Morgan Stanley on the refinancing tsunami + Technical analysis of the ASX 200

Welcome to Charts and Caffeine - Livewire's pre-market open news and analysis wrap. We'll get you across the overnight session and share our best insights to get you better set for the investing day ahead.

Today is also a changing of the guard for the morning wrap. From today, and every Friday, Chris Conway will be writing Charts and Caffeine, taking the reins from the one and only Hans Lee. Hans will continue to write Monday to Thursday.

MARKETS WRAP

• DOW - 31,775 (+0.61%)
• S&P 500 - 4,006 (+0.66%)
• NASDAQ - 11,862 (+0.60%)
• CBOE VIX - 23.61 (-4.18%)
• US 10YR - 3.328%
• USD INDEX - 109.65
• FTSE 100 - 7,262 (+0.33%)
• STOXX 600 - 414.09 (+0.50%)
• UK 10YR - 3.162%
• GOLD - US$1,720/oz (-0.4%)
• WTI CRUDE - US$83.54/bbl (+2%)
• DALIAN IRON ORE - US$100.09/T (+3%)

MAJOR HEADLINES

• US markets end higher in choppy trade
• US Fed Chair Powell said the US central bank is "strongly committed" to fighting inflation 
  
• Fed Vice Chair Brainard says risks to become two-sided at some point, though still too early to pull back tightening
• Fed says economic activity stabilising, slower pace of price increases
• European Markets rose but the ruro remained unchanged after the ECB raised interest rates by 75 basis points as expected. Eurozone inflation over there is approaching double-digit territory, and policymakers are worried that rapid price growth could become entrenched. But, as is with the Euro these days, it's more about gas prices than it is about interest rates.
• RBA Governor Lowe says case for slowdown in pace of tightening strengthens as cash rate rises
• Markets price in greater likelihood of a 75 bp Fed rate hike in September
• Japan Q2 GDP revised up by more than expected, supported by private consumption and business spending
• EU officials set to meet tonight to discuss next steps on energy intervention

THE CALENDAR

Before we dive into what is on the docket next week, let’s not forget that Fed Member George and Fed Governor Waller speak tomorrow morning, at 2am AEST. Waller is the big one. There have been some communiques from the Fed of late that the battle against inflation will be paid for with lost jobs. 

Reminds me a bit of Lord Farquaad in Shrek…

In an attempt to soften the blow, Waller has recently been referencing the Beveridge Curve, which plots the relationship between job openings and the unemployment rate. The argument is that because of the current ratio of two job openings for each unemployed person – which is a record – there is the possibility that job openings can fall sharply as the economy slows, relieving pressure on wages and prices, without much of a rise in unemployment. In other words, there are too many jobs and if we only kill the jobs that no one wants, it won’t make much difference. Sounds like hocus pocus to me. If the Fed isn’t actually slowing the economy, reducing demand and ultimately increasing unemployment, then the surely upward pressure remains on wages and prices, and the US runs the risk of enduring an economy-killing wage-price spiral. 

Recent estimates from a team of researchers, including two staff economists from the IMF, showed that the US unemployment rate might need to reach 7.5% to break the inflationary cycle. US unemployment is currently 3.7%. Yikes. 

So, clearly there is a divergence of opinion on the matter and it will be interesting if Waller keeps trying to push the Beveridge Curve barrow when he speaks. Beveridge Curve graphic for reference below, sourced from Reuters. 

As for next week, the big data point is the US CPI number for August, on Tuesday night at 10:30 pm, AEST. For reference, in July headline CPI came in at 8.5% against expectations of 8.7%, and down from the 9.1% the month prior. A retreating oil price was the major moving part and there is some expectation a continued pullback in energy prices will see inflation fall again next week. The market will be looking for further signs of ‘peak inflation’ and less pressure on the Fed to keep hiking aggressively.

Other notable data points include the Aussie employment numbers, at 11:30 am AEST on Wednesday, US retail sales on Thursday night at 10:30 pm, AEST, and US consumer sentiment on Friday night, midnight, AEST. A big week ahead. 

THE CHART

I couldn't go past this chart from Morgan Stanley in their coverage on Australian banks. There was a real shift in mid-August when the market collectively decided that rising rates were a headwind, rather than a tailwind, and bank share prices fell in unison. Up until that point, rising rates were considered a sugar hit for the banks as the expectation was that they would fatten up their net interest margins (NIMs) - the difference between what the banks borrow at and what they lend at. The other side of that coin, however, is that if you raise too much and too fast, bad and doubtful debts rise as more and more households are unable to service their mortgages. 

The chart above from Morgan Stanley highlights one of the symptoms of increasing mortgage stress. More and more people are shopping around to get a better deal and, being the competitive monsters that they are, the banks are offering sweeter and sweeter deals to attract the ever-growing pool of migratory customers. Morgan Stanley points out that margin headwinds from mortgage competition and mix have increased from an average of -3 basis points (bps) per half in 2019, to -7 bps per half so far this year. 

Meanwhile, ABS data shows that monthly refinancing reached record levels of ~$18 billion in June and July as the RBA started hiking rates, and Morgan Stanley expects a further increase in refinancing over the next year or so. Time to call my broker. 

TECHNICALLY SPEAKING

In a previous life, I was a technical analyst and whilst some of you might think TA is a subcategory of the dark arts, or nothing more than glorified tea leaf reading, I love a good chart and what it tells me about the trend. The chart above is a daily chart of the ASX 200, showing three exponential moving averages (green = 125-period, blue = 21-period, and red = 8-period). If none of that makes sense to you, don't worry. Simply put, the EMAs show me the trend across multiple timeframes. Note that they are all pointed lower on the right-hand side of the chart. So the path of least resistance, and therefore the likely outcome, is that the market will move lower. Not a particularly revelatory insight; I think most people are of the opinion that the rally from the June low was a bear market rally, and that we're headed lower in the near to medium term. The question worth asking and answering, however, is where the index might find some support on the way down.

Note the horizontal line I have drawn around 6920. This is a key swing point, having acted as support multiple times on the way down, and likely resistance on any attempt by the bulls to push higher. Below the current market price, the 6600 level is a strong candidate for support, whilst the June low is the obvious area, around 6400. 

I'm not the only one thinking markets are heading towards the June lows. In an article on MarketWatch, Jonathan Krinsky, chief market technician at BTIG, provided the following chart and noted that "bear markets typically don’t bottom until monthly RSI hits 42 or lower.”

For those unfamiliar, RSI stands for Relative Strength Index, and it measures the speed and magnitude of price changes. The current RSI for the S&P 500 is 48.54 - still some way from the 42 level Krinsky highlights as being the key point at which bear markets are more likely to bottom out. 

THE TWEET

Even Michael Burry is piling on to the 'retesting the lows' bandwagon, although he's coming at it from a vastly different angle.

That's it for this week. I hope you enjoyed my first crack at Chart and Caffeine. It's a little different but hopefully entertaining and insightful. I'm sure you will let me know in the comments below.