VirtuTrade - The Market Makers Academy

What Does This Mean?

The world’s been getting hangry about food prices for a while now: harvests were disrupted by bad weather last year, and those dwindling supplies haven’t kept up with the post-lockdown bounceback in demand. But the Ukraine war has poured fuel on the fire: the country is the top exporter of sunflower oil in the world, and accounts for around 30% of the global wheat trade alongside Russia. That’s to say nothing of the damage the conflict has done to global trade more broadly. Put it together, and a UN index that tracks global food prices climbed 13% higher last month than the month before – meaning it’s now jumped more than 50% since mid-2020.

Why Should I Care?

The UN has been vocal about the fact that the situation could get even dicier, especially now that some countries are limiting exports so they can feed themselves. The US, for its part, has floated the idea that Australia and India would be able to cover around half as much of Ukraine and Russia’s wheat output if they just upped exports. As for what it’s planning to do, the country’s reportedly thinking about the possibility of investing something sometime, maybe?

Brits are feeling the effects: data out last week showed that UK grocery spending was lower last month than it was in March 2021. Shoppers are swapping big-name brands for cheaper alternatives too, with sales of white-label goods on the rise. That might be why Lidl and Aldi – two German discount stores that have made waves in the UK specializing in own-brand products – were among the only retailers to gain market share last month.

The UK government said two years ago that it’d be banning the sale of new petrol and diesel cars from 2030, and this move should help it get there: it’s introducing China-style rules that’ll force carmakers to make 22% of their output fully electric by 2024, 52% by 2028, and 80% by 2030. But some industry organizations are calling for more relaxed targets – not least because there’s not much talk of actively incentivizing British customers to actually buy EVs. They’re also not convinced there’ll be enough charging stations across the UK to power them – a shortfall that’s long been putting off potential electric converts in the country.

The UK government’s latest plan is focused squarely on fully electric cars, but it hasn’t said anything about hybrids. That’s left hybrid specialists like Toyota wondering if they’ll even be able to sell them to British customers after 2030, which might be why the world’s biggest carmaker has threatened to stop investing in its UK-based carmaking plant – one of the biggest in the country.

Government-led EV initiatives – of which there are more and more each year – do seem to be working: data from Bloomberg out on Friday showed there were around 16 million EVs on the world’s roads by the end of last year – up from just 1 million in 2016 And since Bloomberg thinks emerging markets will end up embracing EVs too, it now reckons that this figure could hit 71 million by 2025 – 10 years ahead of previous forecasts.

The Fed has two main ways of fighting inflation: it can raise interest rates, or it can sell off some of the $9 trillion worth of bonds it’s accumulated – a move that drives down their prices, pushes up their yields, and increases the overall cost of borrowing. The central bank already started doing the first of the two last month, but now it’s resorting to the latter: the central bank said it could ramp up to selling $95 billion worth of bonds every month – almost twice as much as when it did the same thing in 2017. It suggested it’d be more aggressive with rate hikes too, which analysts took to mean we can expect at least two 0.5% hikes – rather than the typical 0.25% – sometime this year.

Why Should I Care?

For you personally: You have been warned.
The tech-heavy Nasdaq index fell on the news, and the message was loud and clear: tech stocks are at risk. See, investors value a stock based on what they think a company’s future profit is worth today. And since tech companies are expected to generate a higher proportion of their profits in the future than other companies, they’re the first to suffer when yields rise. Then again, you might just want to ride it out: data shows that fast-growing stocks like tech have beaten cheap-looking value stocks in three of the last four periods of Fed rate hikes.

The bigger picture: The R word.
It’s no secret that the Fed’s efforts to limit inflation will drag on economic growth, but some economists are more pessimistic than others. Take Deutsche Bank: it said this week that it’s expecting the US economy to fall into recession next year.

Retail sales in Europe rose just 0.3% in February from the month before – short of the 0.6% economists were expecting. And this is before the effects of war in Ukraine really came to a head, which is a problem: European consumer confidence has only been falling – and inflation only rising – ever since. And given that consumer spending makes up a huge chunk of the region’s economy, economists think the slowdown will play a major part in dragging down economic growth this quarter.

Why Should I Care?

The bigger picture: Be more direct.
With retailers making fewer sales, they’re looking for ways to profit more from those they are making. So they’ve been veering away from wholesalers and third-party marketplaces, which take a cut of the profits and hoard data on shopping habits for themselves. Levi’s knows what’s up: “direct sales” – those that cut out the middleman – made up around 40% of its total sales last quarter, helping the denim giant grow its profit by a better-than-expected 37% (tweet this).

Zooming out: Crypto has you covered.
We know what you’re thinking: couldn’t European businesses just let shoppers pay with bitcoin to boost business? That same question might’ve crossed Bolt Financial’s mind: the US company – which specializes in online checkout operating systems – announced on Thursday that it’s buying crypto infrastructure provider Wyre Payments for a reported $1.5 billion. Bolt – which counts major retailers like Forever 21 and Juicy Couture as customers – is looking to incorporate digital currency payments onto its platform, in a bid to make paying for Ben & Jerry’s with bitcoin the norm.

50bp in May with a QT start
Fed Governor Lael Brainard’s comments on Tuesday gave us fair warning for what to expect in the minutes to the March FOMC meeting that have just been released. Brainard, who continues to await confirmation as vice chair of the Federal Reserve, is often viewed as being on the more dovish wing of FOMC members. For her to endorse “a series of interest rate increases” plus the promise to “reduce the balance sheet at a rapid pace as soon as our May meeting” underscores the Fed’s desire to “catch up” to regain control of inflation and inflation expectations.

In the end though the FOMC minutes don’t appear to go any further than what Lael Brainard outlined. They show one or more 50bp rate hikes “could be appropriate” at upcoming meetings (“many” would likely have voted 50bp in March had it not been for the Russian invasion of Ukraine). Note many in the market (ourselves included) expect three consecutive 50bp hikes from the Federal Reserve.

However,

The Fed won't leave it long before cutting rates again
Financial markets are already pricing in rate cuts in 2024, but we suspect that they could come sooner. The average period of time between the last Fed hike in a cycle and the first rate cut has only been 7-8 months over the past 50 years. A rate hike peak in the first quarter of 2023 would typically suggest rate cuts in the fourth quarter of 2023 and that is what we are forecasting as seen in the top chart. It suggests that the Fed’s aspiration of shrinking the balance sheet may come to a halt late next year too.

What Does This Mean?

With digitization and hybrid working now the norm, there’s been a massive surge in demand for the data centers that house the servers underpinning the world’s IT infrastructure. That’s made operators build out even bigger centers, and in turn look for ways to make them run even more efficiently. Enter AMD: the chipmaker just announced the $1.9 billion purchase of Pensando, whose chips and software speed up processing times and reduce operating costs for data centers. It could be a game-changer: the deal will allow AMD to get its hands on Pensando’s cost-saving chips and a long list of big-name clients – including Goldman Sachs, Oracle, and Microsoft – to boot.

Why Should I Care?

For markets: Intel snoozes, Intel loses.
AMD’s been growing fast over the past few years, and a lot of that’s down to the market share it’s been poaching off data center rival Intel. The chipmaker went from controlling less than 1% of the market in 2017 to 18% at the end of last year, as Intel slipped from 98% to 76%. That might partly be why investors sent AMD’s stock up 1,300% and Intel’s just 12% over the same period...

AMD still has some stiff competition: Nvidia just released a new AI-powered chip designed to enhance data center performance, which could help cut down processing times from weeks to days. Issue is, the sheer amount of power it needs to do the job could put potential customers off – especially given how crippling energy prices are right now. That’s probably something Nvidia will need to fix if it wants to become a more significant threat to Intel and AMD in the space.

Miners have fallen out of favor with investors in the last few years, mostly because the carbon-intensive practice doesn’t suit the trend toward renewable investments. But here’s the acute irony: industrial metals like copper and nickel are more important than ever to eco-friendly technologies, from electric vehicle batteries to wind farms.

Legal & General Investment Management, then, is predicting that miners will need to produce twice as much copper and four times as much nickel over the next 30 years. If they don’t, the world will struggle to keep global warming within 1.5 degrees celsius above pre-industrial levels. And right now, it thinks those production targets aren’t feasible. In fact, consultant Wood Mackenzie thinks the mining industry needs $2 trillion worth of investment to stand any chance of meeting those ambitious goals.

Why Should I Care?

If you’re going to play your part, keep in mind that some miners are greener than others: coal-powered nickel producers in Indonesia generate far more emissions than hydropower ones in Canada, for instance. That’s why Legal & General thinks you should back those with the lowest possible carbon footprints to help bring down emissions across the entire mining industry.

The bigger picture: The UN kills the vibe.
That wasn’t the only cause for concern this week: the UN also warned that the energy transition is “backsliding” as countries scramble to find alternatives to Russian gas. And since most haven’t built up a robust enough renewable infrastructure yet, those alternatives ain’t pretty: the amount of funds raised for coal projects last quarter were twice as high as they were the same time last year. The UN isn’t hopeful: it now thinks the world’s on track to warm by more than 3 degrees.

The initiative is part of a broader effort by the UK government to “lead the way” in cryptoassets globally. The minister announced a number of steps the UK will take to bring digital assets under more regulatory scrutiny, including plans to:

Bring certain stablecoins into the UK payments framework so that stablecoin issuers and service providers can “operate and grow in the UK.”

Consult on a “world-leading regime” for regulating trade in other cryptocurrencies, including bitcoin.
Ask the Law Commission to consider the legal status of blockchain-based communities known as decentralised autonomous organisations, or DAOs.
Examine the tax treatment of decentralised finance (DeFi) loans and “staking,” which gives crypto users the ability to earn interest on their savings.
Establish a Cryptoasset Engagement Group that will be chaired by ministers and host members from the UK regulators and cryptoasset businesses.

Explore the application of blockchain technology in issuing debt instruments.
Chancellor of the Exchequer, Rishi Sunak said:

"It’s my ambition to make the UK a global hub for cryptoasset technology, and the measures we’ve outlined today will help to ensure firms can invest, innovate and scale up in this country. We want to see the businesses of tomorrow – and the jobs they create - here in the UK, and by regulating effectively we can give them the confidence they need to think and invest long-term. This is part of our plan to ensure the UK financial services industry is always at the forefront of technology and innovation."

It was a record year for mergers and acquisitions (M&A) last year, and there were a couple of key reasons why. First, interest rates were so low that companies would’ve been crazy not to borrow cheap money while they could. And for another, they didn’t even need to borrow cash: stock prices were so high that companies could pay up using their own shares instead.

But this year’s taken a turn: central banks have been hiking interest rates to slow down rising prices, which has made it more expensive to borrow cash. And last quarter’s stock market dip meant companies’ shares suddenly didn’t go nearly as far. All that, at a time when higher costs are weighing heavier on their bottom lines. Say no more: the value of deals struck was 23% lower than the same time last year.

Still, it’s all relative, and companies were still keen to buy up other businesses. Firstly, this was the seventh-straight quarter where companies shook hands on a total of over $1 trillion worth of M&A. Secondly, they signed more deals worth over $10 billion than the same time last year. And thirdly, private equity groups – which buy struggling firms, improve them, and then sell them on for a profit – spent a record amount on deals during the first quarter of the year.

Investment banks charge fees for advising on M&A, so this slowdown has analysts expecting some of the world’s biggest banks – including Citigroup and JPMorgan – to report a drop in quarterly profits for the first time in nearly two years. That might explain why JPMorgan’s and Citi’s stocks have fallen around three times as much as the US stock market this year.

The US has beaten economists’ expectations for the last two months, but clearly it couldn’t handle the mounting pressure: the country posted 431,000 new jobs last month – some way shy of the 490,000 economists were expecting. And while that’s nothing to be sniffed at, there are still almost twice as many job openings as there are job seekers.

Still, let’s look at the bigger picture: the US added nearly 1.7 million jobs last quarter, which puts economists’ expectations to shame. What’s more, the proportion of people in or looking for work – known as the “labor force participation rate” – is back to within a hair’s breadth of pre-pandemic levels.

Why Should I Care?

Desperate times call for desperate measures: a near-record 49% of small US businesses raised salaries in March in an effort to fill their vacant roles, helping push the average hourly pay up 5.6% from the same time last year. Thing is, businesses will probably just pass those higher costs back onto customers by raising prices, and that potential “wage price spiral” could push up inflation and put more even pressure on the economy as a whole.

For markets: A recession is nearly inevitable.
Investors are worried that Friday’s strong data will encourage the Federal Reserve to push ahead with plans to raise interest rates multiple times this year, potentially even with bigger increases than the typical 0.25%. And since investors are aware of the short-term damage that could do to economic growth, they’re flocking to longer-term assets like 10-year bonds. In fact, demand for them pushed their yields lower than those of 2-year bonds on Friday. That “inversion” is as rare as it is foreboding: it’s historically been a sign of an imminent recession.

The March jobs report shows that the labour market continues to strengthen with non-farm payrolls rising 431k with an additional 95k of upward revisions to January and February data. This is versus a consensus forecast of 490k. The gains were spread throughout all sectors with manufacturing posting a 38k increase, retail was up 49k, trade and transport up 54k and business services up 102k. Leisure and hospitality continued to grow strongly with employment growth of 112,000 while Federal government was the only disappointment with 1,000 jobs lost. In aggregate, payrolls now stand at 150.93mn, which is 1.58mn below the February 2020 peak.

The household survey, which is used to calculate the unemployment rate showed employment rising an even more impressive 736k. The number of people classifying themselves as unemployed fell 318k so the result is the unemployment rate dropping more than expected from 3.8% to 3.6%. The participation rate continues to grind higher and now stands at 62.4%, a full percentage point below the pre-pandemic level with the participation rate of the over 55s 1.4 percentage points lower.

Will supply of workers improve? Well, labour participation rates remain relatively low and the notion of people making lifestyle changes could explain this. People who have seen their 401k retirement plans surge in value, for example, or some people who built up a cash reserve due to financial support may not feel it is the right time to return yet. Also, the pandemic still makes some people reluctant to return to work full time while (legal) immigration, which could pick up some of the slack, has been restricted due to the pandemic.

Rising wages may well attract more people back in time, but this is not like turning on a light switch. Demand outstripping supply will likely remain in place for quite a long time, thereby keeping inflation pressures elevated and the Federal Reserve in hiking mode. We look for 50bp Fed hikes in May, June and July, before they switch to 25bp as quantitative tightening kicks in and contributes to tighter monetary conditions.

Just when Chinese companies thought they were back to business, a surge of Covid cases led to tighter restrictions across the country. That zero-tolerance attitude is having an impact: the latest business activity survey – which asks the country’s managers how busy their firms have been that month – showed that the services industry shrank last month. So did the manufacturing sector, which lost workers to quarantine and international customers to war-related belt-tightening. And the worst could be yet to come: Shanghai – home to the world’s biggest shipping container port – went into lockdown in late March, and economists think it could cripple the country’s companies for months to come.

Why Should I Care?

It’s hardly a surprise that the services sector saw a drop-off: survey data out from the People’s Bank of China this week showed that 55% of respondents preferred saving money to spending or investing it last quarter – the highest proportion for almost 20 years. That doesn’t bode well: consumer spending makes up more than half of China’s economy, so a drop in spending could stunt economic growth even more.

The bigger picture: China isn’t giving up.

At least China has a plan to get things back on track: the government said this week that it’s going to roll out measures to support the economy, including issuing more “special government bonds” to help fund infrastructure projects. Economists are also expecting the country’s central bank to cut interest rates, which should get the country spending again. It had better hope so: it’s aiming to grow its economy by 5.5% this year.