Rethinking The Narrative

Market participants are likely rethinking the narrative headed into the new week after Friday’s payrolls shocker. Suddenly, the idea of a “V-shaped” recovery doesn’t seem quite as absurd as it did just a week previous. (Some readers will say it’s still a ridiculous notion, and I wouldn’t totally disagree.)

Of course, nothing says the rest of the data will play along. A month from now, we could very well discover that “the greatest comeback in American history” (as Trump called the May jobs report) was a head fake. But for right now, the combination of a stunning beat on the world’s most important economic indicator, rampant reopening optimism, stimulus aplenty and, tangentially, the extension of the OPEC+ cuts with an emphasis on compliance, makes for a reflationary setup.

The Fed is on deck, and the market will be looking for any pushback against the rise in long-end yields. Yield-curve control (YCC) is almost surely coming to the US, it’s just a matter of when and what part of the curve the Fed will target. One thing is for sure: A disorderly rise in borrowing costs at a time when Steve Mnuchin is flooding the market with supply to fund virus relief is a non-starter. 10-year yields rose 24bps last week, the most since September, when bonds were bludgeoned in a brutal snapback after August’s big rally that inverted the 2s10s.

The Fed will taper bond-buying to $4 billion per day this week – we’re a long way from the $75 billion per day pace that prevailed briefly during the worst days of the crisis. Markets are looking for guidance about what’s next. Most see the Fed settling on a monthly amount, but there’s a chance they continue to manage things on a week-to-week basis.

“We see the most likely outturn — perhaps 65% probability – as being that the Fed will announce a ‘steady state’ pace of QE around $65-$85 billion/month until further notice in a sort of QE infinity”, Deutsche Bank’s Stuart Sparks said Friday. That’s not necessarily a call on the June meeting – it’s just a general comment on what’s coming eventually. “We would put the probability around 30% that no formal announcement will be made, instead leaving the trajectory of purchases to the weekly announcements”, Sparks went on to say.

The market doesn’t expect YCC until September, but you never know. “The Fed has no policy surprises in store at this week’s meeting. The key message will be on forward guidance”, SocGen said Sunday. “Lower-for-longer rate guidance is the key. We see the Fed shifting to yield-curve control in due course, but not yet”.

The curve is bear-steepening pretty aggressively of late, and opinions vary on what’s behind the move. The standard explanation is that a deluge of corporate issuance (see the figure) is colliding with Treasury supply and reopening optimism to catalyze a sell-off at the long end. But some have a more nuanced take.

Recent steepening in the curve has catalyzed a meaningful rotation in equities. Those inclined to “look under the hood” (so to speak) will be watching more than just the benchmarks this week.

The pro-cyclical rotation trade is in focus, and there will be plenty of interest in whether value, banks, energy, and the like, can continue to outperform. One high beta product is coming off an astounding week.

Meanwhile, tensions with China could heat up, especially if the White House feels emboldened by the jobs report and surging US equities.

Mike Pompeo and Global Times Editor Hu Xijin took turns calling each other Nazis over the weekend, in a truly silly exchange made even more ridiculous by Hu using a screengrab from Sputnik, one of Russia’s two English language propaganda outlets.

What you see below is the Chinese propaganda machine responding to the US propaganda machine by way of a tweet with a screenshot from Russian propaganda. To paraphrase Fletch, “It’s all propaganda nowadays”.

China logged a record trade surplus in May, data out over the weekend showed. Imports plunged more than expected, partly as a result of falling prices for commodities, while exports fell less than forecast thanks to shipments of medical supplies abroad.

It’s probably not a good idea to read too much into China’s trade data right now. Distortions are everywhere, as external demand is still depressed from the lockdowns, and the plunge in commodity prices likely affected the headline imports figure.

At a press briefing in Beijing on Sunday, the head of the State Council Information Office hit back at allegations that China engaged in a coverup around the origins of COVID-19.

“Some foreign politicians and media have presumed guilt for the origin of the virus, put labels on the virus and politicized the epidemic”, Xu Lin chided, adding that “the fabricated assumptions are utterly baseless, unreasonable and disrespectful of science”.



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15 thoughts on “Rethinking The Narrative

  1. Walt, regarding last week’s bear-steepening (long-end yields higher), I also read on Bloomberg that CTA’s hit a big sell trigger on 10-year futures after the 0.70% (-ish) level was breached, adding to the list of reasons for the move.

    I am in agreement with your recent argument that US Treasury rates are already being “set” by the Fed & Treasury (i.e. rates go wherever the Fed & Treasury ALLOW them to go). So, with this in mind, last week’s steepening must have been ALLOWED to occur. Perhaps to help the Banks/Industrials/Cyclicals continue their rally, and remedy the prior “bad breadth” issue in US Equities?

    Will be interesting to see where their line in the sand is located, near term. Also, with Residential Mortgage spreads still fairly wide, seems like they have to be mindful of this summer’s housing market activity. Not a good time for a giant pop in 30-year fixed rates!

    Thanks again for all the good info and commentary that you provide.

    1. Yeah, i saw that same little blurb on the terminal. I mean, bear in mind that when I talk about “administered” markets and what the Fed will and won’t “allow”, I don’t mean they’re sitting by a Bloomie and literally trying to micromanage every tick. It’s entirely possible that yields can spike abruptly — I just mean that generally speaking, we live in a world where central banks are going to get what they want in terms of market outcomes over the medium-term — or they’re going to die trying (figuratively speaking). What happens on any given day, hour, minute is obviously up in the air, though.

  2. Subscribed to this report because of astute commentary. And, you understand MMT! MMT is what’s happening now. When they turn to the printing press to ask how much they owe, they get no response.

    1. It is a response,no? Bonds want what stocks are getting.I may be a layman at bond markets but one would think that bonds are reading inflation expectations as part of the rise of stocks. Corporates being backstopped by the same bank being more attractive.

  3. I’m not sitting in front of a bunch of charts, but I think that in modern times, major market bottoms are usually pointy shaped, so that’s not weird.

    The rally has been fast, huge and relentless, that’s weird but explained by umpty trillion of liquidity plus backstops from a Fed that admits it has crossed many “red lines” and won’t rule out crossing others, and umpty trillion of fiscal stimulus from a Congress where both parties have incentives to keep sending checks to voters.

    Rotation from defensive hi-quality to cyclical lo-quality is also typical in major recoveries. Look back at 2009 after March, what were you buying – probably the junkiest, most stressed names you could find.

    The “V” in stock indicies is pretty much written already, the pen is in the final part of the upstroke.

    So we’re all wondering if stocks are going to head back into a “W”. That seems to me more like something frustrated bears are hoping for than something that is actually very likely to happen.

    The economy is very very bad so no reason for the Fed to withdraw liquidity. There’s an election in November so no reason for Congress to turn off fiscal support. Valuation alone is never a reason for stocks to reverse.

    By theway, I don’t know how the strategists see market valuation now, but when I do DCFs on a bunch of small/mid cap names, using pretty stiff discount rates and pretty modest terminal growth rates (typically 8-9% and 2-4% respectively), their current valuations don’t look high. Which makes sense when you think about how DCFs work.

    I think what’s more likely than a sharp U turn and nosedive in stocks is that they climb to wherever they’re going to, then look around and wait to see what the Fed, Congress, and economy do. If the economy – by which we mean corporate profits and buyside estimates, of course – climbs little by little out of this deep hole, and the Fed/Congress bazookas stay armed and ready, then maybe the stock market gets kinda boring in 3Q. Which would be fine with many investors, I’m sure.

  4. Assuming that the latest BLS unemployment report isn’t just intentionally fraudulent, it isn’t a good idea to pay much attention to it (just as you said about China’s trade data) since there are all sorts of reasons that people can be counted as employed (such as working one hour per week) along with sampling error (the BLS report is based on sampling 60,000 households). Because the effect of the Covid-19 layoffs are so concentrated in particular areas, normal survey methods could easily overstate or understate employment depending on the location or the type of household surveyed.

    Also any reduction in social distancing will increase Coronavirus cases (cases started a national upturn this week) and any increase in voluntary social distancing will have the same effect as mandatory social distancing. In addition the United States has NO plan (whether or not you would agree with any plan) for reopening the economy or controlling the outbreak. So I don’t place a lot of hope in a V shaped recovery.

    1. Throwing humanity out the window a quickening virus is not going to stall the economy as too few people perish, many are out of work and others are retired. The real risk to the economy is if ICU beds fill and the governors need to force distancing again. Is that going to happen? Well it certainly has done this in past epidemics. We are playing with fire with our cavalier attitude and if the virus is hampered by summer it is likely coming back with a vengeance come fall. Probably before any vaccine is widely available and before the election.

  5. I think we’ll have a virus “second wave” but don’t know how bad it will be. Masking and social distancing precautions should have “some” effect. Lower density/less urbanized places may be less vulnerable than NYC, and that describes many of the states that aren’t taking precautions.

    Can the US economy struggle toward recovery with 1,000 people dying each day? Sure. People can get used to lots of endemic tragedy. 1,000 / day, spread over 50 states, is different than 1,000 / day, in one city. Sigh.

  6. I suspect that A. Allowing PPP to end in July along with the unemployment benefits will show what the reality is, B. That the senate is going to be unwilling to pass any additional stimulus until another crisis erupts that threatens Trumps chances in November, and C. That the virus wave 1 never really ebbed, it stabilized after much social distancing and is set to skyrocket in June/July as we end social distancing measures. My factory doesn’t plan on sending remote workers back until October at the earliest due to cases on the mfg floor despite intense screening and cleaning. All this boils down to real economic hardship to persist this year. What that means for stocks and bonds who knows? Probably record prices.

  7. Another thought, which I didn’t write before because it is pretty ugly, but oh well . . .

    Whatever the Covid death rate goes to, you can cut it by half. Because about 50% of deaths are elderly persons in nursing homes. It is horribly easy for many people to dismiss those deaths. Then cut the remaining deaths by another half. Because about 25% of deaths are non-institutionalized people with morbidities. It is easy for many people to consider themselves are personally healthy. In other words, if 1,000 die each day, for many people it only feels like 250, which they see as a negligible number.

    I’ve had many arguments with people who are 65-75 y/o and take a fistful of daily pills for chronic morbid conditions, yet insist the Covid deaths are all old or sick people not “like me” so, really, who cares?

    Empathy is in short supply, as are mirrors. Even scarcer is attention span for abstract concepts. Most people can’t actually pay attention to anything for more than a couple weeks, unless it is right in their living room. For them, Covid is already old news, just background noise.

    That’s why I think the virus can surge again (heck, not can, is) and that won’t make a whit of difference to the “reopening”. Too many people simply couldn’t care less. There are huge incentives (political, economic) to keep them indifferent and distracted.

    I think the average person has a close social circle of maybe 20-40 other persons. Defined as, he (or she) would actually be emotionally affected in a significant way if one of those people dies, as opposed to “oh, bummer, what’s for dinner”. So unless he is in NY, NJ, MA etc, the chances that someone in his close social circle has died from Covid is negligible. Unless he’s one of those with empathy and the ability to care about things that don’t affect him directly, the pandemic is already boring.

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