Transcript
Speaker: Welcome to HSBC Global Viewpoint, the podcast series that brings together business leaders and industry experts to explore the latest global insights, trends, and opportunities.
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Speaker: The following podcast was recorded for publication on the 8th of August, 2024 by HSBC Global Research.
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Speaker: Hello and welcome to the Macro Brief.
Speaker: I'm Piers Butler.
Speaker: And there's only one story on investors' minds this week, the significant volatility that has swept across markets.
Speaker: So on this week's podcast, we're going to be looking at what's caused the market moves, whether we're through the worst, and where we go from here.
Speaker: I'm joined by a stellar lineup of guests.
Speaker: Here in London, we have James Pomeroy, Global Economist, Paul Mackel, Global Head of FX Research, and Max Kettner, Chief Multi-Asset Strategist.
Speaker: And joining us from Dubai is Stephen Major, Global Head of Fixed Income Research.
Speaker: Thank you all for joining us today.
Speaker: Thank you very much.
Speaker: Thank you.
Speaker: Right.
Speaker: Well, the calm seems to have returned to the markets.
Speaker: So I guess the question that needs answering today is, has the storm passed or are we in the eye of the storm?
Speaker: So to answer this, I think we need to look at what may have triggered the sell-off in the first place.
Speaker: And James, perhaps I can turn to you first.
Speaker: Why did everyone start worrying about the prospects of a US recession?
Speaker: It was all going so well.
Speaker: And in fact, the other question that you bring up in one of your reports is, are people looking in the wrong place?
Speaker: It's a good question.
Speaker: Because if you look at the US data we got at the back end of last week, there is a few things that got people a little bit nervous.
Speaker: So if you look at the labour market data, we had the rise in the unemployment rate, which triggered the sum rule, which got people a little bit nervous about maybe this was a sign we were going into recession.
Speaker: We had a slightly weaker payroll sprinter as part of that release as well.
Speaker: And people were starting to get nervous about maybe this idea that higher rates have started to hurt the US labour market.
Speaker: This happened alongside a big fall in the ISM manufacturing as well.
Speaker: And rightly or wrongly, people see that as a barometer of health of the US and global economy.
Speaker: And that number did come back.
Speaker: So you put those two things together, people start getting quite nervous about the US economy.
Speaker: But if you take a step back and you look at the broader set of data, things aren't quite so concerning.
Speaker: That ISM manufacturing fell all the way back to levels last seen all the way through last year when the US economy grew pretty healthily.
Speaker: So it's not necessarily a barometer of the overall health of the economy.
Speaker: And if we look at the labour market data in more detail, actually the broader set of data still look okay.
Speaker: Yes, there's been some cooling down in hiring and you've seen a drop in the quits rate.
Speaker: By that we mean the share of people quitting their job.
Speaker: But layoffs haven't picked up at all.
Speaker: If anything, they've fallen.
Speaker: And that's encouraging because it suggests that this rise in the unemployment rate is driven more so by supply issues than a lack of demand.
Speaker: So inward migration, more people coming to the labour force.
Speaker: And that's why you're not seeing any impact on consumer spending.
Speaker: Demand is holding up and the economy is ticking along.
Speaker: So...
Speaker: I can see why people got nervous, but it looks to me like the broader set of data look a little bit healthier than maybe people anticipated just looking at those numbers at the back end of last week.
Speaker: Now, the other thing that was going around, Paul, was all this talk around the yen carry trade.
Speaker: Suffice you to remind us what that is and what triggered the so-called unwind.
Speaker: Well, essentially, the yen carry trade has been existing for many years, if not decades.
Speaker: But it's when you're borrowing in that very low-yielding currency and investing in higher-yielding currencies, whether it's the U.S. dollar or some emerging market currencies.
Speaker: I think the Mexican peso has been a very popular vehicle for people to do so.
Speaker: over the past year, if not longer.
Speaker: But what we've seen through the month of July is the fastest period of yen strength since October 2008.
Speaker: So that's a pretty striking comparison because that's around the global financial crisis.
Speaker: So there are a few things that were creating this unwind of the yen carry trade.
Speaker: In our view, it started roughly about the 11th of July.
Speaker: So we had a very soft CPI print out of the U.S. There were seemingly some intervention procedures
Speaker: from the Bank of Japan on behalf of the Ministry of Finance.
Speaker: And that was sowing the seeds of this type of destruction in this carry trade backdrop that I'm outlining.
Speaker: Thereafter, market expectations started to become a lot more sensitive that the Bank of Japan could be raising interest rates more than expected or could even surprise on the hawkish side.
Speaker: So we saw this snowball type effect build and it just really cascaded into this currency getting stronger and stronger and stronger.
Speaker: And of course, the final piece of the puzzle was very much associated with what James was just outlining, concerns about the U.S. So a few things there are playing out, but in a very nasty way.
Speaker: And then adding to that mix, Max, if we look at it as sort of some kind of cocktail, is the positioning.
Speaker: So is it fair to say that the positioning in the U.S. equity market was stretched, particularly around the so-called Max 7?
Speaker: And there was a lot of hype around AI that perhaps people started to focus on?
Speaker: Yeah, I think that's right, Pierce.
Speaker: I think there's really what we sort of described as a triple whammy, this rotation out of AI and tech stocks, which first was going into the small caps, but then really was a rotation entirely out of those behemoths.
Speaker: And then of course we had, just like Paul was lining out, this unwind of the global carry trade and then recession concerns.
Speaker: And all those three coming together at the same time was really creating a pretty toxic mix, especially in an environment where there is of course typically lower liquidity during those summer months.
Speaker: I guess also when we look at positioning of more systematic strategies according to our measures, CTAs for example, by which I mean commodity trading advisors were running equity exposure as high as it's been last in the summer of 2021 when all of us remember this meme saga and this meme craziness was going on when we were spending more time on Reddit and Wall Street bets than on Bloomberg terminals.
Speaker: And I guess other strategies, systematic strategies, were running similar exposure.
Speaker: When we look at volatility target strategies, for example, again, they've had pretty elevated exposure, which has now started to come down.
Speaker: And Steve, finally, were you surprised at the speed of the adjustment and the scale of it in the bond markets?
Speaker: Well, I'll add to Max's triple whammy with the triple top, because that's what's happened at the short end of the yield curve.
Speaker: I wrote a paper in April talking about a triple top, and two-year yields have tried to break above 5% on three occasions in the last couple of years.
Speaker: and failed.
Speaker: So the trend line was already in place.
Speaker: And I'm no technical analyst here.
Speaker: I'm not talking about charts and stuff to justify the view.
Speaker: We've been projecting lower 10-year yields for some time.
Speaker: With that in mind, it's not a total surprise that yields are coming down.
Speaker: The speed of the move, this is kind of how it works.
Speaker: The turning points in markets are not benign.
Speaker: And the idea that we could call a benign turn looking at cyclical data, I think, is also something to be careful with.
Speaker: So this is often what happens.
Speaker: You have a whole confluence of events and a fairly violent episode, and then the turn is in place.
Speaker: Yes.
Speaker: So picking up on that point, I guess the question is, what now?
Speaker: Are we back to the summer doldrums or has something fundamental changed?
Speaker: And in that case, what should investors be looking for in terms of confirming that?
Speaker: Steve, we had you on the podcast recently and you made the point from a bond perspective that you were rewarded for being patient.
Speaker: Do you think that patience is still advocated?
Speaker: Yeah, so from a bond perspective, these days, there's an asymmetry in the return outlook.
Speaker: You're collecting a decent coupon, which is what lots of people have been doing in credit for some time and just waiting for the turn.
Speaker: In equities, you could argue that you've had a long trend and valuations were stretched.
Speaker: It's not for me to tell you whether equities were rich or cheap, but
Speaker: bonds are not supposed to be the exciting part of the portfolio.
Speaker: It does strike me that they serve a purpose in diversification.
Speaker: And so just being patient, sitting in bonds, waiting for lower rates has been rewarded.
Speaker: And Paul, in terms of the BOJ, they have come out and said that they will not hike when the stock markets are volatile.
Speaker: Is that a significant statement?
Speaker: I think in the eyes of the FX market, it is.
Speaker: I mean,
Speaker: On the back of that, we have seen some stabilization in the Japanese yen, which is spilled over to other currencies stabilizing.
Speaker: So to your point, are we still in the eye of the storm?
Speaker: Of course, we could be.
Speaker: But on the other hand, we are seeing some behaviors in exchange rates that are showing some signs of stabilization, which is encouraging.
Speaker: But yes, it is a significant statement in my view that the Bank of Japan is aware of how volatile markets have been.
Speaker: And in some ways, they've been associated with the epicenter of this volatility.
Speaker: Max, how much of all of this was a result of the fact that a lot of people are on holiday and therefore the markets were pretty thinly traded?
Speaker: Yeah, quite a lot, I think.
Speaker: And particularly with regard to systematic strategies, I think a lot of it was really driven by this unwind of systematic strategies and the various factors that we've been going through in the last couple of minutes.
Speaker: So I think going forward, what we now need to watch, what now, we need to watch for some of those systematic strategies starting to flag a bit of contrarian buy signals.
Speaker: So we need to have things like CTAs moving towards net short equities, net long rates, which they're looking like they're doing.
Speaker: We need to look
Speaker: at typical momentum signals where the signs are flipping.
Speaker: We need to look at things like volatility target strategies.
Speaker: There, we have definitely seen a pickup in volatility really spilling over into lower exposure in equities and higher exposure in cash.
Speaker: So absolutely.
Speaker: There is also other indicators that are already flashing it.
Speaker: So we're looking at implied volatility curves.
Speaker: So the term structure of the so-called VIX, which has been heavily inverted.
Speaker: So now going forward, I think a lot of it, yes, has been triggered by those systematic strategies.
Speaker: A lot of it has been triggered by perhaps poorer liquidity conditions.
Speaker: So going forward, that means we've got to also look at those same indicators to really gauge when they become too stretched to start getting back into the market.
Speaker: And James, on AI, obviously that's been one of the sort of big, big themes out there.
Speaker: To what extent are we in fact following the pattern that our colleague David Jost, our thematic analyst, has highlighted in tech, which is the disruptive framework, early adoption, hypermania, and then the backlash window?
Speaker: Are we entering a bit of a backlash window in AI before we kind of see the new normal?
Speaker: It's slightly odd because there's a bit of a difference in how the economy and the impact of that of AI on the economy is faring versus in markets.
Speaker: So on the market side, you've obviously seen a lot of hype around AI and Nvidia and these other stocks going up as a result of this.
Speaker: And then generally everyone getting excited.
Speaker: This is this new sort of paradigm we're moving to about much faster global growth and that feeding through into earnings expectations.
Speaker: But on the macro side, you are starting to see the whites of the eyes of this coming through.
Speaker: You can see it in the export data out of Taiwan.
Speaker: You can see a lot of trade data in Asia.
Speaker: You can see it in the investment data that's happening in the US and across the world.
Speaker: Tech investment is picking up really strongly.
Speaker: So it's slightly odd when there's now a disconnect between markets that maybe went early and went very strong.
Speaker: And now the economic implications starting to become a little bit more evident.
Speaker: And we think in the course of the coming years,
Speaker: you're going to see this come through more and more and more in that trade data, in that investment data, and eventually maybe in the productivity data too.
Speaker: So we still think you're on this upward trend.
Speaker: The question is where the markets went a bit too early and we're getting a bit of a reset there.
Speaker: But that underlying story in AI is playing a bigger role in the global economy still appears to be very much in place, at least in the economics data.
Speaker: Is there any big macro data that we should be looking at for in the next few weeks?
Speaker: I think a lot of focus is going to be on the next US inflation print just simply because of how much that's going to matter to the Fed.
Speaker: There's anything to do with the US labour market.
Speaker: It's going to get way more attention than it might have done historically.
Speaker: You look at things like initial jobless claims we get every week.
Speaker: Most people don't normally care that much.
Speaker: But I think in the coming weeks, those numbers are going to be really interesting.
Speaker: It's worth keeping an eye on those in particular around some of the seasonality.
Speaker: We had a very seasonal pattern last year, which we're tracking for now, even if numbers are still going up.
Speaker: We had the same story last year.
Speaker: So we've got to keep an eye on these numbers.
Speaker: I think anything to do with the US consumer is going to be interesting as well.
Speaker: Confidence data, spending data is going to get a bigger attention now than it might have done.
Speaker: Because the worry is you've had some signs of softness in the labour market.
Speaker: If people start cutting back and that leads to layoffs and that then spills out of control, that's when the recession risks are pretty clear.
Speaker: But as long as people keep spending, as long as layoffs stay low, then it's a much more comfortable environment and the soft landing that's in our forecast.
Speaker: So anything to do with the impact of this on the consumer and on the labour market is going to get loads more attention in the next few weeks than I think it has done in a long, long time.
Speaker: All right.
Speaker: Well, maybe we'll have you back on the podcast on some other data.
Speaker: But for now, James, Paul, Max and Steve, thank you very much for joining us today.
Speaker: Thank you very much.
Speaker: Thank you.
Speaker: Thank you.
Speaker: So that's all from us today.
Speaker: If you'd like more information on anything we've discussed, then please email askresearch at hsbc.com.
Speaker: Thanks for listening and we'll see you next time on The Macrobrief.
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