Macro
On Friday, we had the latest US job numbers with a downward revision for February to 275k (ahead of the 200k estimate). However, the unemployment rate jumped to 3.9% (expected 3.7%), a new two-year high. Average hourly earnings increased by just 0.1% MoM or 4.3% YoY. These numbers indicate that the US labour market remains resilient, but it started to moderate and did not fundamentally change the picture of the overall strong economy. As the job market begins to moderate, the focus shifts towards consumers’ health, including changes in saving rates, retail data, and delinquency rates.
From the monetary perspective, we are getting closer to easing. Last week, we also heard from the FED that they are gaining confidence that inflation is reaching the target and that,t at this point, it is appropriate to start dialling back monetary restrictions to avoid the risk of putting the economy into unintended recession. The problem is that the economic policy is hitting the economy unevenly, penalising the most levered companies and households. Easing would help to manage that risk. From the fiscal perspective, the US government need to become more sensitive to the costs of its socio-economic policies as the deficit mountain.
Many argue that the US economy behaved so well because of the excess liquidity still circulating in it. Although the money supply has started to decrease since QT, the M2 measure remains $2.7t above the pre-pandemic trend.
Global investors focused on China, and on Tuesday, they published a very ambitious 2024 economic growth target of 5%. The target is similar to last year’s, but meeting it will be more challenging. The Chinese economy is in the middle of a property bust, slowing growth and deflation. In addition, there is a collapse in the confidence of international and domestic investors, as well as a collapse in consumer confidence. In addition, demographics have a negative impact due to the ageing population and shrinking labour force (for more details, see ‘Week 7’ update).
These are the signs of what can become economic malaise, which can last years or, in this case, decades (similar to a lengthy period of economic stagnation in Japan). On a positive note, Beijing has now started to signal that it prioritises growth over social reforms that curb growth in many sectors of the economy.
Rates
Several factors have recently put upward pressure on the neutral rate of interest. They include huge budget deficits, significant investments in infrastructure and renewables, investments in the resilience of the local supply chain, and an ageing population. If the neutral rate is much higher than the 2-2.5% assumed in the past, then the current monetary policy is much less restrictive than the market anticipates.
The market’s expectations of rate cuts for this year have moved from 6 rate cuts at the start of the year to 3 rate cuts. This drastic repricing took place without any disruption or dislocation in the treasury market. The probable case is that the next move is to cut rates, but the FED has to remain cautious, as its dovish pivot in December caused a significant loosening of financial conditions and led to an increase in asset valuations.
Investors are more in the rush to lock in rates before the cut. 2Y was over 4.7% two weeks ago, now meaningfully below 4.5%. Investors looking to increase their exposure rates may find the best opportunities in the belly of the curve. Within longer-term rates, 10Y, 20Y, and 30Y, there is a higher risk of further spending due to an ample supply of treasuries investors need to contend with. The risk profile looks more attractive for the intermediary part of the curve,, where there is less duration risk, and coupons remain attractive.
Credit
As spreads get tighter, credit investors focus more on the total yield. The strategy of looking only at total yield in credit markets often brings complacency and has historically ended badly multiple times. MBS and structure products allow to get similar yields without taking on much of a credit risk.
From the performance perspective, CMBS and leverage loans have been the best performers this year, while the investment grade generally underperformed. Most of this is driven by duration risk, and a rise in the key rates applicable to those issuances causes losses.
Credit YTD Performance (4th of March, 2024)
Source: DoubleLine Capital, Bloomberg
BBB-BB spread is paying now only 80 bps, way below the historic 155 bps average, and not much above a low of 45 bps (BBB-BB spread was below 50 bps only in late 1997, 2005, 2007, and 2019, but each time bounced back rapidly toward 200 bps). CCC-BB spread is much higher at 540 bps vs the historical average of around 500 bps and lows of 250-300 bps (204 bps actual low in 2007). This spread is elevated as investors tend to shy away from more risky credit during the late cycle, and because default rates started picking up, recessionary risks are still priced in lower quality issues.
Equity
Nvidia had a $100 intraday move (almost 10%) on Friday, and Broadcom, Marvell Technology, Intel and other chipmakers had a significant negative day. Many of those firms benefited from the AI halo effect, as investors were motivated by a broader narrative of implementing a ‘picks and shovels’ strategy (investing in companies that provide essential tools, services, or products necessary for an industry to function). Many investors chased the next Nvidia and bought chipmaker companies even though their core business mainly stayed the same by the AI trend.
Nvidia represents the next leg of corporate America’s economic growth, productivity growth, and earnings growth. Its earnings announcement on the 21st of February triggered a furious global rally in technology stocks worldwide and caused option volumes to leap. The AI revolution is something that now every investor wants to be part of. If not for potential earnings yield brought by an increase in productivity, then from fear of missing out or even hedging themselves from disruption.