On 23rd Aug Indian Finance Minister, Nirmala Sitharaman, came up with a massive pseudo privatization plan for the public sector entities and ventures. The ministry has to replenish its treasury after the colossal covid stimulus packages stretched its limits.
The risk aversion theme seems to be coming up all over again, treasuries are sticky downwards, USD and JPY, the safe haven currencies are beating Nov 2020 watermarks. Consumer confidence index signals fading 2021 recovery story that was embedded in the ravaging equity indices. Commodity prices don’t see any near term reversion, given the supply chain disruptions and labour shortages.
The big decision is how we define whether the economy is good enough for the Fed to start tapering, given that the crisis and the recovery were all very different, and thus the toolkit to rejig the economy also needs to be anew. We boil down to deciding the following:
Timing of the taper
Scale
Instruments and market segments
Plan B, if things don’t work as expected, then what is the rescue plan
Powell mentioned Inflation 71 times in the virtual Jackson Hole symposium. If we were to keep track of keywords, it was among the most spoken keywords. Though this data may sound funny to prove our point of relative focus on the inflation theme, inflation is really the elephant in the room and ought to be at the heart of the symposium. Back in Feb when the inflation numbers first breach the 2% target, markets contemplated the components of such inflation, and now fast forward 6 months, we are questioning the longevity of such inflation numbers.
It's interesting to see 2 contra forces at work here. While US inflation numbers are inching higher every month, which theoretically should reduce DXY index, delta variant is causing new disharmony in the recovery across global markets, which makes investors buy the safe havens. And it looks like the latter has outpowered the former in guiding the DXY higher over the last 3 months.
Utilities and healthcare have outperformed the broad index over the last 2 months. As we see new containment measures in parts of the country, people are flocking back to grocery stores to pile up. Another explanation for the sudden outperformance of the 2 sectors is a very cheap entry point. After the recovery took force, the defensives have nosedived to year lows.
It would be very interesting to monitor the steepening or flattening of the yield curve. If the Fed starts tapering soon, then we don’t expect the 5 year (mid term) to fall as much, as they cant really keep on increasing rate over the next half a decade. Furthermore, the 10 year yield isn't affected as much by the taper either. This positions us well for a long dated receiver swap.
Additionally, while at +6.1% q/o/q, Q2 Core Personal Consumption Expenditures (PCE) came in on target, it was the highest since September 1983. Keep in mind that this is the Fed’s preferred inflation gauge and their inflation target in only +2.0%. No wonder traders are so much glued to the inflation theme and was in fact the primary talk point at Jackson Hole.
The Bank of England is using a different approach this time. They are prioritizing reaching the target interest rate and then unwinding their positions in order to reduce the balance sheet size. Back in 2011, after the GFC, it did not focus on unwinding as much as it did on reaching the target 1.5% rate. All these developments and policy guidance are heavily influenced by what and how the Fed thinks to start tapering. This in turn would influence the long term treasury yields, and that would influence style rotation between value and growth in the equity markets. Though the statements may be well envisaged, the impact may come in different shapes and sizes.
Investors in the US have started shedding leverage off their portfolios. This is happening for the first time since the pandemic began in March 2020. Investors point to the rising concern over Chinese regulatory crackdown and fading consumer confidence in the US. But such a trend raises concerns over whether the decade long rally of SPX would continue? The market has squeezed almost every penny available on the street and now it's payback time.
Interesting Charts:
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