premium-asia
- Barack and Michelle Obama are moving their podcast away from Spotify. The former first family’s production company, Higher Ground, will not be signing a new deal with the audio platform. The company is stead talking to other distributors without a deal worth tens of millions of dollars, among the most lucrative in the podcasting business. Higher Grounds is in the middle of negotiations with several potential partners, including Amazon’s “Audible, and iHeartMedia. Higher Ground is seeking a deal that will allow it to produce several shows and release them on multiple platforms at the same time. This could explain iHeart’s interest given that it has not historically relied on an exclusive strategy for its podcasts.
- The belief in everlasting growth that is priced into technology companies’ lofty stock market valuations is increasingly looking more like a myth than reality. Netflix helped set off this existential crisis late Tuesday by shocking investors with its first loss of subscribers in more than a decade. a day later, shares of the streaming pioneer plummeted while dragging down media and tech peers as investors question their assumptions. Meanwhile, Tesla, the ultimate growth stock, reported an earnings beat after the bell on Wednesday, giving investors another opportunity to judge whether these high flying companies can keep soaring amid rising Treasury yields and booming inflation. Underlying the high valuations was a strong belief that these companies could continue to see unparalleled growth and emerge as winners, but there are increasing evidence now that calls the assumption into question.
- Amazon’s cloud chief Adam Selipsky said the e-commerce giant does not plan to spin off its profitable AWS division. AWS is the largest provider of rented computing power and other cloud infrastructure. The unit generated more than $62 billion in revenue in 2021 and about 74% of the company’s $24.9 billion operating profit. The unit is still in early days of cloud integration – just 5% to 15% of corporate technology spending is dedicated to cloud. AWS has potential to maintain its lead in cloud infrastructure and services as the market grows if the company continues to move fast. While AWS had historical sought small acquisitions, Selipsky said the unit is open for deals of all sizes. But tuck-in purchases are preferred because it is more difficult to integrate big corporate mergers in the technology industry.
- Shopify is in talks to buy technology start-up Deliverr, a move that would help the Canadian e-commerce company expand in fulfilment services. The deal could value Deliverr at more than $2 billion. Deliverr helps merchants on Amazon, eBay and other online retailers get products to consumers in two days or less. Fast shipping has become a must-have service for retailers, as the booming online shopping market became increasingly competitive during the pandemic. Deliverr uses analysts to predict where people might be interested in buying art supplies, makeup, shampoo and other goods. Then, it uses that information to position items in its warehousing network to achieve swift delivery. The deal, if completed, would make Shopify’s largest transaction of this kind, and complement the company’s subscription-based software that allows anyone to set up shop online.
- Citigroup analysts say the U.S. internet sector is healthy, naming Amazon and Airbnb among their top stock picks despite pressure on tech valuations from the surge in bond yields. The call comes as the Nasdaq 100 is off to a stuttering start in 2022, with growth stocks like Netflix spiralling as the short-term boom from the pandemic fades. Investors have pulled back from tech stocks because of higher interest rates, sky-high valuations and mounting concern about an economic slowdown. Citigroup cited that the broader sector remains healthy as consumer engagement online continues to be more immersive and grow.
o https://www.bloomberg.com/news/articles/2022-04-20/citi-bullish-on-amazon-and-airbnb-even-as-macro-fears-cloud-tech?srnd=technology-vp
Electric Vehicles
- Tesla reported better-than-expected first quarter results, buoyed by strong demand for its EVs, with Elon Musk predicting output will grow at a fast clip for the rest of the year despite supply chain challenges. Tesla cautioned that production remains constrained by shortages and higher prices for key components, a common refrain for automakers due to global bottlenecks on supplies of parts such as semiconductors. Musk said Tesla should be able to make up for any production shortfalls in the first half of the year from COVID-related shutdowns in Shanghai and is on track to expand production to more than 1.5 million vehicles this year. Second half results are expected to be higher than the first half according to Musk’s remarks on Wednesday evening. Tesla’s sale of regulatory credits in the first quarter almost doubled from Q4’21; however, the company cited that credit revenue would have declined compared to the same period in the prior year if not for a one-time $288 million benefit linked to stiffer U.S. emissions penalties. Tesla has repeatedly said it expects credit revenue to shrink over time as more automakers launch EVs to meet the growing demand for battery-powered vehicles. Tesla profits totalled $3.22 per share during the first quarter, beating consensus estimate of $2.27 per share. Revenue rose to $18.8 billion, compared with estimates of $17.9 billion. increased sales of higher margin vehicles and cost cuts helped Tesla improve its automotive gross margin to 32.9%, which is a positive surprise that bodes well for its ability to keep costs in check and drive sales. The cost improvements will be critical in helping Tesla fund lower priced vehicles. Tesla finished the quarter with $18 billion in cash and cash equivalents. It also continues to chip away at its debt load, carrying less than $100 million in borrowings at the end of the quarter, excluding financing for its vehicle and energy products. Tesla is also currently working on a vehicle with no steering wheels or pedals dedicated to robotaxi. Musk vowed to unveil the car in the next two years and achieve volume production by 2024.
- Tesla’s solar deployments fell by 48% as import challenges held up deliveries of some components. The EV maker deployed 48 megawatts of solar in the first quarter, down from 92 megawatts in the prior year and 85 megawatts in the fourth quarter. Logistics constraints and trade obstacles in the past year remain the largest culprits of the shortfall, as most panels installed in the U.S. are imported by Southeast Asia.
o https://www.bloomberg.com/news/articles/2022-04-20/tesla-s-solar-deployments-plummet-48-amid-import-delays?srnd=premium-asia
- Tesla’s first quarter earnings beat has buoyed industry peer stocks, including Rivian and Lucid, which both posted after-market gains. The auto industry’s persistent supply chain troubles have intensified this year amid Russia’s war on Ukraine, with soaring costs of raw materials, especially for batteries. While Tesla has been able to navigate the shortages better than even traditional behemoths such as Ford and GM, Musk had earlier cited on Twitter that prices of lithium had reached insane levels. Both Rivian and Lucid had also warned of supply chain pressures and rising costs. Supply chain disruptions have induced corrections in semiconductor and EV stocks this year, but EV upstarts could benefit in the long-run as supply chains improve given secular-30% EV growth through 2030.
- The war in Ukraine is deepening European manufactures’ supply chain woes, eroding expectations for a recovery in the region’s car sales and spreading to industrial giants like Siemens Energy. Passenger car registrations in Europe slumped 19% in March. It was the ninth consecutive monthly decline amid production stops due to the war in Ukraine hitting local suppliers. Parts shortages and production halts related to the Ukraine war are set to limit auto supply and delay an expected sales recovery. So far, European industrials have borne the brunt of war-worsened supply chain shortages. Consumer goods companies have also faced cost squeezes.
- Proposed changes to the U.K. Highway Code includes holding insurance companies for self-driving vehicles liable for claims in related circumstances. The update to the Code will make it clear that motorists must be ready to take back control of vehicles when needed. The U.K. Department of Transport also intends to allow drivers to watch television programmes and films on built-in screens while using self-driving cars, but it will still be illegal to use a phone behind the wheel. A full regulatory framework is set to be in place by 2025. There are currently no vehicles approved for self-driving in Britain, but the first could be given the go-ahead this year. The Department of Transportation announced in April 2021 it would allow hands-free driving in vehicles with lane-keeping technology on congested motorways. The development of self-driving vehicles could create around 38,000 new jobs in Britain and be worth 41.7 billion pounds to the economy by 2035.
- BMW has long tried to bill its flagship 7 series sedan as the more fun-to-drive alternative to similar offerings from Mercedes Benz. As the rivalry goes electric, BMW is also trying to win over people sitting in the back. The new BMW i7 unveiled Wednesday boasts a luxurious interior that includes a flatscreen lowering from the ceiling to entertain passengers in the rear. The vehicle is capable of 388 miles of range on a single charge and will become available to customers from November.
o https://www.bloomberg.com/news/articles/2022-04-20/bmw-2022-i7-ev-specs-price-range?srnd=hyperdrive
Consumer / Retail
China Market
- China’s trucking fleet has been caught up in the nation’s push for COVID Zero, further threating oil demand as supply chains snarl. Drivers remain held up in a web of quarantine controls that has led to long queues and disruption to deliveries, with the volume of road freight hauled across provinces from Jiangsu to Guangdong declining in March from a year earlier. Trucks play an essential role in commercial transport and prolonged curbs will crimp diesel consumption and weigh on China’s oil demand. China International Capital Corp. estimates fuel demand in April to fall by 2 million barrels a day from a year ago, with the biggest decline expected in diesel and gasoline. Trucks haul about three-quarters of total freight in China. But data released this week by the Ministry of Transport show that the volume of road freight in Jiangsu fell by 19% in March from a year ago, while it was down in Guangdong, Shanxi and Shanghai by 11%, 7%, and 6%, respectively. As a result, even factories that have operated under a closed-loop system in recent weeks may be forced to halt productions due to parts shortages or logistical challenges that make moving people and goods around the country near impossible.
- Investors are shifting more of their shares in Chinese e-commerce giants to the Hong Kong market, as Beijing’s efforts have yet to dispel concerns over the companies’ eligibility to remain listed on Wall Street. About 77% of JD.com’s shares are circulating in Hong Kong’s clearing and settling system as of Tuesday, versus 44% at the beginning of this year. Alibaba’s Hong Kong listed share portion rose to 56% from 53% over the same period. By slashing exposure to ADRs, investors avoid direct regulatory shocks that may force trading suspensions and liquidation of their stock in the U.S. The U.S. SEC has named at least 23 Chinese companies on a list of those who are running afoul of the auditing requirements. A conversion does not fully offset all of the risks introduced by U.S. delisting. Investors will need to deal with a less liquid market and potentially lower valuation when shares are shifted back to Hong Kong.
- Shanghai published plans to resume work in the city after weeks of COVID lockdown snarled supply chains and dealt a blow to the Chinese economy. Businesses have been advised to formulate plans for closed-loop systems, where workers live onsite and are tested regularly. They should also apply for approval to restart production with COVID-control authorities. The key to address the country’s economic woes is adjusting China’s COVID Zero policy approach, as the Chinese central bank takes a cautious approach with monetary easing. Some 276 auto component suppliers have gotten back to work since the onset of China’s latest COVID outbreak. Under the new work resumption plan, different parts of factories must be separated, and all staffers should work and live in designated locations, reducing direct contact with people in other areas as much as possible. Visitors will also be tightly restricted and company truck drivers must provide negative nucleic acid test results within 48 hours or a negative antigen test within 24 hours before entry. Makeshift hospital should be set up at firms with a large number of workers.
- Patience is earing thin among China’s beleaguered stock investors as worries about the impact of the latest COVID upsurge eclipse promises of official market support. Authorities have somewhat delivered on last month’s pledges by extended a lifeline to the property sector, committing to ease monetary policy, shelving plans for a real estate tax, restarting some gaming approvals and removing a key hurdle that threatened to pull ADRs listed in New York. But market reaction has remained damp as all eyes turn to effects of COVID Zero. The market now desperately wants economic activity to return to normal. Though unleashing more liquidity at this stage would help, that would not be as potent as easing virus curbs. The PBOC gave lenders a modest cash boost on Friday and refrained from cutting interest rates, taking a cautious approach with monetary easing even as the COVID outbreak takes a toll on the economy. The property market remains at a critical juncture with defaults setting another record pace and the country’s fourth largest builder failing to make a bond payment on time. Meanwhile, investors in Chinese internet stocks remain wary, with even a start of gaming approvals being insufficient to extend the cohort’s rebound as traders wager Beijing’s regulatory crackdown not over yet. China kicked off a formal campaign this month to rein in potential abuse of algorithms by internet giants to serve up ads. Meanwhile, how Beijing will cooperate with Washington to prevent ADR delisting also remains unclear. But a key rebound catalyst could be simply for China to get a grip on COVID. Lifting lockdowns in Shanghai may take some time because the virus has already spread quite a bit but in other cities, there should be clear improvements soon. While economic sentiment is currently very poor, it could bottom out some time in the April-June quarter.
- China ratified two international treaties on forced labour amid criticism over its treatment of the Uyghur ethnic minority, which has hindered trade ties with the U.S. and Europe. The nation’s top legislative body decided Wednesday to sign onto the Forced Labour Convention and Abolition of Forced Labour Convention. The elimination of forced labour is a fundamental principle and right at work. U.S. President Biden last year signed the Uyghur Forced Labour Prevention Act, which bans imports of goods from Xinjiang starting in June unless companies can prove they were not made with forced labour. Beijing’s long-anticipated trade deal with the EU was also paused last year after clashes over sanctions imposed due to alleged abuses in the region. Still, China’s latest signing of the accords is unlikely to improve trade ties with the U.S. and Europe after President Xi provided diplomatic support to Russia in the wake of President Putin’s war in Ukraine. But nonetheless, ratification of the conventions would send an important signal that China aims to be a responsible stakeholder in the international economic system.
o https://www.bloomberg.com/news/articles/2022-04-20/china-to-sign-forced-labor-treaties-as-xinjiang-scrutiny-grows
Russia-Ukraine Development
- The U.S. has imposed fresh sanctions on Russia, including on a cryptocurrency miner BitRiver, and is preparing to announce another $800 million in weapons and support for Ukraine. Russian banks under sanctions also will not be able to issue Chinese payment cards UnionPay, given the provider’s concerns about the risk of secondary sanctions. The UN secretary general sought meetings with Russian President Putin and Ukrainian President Zelenskiy as Moscow forces step up their offensive in the east. Kyiv has called for urgent talks to save the lives of fighters and civilians trapped in the city of Mariupol.
- The U.S. Treasury Department imposed sanctions on crypto mining company BitRiver, targeting one of the industry’s largest data center service providers over its operations in Russia in its first such action. The Switzerland-based firm offers energy sources, mining facilities and large-scale management solutions to Bitcoin miners across the world, including those in Easter Europe and Russia. Treasury’s action comes just a day after the IMF warned in a report that cryptocurrency mining could offer a pathway for countries like Russia and Iran to bypass sanctions by putting natural resources they are unable to export toward energy-intensive mining operations, such as Bitcoin mining.
o https://www.bloomberg.com/news/articles/2022-04-20/u-s-sanctions-crypto-miner-bitriver-over-russian-operations?srnd=premium-asia
- Russia said it test fired a new intercontinental ballistic missile, a move President Putin said would give the U.S. and its allies something to think about. The Sarmat intercontinental ballistic missile was fired from the Plesetsk cosmodrome in the northern Arkhangelsk region. President Putin has signalled the possibility of escalation, ordering Russia’s strategic nuclear forces on high alert just days after his troops moved into Ukraine. He also warned that any intervention by other countries in the conflict would trigger “consequences you have never seen”. U.S. and European arm deliveries have helped Ukraine blunt the Russian attack, which is refocused on the east after failed efforts to capture the capital Kyiv. Foreign Minister Sergei Lavrov did not give a direct answer to repeated questions about whether Russia might use atomic weapons in Ukraine in an interview released Tuesday, though he said Moscow was firmly against nuclear conflict.
- This week’s meeting of the G-20 was the first of its kind since the war began in late February and was closely watched for signs of how the world’s leading international bodies are responding to Russia’s aggression. Nations in the smaller G-7 have taken the lead in pursuing sanctions against Russia and some have sent weapons to Ukraine. They have sought to engage other countries to condemn President Putin and put limits on trade and investment with Moscow, including energy. But many governments in Latin America, Africa, Asia and the Middle East, including China and India, remain reluctant to do so. Many attending members of the meeting had condemned Russia’s invasion of Ukraine has unprovoked and unjustifiable, with some expressing concerns about its economic consequences and the protest against Rissa’s participation was understandable.
- A small group of Kremlin insiders are quietly questioning President Putin’s decision to go to war. Some are now believing the invasion to be a catastrophic mistake that will set the country back for years. So far, these people see no chance the Russian President will change course and no prospect of any challenge to him at home. More and more reliant on a narrowing circle of headline advisors, President Putin has dismissed attempts by other officials to warn him of the crippling economic and political cost. Some have also expressed increasing concerns that President Putin could turn to a limited use of nuclear weapons if faced with failure in a campaign he views has his historic mission, echoing claims by the U.S. intelligence officials. The skeptics were surprised by the speed and breadth of the response by the U.S. and its allies, with sanctions freezing half of the central bank’s $640 billion in reserves and foreign companies ditching decades of investment to shut down operations almost overnight, as well as the steadily expanding military support for Kyiv that is helping its forces blunt the Russian advance. President Putin current remains confident that the public is behind him, with Russians ready to ensure years of sacrifice for his vision of national greatness. With the help of tough capital controls, the ruble has recovered most of its initial losses and while inflation has spiked, economic disruption remains relatively limited so far.
- Russia was judged to have breached the terms of two bonds by a derivatives panel, marking another milestone on the nation’s path to its first foreign debt default in a century. The Credit Derivatives Determinations Committee said Wednesday that its payment of rubles on two dollar bonds was a potential failure to pay event for credit default swaps. The nation could still avert a default if it pays bondholders in dollars before a 30-day grace period ends on May 4th.
- Aeroflot is looking at purchasing eight leased Airbus jets after the EU provided a mechanism for financiers to dispose of some planes held in Russia following the invasion of Ukraine. Aeroflot will decide whether to buy the A330 wide-bodies at a board meeting Monday. The aircraft are on finance leases, for which the EU this month created a carve out from sanctions allowing the receipt of payments from deals signed before February 26th. Firms must seek government permission o sell the planes and no resources can be made available beyond the transfer of ownership. Finance leases typically concern new Airbus and Boeing jets, where export credit agencies guarantee about 85% of the amount loaned to an airline by a banking syndicate.
o https://www.bloomberg.com/news/articles/2022-04-20/aeroflot-may-buy-airbus-jets-tapping-eu-sanctions-workaround
Market Update
- U.S. equities climbed in Asia trading Thursday as debate around whether inflation is peaking sparked a rally in Treasuries; S&P 500 and Nasdaq 100 futures also advanced after positive earnings from Tesla and United Airlines, after tumbling on Wednesday trading as mediocre Netflix results weighed on streaming and media companies
- Rate markets underwent a sharp repricing, sending long bond yields sinking as investors such as Bank of America and Nomura Asset Management said this is a buying opportunity after the recent rout; 10-year yields largely maintained the steep retreat while a robust demand for 20-year bond auction added fuel to the rally
- U.S. 10-year real yields briefly turned positive on Wednesday for the first time since March 2020 as traders added to bets on an aggressive Fed hiking cycle; there are risks of 10-year yields pushing higher still on the back of increasing economic uncertainty, as investors await details on the Fed’s timeline for shrinking its balance sheet
- The U.S. economy grew at a moderate pace through mid-April, but rising prices and geopolitical developments created uncertainty and clouded the outlook for future growth
- Chinese equities are likely to remain under pressure as investors assess the scope for policy support amid a slowing economy burdened by extended COVID restrictions
- S&P 500 futures rose 0.4%, while the S&P 500 was little changed at 4,459.45
- Nasdaq 100 futures gained 0.6%, while the Nasdaq 100 fell 1.5% to 13,998.53
- 10-year Treasury yield rose one basis point to 2.84%
- WTI crude was at $102.51 a barrel, up 0.3%
- Gold was little changed at $1.955.77 an ounce
- The rally on U.S. equities Tuesday has been fuelled by a string of unexpectedly sturdy economic data despite no changes to the long list of worries ranging from inflation and war to COVID. The optimistic economic data undermines arguments that a recession is at hand. Housing starts came in better than forecast, surging to the highest level since 2006 during March, which suggests strength in an area of the economy that is highly sensitive to interest rate moves. Hiring remains robust as well and applications for unemployment benefits are near historic lows. Consumers are also out in droves shopping and dining again. Earnings reports from the country’s biggest banks indicate worries over consumer strength might have been misplaced – data showed spending on U.S. consumer credit cards surged in the first quarter as customers began travelling and dining out again, and even with increased spending, borrowers kept up with their bills.
- Anticipation of the Federal Reserve’s balance sheet reduction is weighing on bonds backed by mortgages, but the actual event may make them an attractive alternative to corporate debt. The Fed is preparing to shed the securities it purchased to provide liquidity during the pandemic at a maximum monthly pace of $95 billion, with $35 billion coming from mortgages. The Fed about doubled its MBS portfolio to around $2.7 trillion the past two years. Prices on the securities have been weakening since the start of 2022 in acknowledgement of the coming selloff by the Fed, the biggest buyer of MBS. Now, money managers see a opportunity to buy the underperforming bonds at even lower prices. MBS are now trading as cheap as at the height of the pandemic in May 2020, based on the difference between yields on current coupon mortgages and a blend of five- and 10-year Treasuries. The risk premium was 1.16 percentage point on Tuesday, while alt year’s average was 0.7 percentage point. The Fed’s policy tightening regime to combat inflation has helped drive down MBS prices. Quickly rising mortgage rates have led the current production of MBS to be in higher coupons, mainly 4% and 4.5% bonds. The average national mortgage rate has risen to more than 5% in recent weeks, completely ending a refinancing wave from last year. Homeowners holding 2% and 2.5% mortgages and bonds that contain them are “out of the money”, meaning they are unable to refinance the debt. As a result, bondholders will not be receiving their cash back anytime soon, lengthening the duration of MBS bonds containing those lower coupons. But the higher current MBS coupons – which will represent the bulk of near-term issuances – have wider spreads and shorter durations. And unlike corporate bonds, MBS have the implicit guarantee of U.S. government entities, which are at essentially no risk of default. For those that are fearing rising rates and looking to shorten duration, MBS may be the way to go without giving up any spread.
- The U.S. economy grew at a moderate pace through mid-April but rising prices and geopolitical developments created uncertainty and clouded the outlook for future growth. Inflationary pressures remained strong since the last report with firms continuing to pass on rising input costs to customers. The Fed is in the process of making a hawkish pivot as it battles the highest inflation in four decades with officials raising rates and preparing to shrink the central banks’ nearly $9 trillion balance sheet. Policy makers have said they will move expeditiously to lift rates back to a neutral level that neither stimulates nor slows the economy. Fed officials are debating whether they will need to raise them above neutral, estimated to lie around 2.4%, and by how much. A number of Fed officials have said they are open to delivering a 50 bps increase to interest rates coming May, while others have suggested support for as high as a 75 bps move.
o https://www.bloomberg.com/news/articles/2022-04-20/fed-says-high-u-s-inflation-geopolitics-are-clouding-outlook?srnd=premium-asia
Summary
- Micro – Equities lost its Tuesday gains during Wednesday’s regular session, weighed by Netflix’s mediocre earnings results. The company had lost subscribers for the first time in a decade during the first quarter, diverging completely from its previous guidance of 2.5 million net adds. It is now predicting further subscription losses in the current quarter, citing concerns that include its new password sharing pricing strategy, as well as increasing competition. Yet, Tesla’s stronger-than-expected results, which included a sales and earnings beat, reported Wednesday evening has already triggered a pre-market rebound. Investors are clearly still sensitive to fundamental changes amidst an increasingly uncertain economic backdrop. Earnings releases by key megacap tech stocks later next week, including Google, Apple, and Amazon will continue to shed light on the strength of fundamentals and valuations amidst growing economic challenges, including a potential economic slowdown and potential dampening of consumer spending amidst rising inflation.
- Macro – Treasuries remained volatile, with the U.S. 10-year real yield briefly turning positive on Wednesday for the first time since March 2020 as investors added to bets on an aggressive Fed hiking cycle following the release of stronger-than-expected economic data. The coming policy meeting in May will be a tell-tale as investors await details on the Fed’s timeline for shrinking the balance sheet.