SignalPlus Morning Briefing 16 Dec 2022
After putting up a defiant showing against the Fed on Thursday, markets were hit by a doze of reality yesterday on the back of a 1–2 strike by a hawkish ECB and unsupportive dataset. The ECB opted for a 50bp rate hike, taking the main refinancing rate to 2.50%, but the messaging from President Lagarde stressed the ECB’s intention to raise rates significantly at a steady pace going forward. In fact, she congratulated a journalist on picking up on the “key message” that rates need to rise at a significant pace, signalling their desire to really hammer the hawkish message home. Furthemore, the ECB acknowledged that the Euro-area is already in a recession, but expects the slowdown to be “short-lived and shallow”, and significantly raised their inflation projections despite the winter recession. Finally, the Governing Council announced the start of its balance sheet uwnind to begin March 2023, which was earlier than market expectations, with an average monthly decline of €15bln per month and revisited by the end of 2Q23.
These messages had a profound impact on European markets, which had seen significant rallies since October in sympathy with global assets, as front-end German schatz spiked by over 20bp, and the European Stoxx index sold off by -3.5% in its worst day since the beginning of the Russian invasion in 1Q22.
On the US data side, markets saw the unfortunate combo of very weak retail sales, empire manufacturing, Philly Fed business outlook, industrial production, and drop in weekly jobless claims (stronger employment) to 3-month lows. Retail sales decreased by 0.6% MoM in November, with the key control category dropping by -0.2%, both weaker than market expectations. Food and beverages showed the largest increase at +0.08%, while furniture (-2.6%), building materials (-2.5%), and motor vehicles (-2.3%) suggested a more reserved consumer due to higher rates and continued weakeness in the housing market.
Philly Fed manufacturing came in soft with weaknesses in employment, shopiments, new orders, and prices-paid components. Empire manufacturing was similarly weak with drops in shipments and new orders, but the employment component actually came in stronger with prices paid flat on the month.
The market response to yesterday’s developments was swift and decisive, with the S&P 500 dropping -2.5% with a near 95% down-day as no sector was spared. The US Treasury curve bear-flattened once again to -78.8bp in 2/10s, with the economic data set continuing to suggest a more protracted activity slowdown against a hawkish Fed. Outside of the Euro, the US Dollar also rallied against most majors in the risk-off move, with Asian currencies suffering the worst daily % sell off against the Greenback in over 2-years.
Looking ahead, today will likely be the last full-liquidity trading day for the year, and we will end it with a bang as an estimated $4 trillion of US equity options will be expiring today. With the SPX trading within a relatively tight 200pt range over the past month, and the option community likely being long gamma into the CPI & Fed this week, the expiration of these positions might lead to sharp and expected moves in the closing weeks, especially in light of the rapidly deteriorating liquidity conditions into the year end.
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With the markets playing an increasingly dangerous game of bluff against the Fed, index gamma hedging rolling off, and market positions certainly no longer as bearish as during the summer, we would be diligent in managing down bulling risk expressions from here. On the crypto side, with both implied and realized volatility trading at their local lows, we might also be due for a volatility-led spike if macro assets were to breakout, hence we would also be careful of any excessive short vol exposures going into the holiday season.
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