Term premium around the corner – Aug 11th 2023

A plethora of US issuance marked this week as the Federal Reserve conducted auctions of above-average volumes of 6-month and 1-year bills, followed by well-received auctions totaling $42 billion in 3-year notes and $38 billion in 10-year notes. The Federal Reserve wrapped up its open market operations with a relatively weaker 30-year auction, contributing to a yield curve steepening.

Market sentiment turned towards safety after softer than expected inflation data emerged from China, pressuring risk assets and prompting an influx of buyers into government paper, aligning with the Fed’s extensive supply schedule.

Although Federal Reserve communication exhibited a somewhat hawkish tone, it’s crucial to emphasize that the prevailing market consensus remains resolute in its conviction that the period of Fed rate hikes has reached its conclusion. This sentiment persisted despite the unanticipated uptick in the Producer Price Index (PPI) to 0.3%, surpassing the projected 0.2%. Today’s PPI release exerted pressure on the belly and long end of the curve, driving 10-year yields to 4.17% and 30-year yields to 4.28%. These movements underscore the market’s continuous assessment of inflation expectations and the gradual recalibration of term premia into the yield curve.

Separately, commodity prices are once again on a steady ascension, with Crude oil comfortably above $80/barrel in WTI following last week’s inventory report, which exhibited one of the largest draws of the year (-15 million barrels). Given the depletion of the Strategic Petroleum Reserve (SPR) by 50% and the projected global demand uptick in 2024, pricing pressures may easily resurface across various economic sectors. It’s evident that the Fed alone cannot entirely manage these dynamics without exposing vulnerabilities and causing turmoil in critical market sectors.

Addressing long-term inflationary pressures and striving for any form of economic landing, whether soft or hard, necessitates a meticulous examination of accompanying fiscal policy. Currently, minimal efforts have been taken to mitigate the supply-induced pressures contributing to enduring challenges within the core inflation basket. We are diligently monitoring these developments.

As we look ahead to the coming week, our focus rests on upcoming data releases and the back-to-school festivities. Key data points include retail sales on Tuesday, housing starts on Wednesday, and jobless claims on Thursday. Additionally, Minneapolis President Kashkari is scheduled for more Fed commentary on Tuesday.

Enjoy the weekend!

** Commentary from RCG Portfolio Managers
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** Dynamic Macro Strategy
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This strategy relies on historical data and quantitative techniques to detect statistical disparities and make predictions in global markets through liquid ETF’s.

“Our re-entry target to EWI was hindered by the recent introduction of a 40% bank windfall tax took the market and BTPs by surprise. We will allow time for consolidation given this regime change and uncertainty to Italian risk assets in spite of it’s price recovery. Tactically, the move in US rates and commodity rally further extended the dislocation between lagging US sectors versus broader indexes. As a result, we have increased exposure to XLE, OIH and IWM in the strategy. ” – Nick Diaz

** Inflection Strategy
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The strategy takes positions in highly out of favor US equities which we believe are inflecting due to changing fundamentals/events.

“We have introduced a new ticker in the strategy which is expected to unlock value in this current cycle. KLX Energy trades at a low multiple of 2.8 times the annualized 1Q23 EBITDA and 5.0 times the annualized net income. The company reported strong results this week and has proven to be a leading operator in their space with strong margins and has recently solidified it’s capital structure. For a deeper dive, please access our full write up (link further below).”- Stefan Lingmerth

** Safe Haven Strategy
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This strategy protects capital during inflationary environments and seeks to maximize yield using fixed income instruments and defensive assets.

“We maintain a 2.5yr duration in the book and have re-instated our core metals positions as the recent US debt downgrade to AA+ puts pressure on the greenback and core inflation although trending lower remains well above target levels and could prove suborn into year end. [YoY CPI @ 3.2%, Core @ 4.7%].” – Nick Diaz