Martin North – Page 40 – Digital Finance Analytics (DFA) Blog

The Slow Strangle That Higher Rates Causes…

While analysts still talk about the strength of the consumer, if you chose to look below the hood there are real issues emerging, thanks to the higher for longer interest rates that are now in the system because of Central Banks attempts to quell the inflation that they created by their earlier actions.

Jerome Powell conceded this past week that with perfect hindsight, their monetary policy settings through the pandemic would have been tighter – with rates not dropped so low, and quantitative easing less extreme.

My surveys in Australia continue to highlight the pressure on some households with for the first time more than half of mortgage holders underwater from a cashflow perspective. And its not only in Australia.

Americans, for example are falling behind on their auto loans at the highest rate in nearly three decades. With interest rate hikes making newer loans more expensive, millions of car owners are struggling to afford their payments. It’s a clear indication of distress at a time when the economy is sending mixed signals, particularly about the health of consumer spending.

And in the UK the bad news keeps coming for Britain’s lettings market, as a surge in mortgage payments pushes more landlords to the brink and threatens to pile extra misery on tenants.

Landlords paid 40% more mortgage interest in August than the same month a year ago, equating to an extra £4.3 billion ($5.3 billion), according to a report from broker Hamptons International. Mortgaged landlords handed over an average of 37% of their rental income to pay interest in August, up from 28% a year earlier.

“For some investors, this will be unaffordable,” said Aneisha Beveridge, head of research at Hamptons. “They will likely bow out, keeping upward pressure on rents.”

And more broadly, UK banks expect to tighten a squeeze on the mortgage market in the coming months as high interest rates stretch affordability and loan defaults pick up.

The Bank of England’s quarterly credit conditions survey found that lenders decreased the supply of mortgages in the third quarter and will restrict availability further in the coming months. Defaults and losses on home loans picked up in the third quarter as more households are forced to refinance at much higher interest rates.

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Seeking Shelter In Troubled Times…

As I have warned, October can be a fickle month on the markets, and is proving to be so again. Growing volatility in U.S. stocks is driving a search for defensive assets, though investors may have fewer places to hide this time around.

On Friday, global stock markets, including those in the US and Europe, experienced declines due to rising US treasury yields which reached a 16-year high and the potential escalation of the Israel-Hamas conflict. The pan-European STOXX 600 index lost 1.36% and MSCI’s gauge of stocks across the globe shed 1.10%. Emerging market stocks lost 0.53%. MSCI’s broadest index of Asia-Pacific shares outside Japan closed 0.6% lower, while Japan’s Nikkei lost 0.54%. So, losses everywhere.

On Friday, US President Biden said he plans to ask Congress for another $US74 billion ($117.2 billion) to fund the wars in Ukraine and the Middle East.

Fed Speak is not helping either, while other Fed officials have hinted that the tightening cycle could be at an end, Federal Reserve Chairman Jerome Powell’s comments on Thursday underscored possible further interest rate hikes, driven by the robust US economy, strong retails sales and tight labor market.

In a Bloomberg TV interview, Mohamed El-Erian took Federal Reserve policymakers to task, saying the US economy is seeing a period of “greater uncertainty” because of a lack of vision from Fed officials.

“You cannot drive a car without some understanding of what the road ahead looks like. You can’t just look at the rear-view mirror and try to adjust to every curve you just had,” El-Erian, the chief economic adviser at Allianz, said. “That is not how you drive policy and it’s certainly not how you drive policy when the impact of policy happens with a lag,” he said. “This is the first Fed I know that has not gotten it.”

In a note, a Bank of America’s team led by Michael Gapen said the Fed could done lifting rates. “Fed commentary has all but confirmed that the Fed will stay on hold in November. We shift the last rate hike in our forecast out to December. We think the strong September data keep another hike in play. But it is a close call. There are meaningful risks that the Fed will either delay the last hike into 2024 or not hike again.”

“Investor sentiment is quite negative, and we believe it’s important to zoom out and focus on the long term – even the intermediate term – and a lot of this will fall by the wayside,” said Ross Mayfield, investment strategy analyst at Baird.

“There’s not enough attention being paid to company earnings, which have been coming in strong, and guidance has been solid,” Mayfield added. “Investors would be wise to pay attention to that as much as the macro events, the geopolitical tensions.”

On Thursday the yield on 10-year U.S. Treasury notes, the bedrock of the global financial system, was briefly bid above the 5% barrier for the first time since July 2007, touching 5.001%. While the benchmark yield eased back from that level, it posted its largest weekly surge since April 2022. The 30-year bond last rose in price to yield 5.078%, from 5.102% late on Thursday. With the 2 year in similar territory, such a flat yield curve is a sign of uncertainty, with some questioning whether the bond market has become unanchored, or whether the big US bond issuance has moved markets, or whether it simply reflects a risk premium. The MOVE index, which measures expected volatility in U.S. Treasuries, stands near a four-month high.

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Property Investors Are Quitting Like Lemmings!

In my stress surveys I have been calling out the pressures on renters and property investors, especially in the Centre of Melbourne and other inner-city areas across the country.

The math is obvious. Despite rental increases, there is a limit on how much property investors can lift them, as renters are under pressure already. And property investors are also faced with significantly higher interest charges and other costs, to the point that the proportion of investors making cash flow positive returns has dropped to an all time low. Given that capital appreciation, the only other growth lever, is at best anemic, and in some cases non-existent, and the fact that you can now get 5 per cent of more on other investments, including term deposits and bonds, investors are continuing to bail. Inner City apartments are on the front line, as listings grow.

The AFR picked this topic up in an recent article, saying low capital gains and the large increase in holding costs are prompting more residential property investors to bail out of inner Melbourne and Sydney markets, data from CoreLogic shows.

The portion of investor-owned listings has ballooned to 60 per cent across Melbourne city over the three months to the September quarter, up from 56.7 per cent from the previous quarter and a sharp jump from the 50.9 per cent share a year ago.

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Things Are Going To Get Worse Before They Get Better…

US stocks mostly finished lower on Friday as tech shares fell and volatility surged, despite earnings from three major banks – JPMorgan, Wells Fargo and Citigroup helping to offset some of the negative sentiment.

Morgan Stanley’s Mike Wilson sees a rebound in earnings in the latter half of 2024 but for now, his message to investors is stick to the stock picker’s playbook as things are going to get worse before they get better.

The downward slide in US equities after the market peaked in July is set to continue with the catalysts for more declines already in place, according to the prominent equity bear who was ranked No. 1 in last year’s Institutional Investor survey after correctly predicting the 2022 stocks sell-off. His year-end target for the S&P 500 Index implies about a 10 per cent drop from the current level.

Oil on the other hand was more than 5 per cent higher, with WTI at 87.69 a barrel as concerns about the conflict between Israel and Hamas widening to include Iran flared. Some economists now estimate oil prices could soar to $US150 a barrel and global growth drop to 1.7 per cent — a recession that takes about $US1 trillion off world output if the conflict between Israel and Hamas widens to include Iran. Brent crude surged 7.5% in the week since the conflict began, posting its highest weekly gain since February, and was last at 90.94. All very inflationary.

Meantime gold surged more than 3 per cent back with the Gold contract above $US1900 an ounce to 1945.90 and the volatility index was more than 20 per cent higher at one point. The VIX was 15.8 per cent higher to 19.32 at the end of trade. The yield on the US 10-year note slid 8 basis points to 4.61 per cent in New York.

“This may be the most dangerous time the world has seen in decades,” JPMorgan boss Jamie Dimon said in a statement with the firm’s third-quarter results.

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More Evidence That Inflation Is Not Playing The Game

Wall Street’s main indexes closed lower on Thursday after a U.S. Treasury auction sent bond yields higher while investors were already digesting data that showed consumer prices rose more than anticipated in September.

After the data, the S&P 500 spent the morning zig-zagging between red and green. It turned decisively lower after a 1 p.m. EDT (1700 GMT) auction of 30-year U.S. Treasuries met weak demand.

US consumer prices advanced at a brisk pace for a second month, reinforcing the Federal Reserve’s intent to keep interest rates high and bring down inflation. Expectations ahead of Thursday’s publication of consumer price index numbers for September were for a continued clear reduction that would eliminate the last concerns that the Federal Reserve would be forced to raise interest rates once more. In the event, the market responded as though it had received a nasty shock, with bond yields surging higher while stocks sold off. An imminent Fed hike still looks unlikely — but evidently, many in the markets were hoping for any such chance to be extinguished.

The number was dominated by housing costs. Shelter inflation, on a year-on-year basis, is still above 7%. The clearest reason for disquietcomes from the “supercore” measure that Fed Chair Jerome Powell has emphasized in recent months — services excluding shelter. This category is heavily led by wage inflation, as labor is a large share of costs for such businesses.

Sentiment reversed after the 30-year Treasury auction, which drew weak demand and weighed heavily on the broader market sentiment. Swap contracts linked to future interest-rate decisions pushed the odds of another quarter-point hike back to about 50%, up from about 30% as recently as Wednesday.

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