RBC: We Are “Losing The Impulse”

Having held on to hope that the reflationary impulse would sustain the adverse series of events and geopolitical shock over the past two weeks, RBC’s head of cross-asset strategy Charlie McElligott is ready to throw in the towel, driven by what we have been pounding the table on for the past three months, namely the fading inflationary impulse out of China, manifesting itself most vividly in the recent crash in various commodities, and iron ore in particular, which has tumbled 30% from recent highs.

In a note released moments ago, McElligott cautions that the market is “losing the impulse” and adds that while attention is focused on events out of the UK where Theresa May unexpectedly announced snap elections, “the “real” macro story in my eyes overnight is the ongoing commodities fade originating out of China. Iron Ore continued its outright collapse (Qingdao 62% Iron Ore is -17.6% MTD and -30.2% from late February highs), while Aluminum, Copper, Zinc, Lead, Rubber, Gold, Silver, Rebar, Brent / WTI Crude, Gasoline and Nat Gas are all markedly lower.“

The larger implications here both with lower commodities as well as the potential for contraction in Chinese credit creation comes back to a weakening in “inflation expectations.” Already over the past few weeks I’ve noted the fading of the ‘energy’ component in recent CPI prints in both Germany and US, as the base-effect in crude thins further. Market indicators such as US breakevens, 5y5y inflation swaps, ‘cyclicals vs defensive’ equities and the aforementioned iron ore are all continuing their collective slide as well.

As a reminder, we showed last week that the Chinese credit impulse has rolled over sharply, and is now the lowest it has been in 7 years.

And some further details this morning from UBS:

Looking at the QI model, either “Inflation Expectations,” “Metals & Agri” or “WTI & Brent” are “top 3” macro factor price-drivers of the following cavalcade of bell-weather securities: UST 10Y, 6th ED$, USD fwd 2Y2Y, Bund 10Y, EUR fwd 2Y2Y, BTP 10Y, Nasdaq, S&P 500, STOXX Europe 600, Nikkei, MSCI Emerging Markets, EURUSD, USDJPY, EURJPY, Gold and JNK (US HY credit). Net / net, “inflation” remains the most critical driver of cross-asset pricing—so if ‘price is news’ and inflation is preparing to fade further (without any seeming ‘US fiscal policy’ booster shot coming near- to medium- term), be ready for negative impact on risk-assets.

For now the market continues to ignore ths most important signal, focusing instead on micro developments, although as more strategists start pointing out this tectonic shift in reflationary forces, expect both sentiment and volatility to shift significantly in the coming weeks.

HIs full note below:

LOSING THE IMPULSE

Overnight

Lots of focus on Theresa May’s shrewd move to call for snap UK elections June 8th—in a move which will actually further solidify her power-base / Brexit leverage as the Tories are currently so far ahead of Labour in polling—is the ‘headliner’ overnight, squeezing the Pound in PAIN-TRADE fashion to multi-month highs and back above its 200DMA for the first time since the referendum last June (although the strength in the currency is roiling FTSE 100 -1.8% as banks and materials lead lower).

Currently we too see the USD as a casualty of this move in Pound (along with Euro strength), with the DXY through the psych level of 100 and the BBDXY cracking lower back through its 200DMA. The implications here for risky-assets are evidenced by the ongoing fade in $/Y, which drives a further bid in USTs as well as weighing on yen-funded FX carry strategies and broad risk appetite. Between the weaker Dollar and weaker commodities / breakevens (5y BE’s through 1.80 level, more below), nominal US yields remain “stuck lower” in their new range.

In turn, this ‘lower rates’ dynamic will continue to drive strength in ‘duration sensitive’ equities—as we already see the defensive ‘bond-proxies’ REITS, Utilities, Consumer Staples and Healthcare as the S&P 500’s top four sectors MTD…while Telcos too remain the top performing sector on a YTD-basis. Flipside, ‘reflation’ themes (value, cyclicals, high beta, leveraged balance sheet, small caps) should continue to get beaten-up as per MTD trend (bottom-chart). The good news for the generalist is that ‘secular growth’ as a ‘hiding-place’ from interest rate- and fiscal policy- risk is ‘hanging in there,’ despite the continued volatility seen in ‘12m momentum’ factor market-neutral strategies which are experiencing their ‘now seasonal’ unwind phenomenon (pressuring both ‘growth’ and ‘value’ sectors from the long-side, and squeezing ‘bond proxies / defensives’ from the short-side).

Inflation

The “real” macro story in my eyes overnight is the ongoing commodities fade originating out of China. Iron Ore continued its outright collapse (Qingdao 62% Iron Ore is -17.6% MTD and -30.2% from late February highs), while Aluminum, Copper, Zinc, Lead, Rubber, Gold, Silver, Rebar, Brent / WTI Crude, Gasoline and Nat Gas are all markedly lower.

The driver of the China commodities selloff (with stocks weaker too: SHCOMP -1.5% WTD, SZCOMP -2.0% WTD and BCIPO -4.8% WTD) is just as I mentioned yesterday: a perverse market concern that the “strengthening economy” (post the weekend +++ data dump) will spur further PBoC tightening with money market rates, potentially trigger a reversal in the central bank mandated “credit stuffing” (the key input to the “global reflation” last yr in conjunction with the Yellen Pivot / G20 Accord) and possibly drive further scrutiny on shadow financing. Another example in the post GFC regime, where “good” data is “bad” for markets, based upon concern surrounding disruption of perpetual credit extension / liquidity / stimulus.

The larger implications here both with lower commodities as well as the potential for contraction in Chinese credit creation comes back to a weakening in “inflation expectations.” Already over the past few weeks I’ve noted the fading of the ‘energy’ component in recent CPI prints in both Germany and US, as the base-effect in crude thins further. Market indicators such as US breakevens, 5y5y inflation swaps, ‘cyclicals vs defensive’ equities and the aforementioned iron ore are all continuing their collective slide as well.

Looking at the QI model, either “Inflation Expectations,” “Metals & Agri” or “WTI & Brent” are “top 3” macro factor price-drivers of the following cavalcade of bell-weather securities: UST 10Y, 6th ED$, USD fwd 2Y2Y, Bund 10Y, EUR fwd 2Y2Y, BTP 10Y, Nasdaq, S&P 500, STOXX Europe 600, Nikkei, MSCI Emerging Markets, EURUSD, USDJPY, EURJPY, Gold and JNK (US HY credit). Net / net, “inflation” remains the most critical driver of cross-asset pricing—so if ‘price is news’ and inflation is preparing to fade further (without any seeming ‘US fiscal policy’ booster shot coming near- to medium- term), be ready for negative impact on risk-assets.

INFLATION (EXPECTATIONS, METALS & AGS, WTI & BRENT) MATTERS MOST IN DRIVING ASSET PRICES: