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What Does “Sticky Inflation” Mean For Your Portfolio?

Darius joined Anthony Pompliano this week to discuss inflation, the “No landing” vs. “Soft landing” debate, the Fed, and more.

If you missed the interview, here are the three most important takeaways from the conversation that have significant implications for your portfolio: 

1. The “No Landing” Scenario Is The Highest Probability Outcome Over The Next 12 Months.

The “Soft landing” vs. “Hard landing” vs. “No landing” debate continues. We define a “Soft landing” as a period of trend or below-trend GDP growth, facilitating a gradual return of inflation to trend over time. Conversely, a “Hard landing” signifies a period of GDP growth significantly below trend, which triggers a contraction in the labor market and ultimately leads to a recession. In contrast, a “No landing” scenario entails GDP growth at or above trend, enabling inflation to decelerate but not return to its 2% target.

Our analysis indicates that a “No landing” scenario is the most probable outcome over the next 12 months. 

We employ two distinct models to forecast inflation. While the median forecast from these models suggests incremental disinflation in the upcoming quarters, by the fourth quarter, we anticipate bottoming at a level higher than the Fed’s 2% target. This scenario is likely to inflict pain on asset markets once policymakers react to this new reality.

2. Regarding Inflation, 3% Is Likely To Become The New 2% 

In our recent deep dive into our secular inflation model, we found a noteworthy key takeaway: we anticipate that 3% will become the new inflation benchmark, replacing the previous benchmark of 2%. 

We believe the Fed will acquiesce to 3% being the new 2%. This shift in perspective seems to be gaining traction, as evidenced by Chair Powell stressing inflation would return to its target “over time” during the March FOMC meeting.

While this transition will not unfold in a linear manner, we foresee that over the next few years, the Fed will embrace 3% inflation as the preferred target over 2% if getting inflation sustainably down to 2% will require a recession. This likely policy regime shift is structurally bullish for risk assets and structurally bearish for Treasury bonds.

3. A Variety Of Factors Have Contributed To The Recent Uptick In Inflation

We analyze several key metrics from the Cleveland Fed: the Median CPI, Trimmed Mean CPI, Median PCE Deflator, and Median Trimmed Mean PCE Deflator. Here is a breakdown of the latest figures:

The surge in these inflation metrics is suggestive of a broad-based acceleration and a preview of what we are likely to witness towards the end of the year as inflation struggles to bottom at a level consistent with the Fed’s 2% target.

That’s a wrap! 

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How Will The Election Year Impact Asset Markets?

Darius joined Victor Jones this week to discuss the impact of the PBOC’s policies, inflation, the election year, and more.

If you missed the interview, here are the three most important takeaways from the conversation that have significant implications for your portfolio: 

1. Policies Coming Out Of The PBOC Have Had A Meaningful Impact On Asset Markets This Year

Since December of last year, we have called for Beijing to implement front-loaded policy support as we entered 2024. 

That is what we have witnessed, and that front-loaded policy support has had two significant impacts on global financial markets:

  1. It has contributed to the uptrend in global liquidity, as evidenced by our 42 Macro Global Liquidity Proxy, an estimate for global liquidity calculated by summing the Global Central Bank Balance Sheet, Global Broad Money Supply, and Global Foreign Exchange Reserves ex-Gold. 
  2. It has supported a rebound in Chinese PMI, suggesting the narrative around the Chinese economy being a black hole is changing at the margins. 

2. The “Immaculate Disinflation” Theme Is Likely to Persist For Another Quarter Or Two

Over the past two months, we have seen Headline PCE, Core PCE, and Sepercore PCE Deflator accelerate to well above trend rates on a three-month annualized basis.

However, investors do not need to be highly concerned about those increases at the current juncture because:

We believe the “Immaculate Disinflation” theme may persist for another quarter or two before inflation bottoms at an unpalatable level relative to the Fed’s mandate. At that point, we believe the narrative around inflation is likely to change, and asset markets are likely to be impacted.

3. Fiscal Policy Is Likely To Continue Supporting Asset Markets Heading Into The Election

One reason we have been bullish on risk assets is that we believed President Biden and Treasury Secretary Yellen would implement favorable fiscal and net financing policies this year, supporting our “Resilient US Economy” theme and US liquidity. 

We believe the election remains a risk-on catalyst for now. However, asset markets are likely to face headwinds after the election. 

Sometime in Q4, we anticipate the RRP balance to have declined to at or near zero and the TGA balance to have decreased by $250B from current levels. Those estimates represent dangerous starting points ahead of another round of debt ceiling negotiations on the horizon is poised to induce volatility in asset markets.

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

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3. Have a great day!

The Fed Pivots From Soft Landing To No Landing… And Got Incrementally Dovish

Darius joined Maggie Lake on Real Vision’s Daily Briefing this week to discuss the implications of the recent FOMC meeting, fiscal policy, AI, and more.

If you missed the interview, here are the three most important takeaways from the conversation that have significant implications for your portfolio: 

1. The Federal Reserve Still Anticipates Three Rate Cuts in 2024

In this week’s meeting, the FOMC released its March Summary of Economic Projections. 

In their projections, the FOMC:

Since the summer of 2022, we have maintained our ‘Resilient US Economy’ theme and its potential to contribute to inflation settling at a level unpalatable to the Fed. Based on their revised projections, the Fed now agrees with our no-landing call. 

2. The Fiscal Impulse Remains Decidedly Positive

The YoY growth rate of the Fiscal YTD US Treasury Federal Budget Net Receipts remains positive at 7%.

However, that lags the year-over-year growth rate of the Fiscal YTD US Treasury Federal Budget Net Outlays, which is currently 9%. This dynamic is further underscored by the 15% year-over-year increase in the Fiscal YTD US Treasury Federal Budget Balance, translating to an expansion in the budget deficit.

This incremental fiscal impulse we continue to see from the Biden Administration signifies an intentional effort to secure victory in the upcoming election.

3. The AI Theme May Be Overpriced for The Current Pace of Development And Deployment

While our overall outlook for the AI sector remains bullish, we anticipate gains to be increasingly experienced by other sectors, as we expect the market performance to continue broadening out as it has done over the past four to six weeks.

Furthermore, at 42 Macro, we closely monitor various metrics, including the combined S&P500 Tech & Communication Services Mean Price to Trailing Twelve Months (TTM) Earnings and Sales Ratios, along with the Combined Market Cap to S&P500 Market Cap ratio. Although the combined S&P500 Tech & Communication Services Mean Price to TTM Earnings ratio falls below the levels seen during the tech bubble in 2000, the Mean Price to TTM Sales and Market Cap as a % of the S&P 500 ratios exceed or match those observed during that period.

While these ratios may exceed these levels, we expect equity market performance to continue broadening out as investors acknowledge the high probability of the no-landing scenario.

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!

Will Rate Cuts Come in 2024?

Darius sat down with Maggie Lake on Real Vision’s Daily Briefing this week to discuss asset markets, productivity growth, Immaculate Disinflation, and more. 

If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio: 

1. A Tug-of-War Has Emerged Between The No-Landing And Soft-Landing Scenarios

Asset markets have pivoted to a soft-landing as consensus since late October, driven by positive surprises in growth, global liquidity, and productivity, as well as favorable treasury net issuance policy.

At the current juncture, the probability of a soft-landing scenario is in the process of peaking, and the no-landing scenario is gaining share.

The no-landing scenario is not yet the modal outcome, however. The February ISM Services Report provided insight into various metrics, including the Headline ISM Services PMI, Prices, New Orders, Employment, Number of Industries Reporting Growth, and Supplier Delivery Times. Collectively, these metrics supported the soft-landing scenario at the expense of the no-landing scenario.

2. Above-Trend Productivity Growth Will Likely Be Sustained For The Next Few Quarters

The recent surge in AI, coupled with decreased employee turnover rates and the thawing of global supply chains between the manufacturing and services sectors, has collectively fueled above-trend productivity growth. 

We anticipate that this momentum in productivity is likely to be sustained over the medium term.

This is important for investors because higher productivity puts less pressure on corporate margins, reducing the need for corporations to shed costs and/or pass on price increases to consumers.

3. Immaculate Disinflation Is Likely to Dissipate In The Second Half of This Year

Immaculate Disinflation persists.

Despite the two hot inflation prints from last month’s CPI and PCE Deflator reports, the Fed recognizes that a single month’s data does not establish a trend. They prefer to see sustained patterns over multiple months before considering a policy shift. 

That said, we believe that the “Immaculate Disinflation” narrative is likely to come to an end in the second half of this year.

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!

Will The US Economy Enter A Recession?

Darius sat down with Chris Berg recently to discuss the outlook for asset markets, the probability of a recession, the Fourth Turning, and more. 

If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio: 

1. The US Economy Is Likely to Avoid A Recession In 2024 If Productivity Growth Remains Above Trend

Productivity, as measured by output per hour in the US labor market, is showing robust growth at 2.7% year-over-year, surpassing the 10-year, 30-year, and 50-year averages of approximately 1.7%.

To achieve a soft landing, at least two of the following three conditions are typically required:

  1. Sustained at-trend or above-trend productivity growth
  2. Rate cuts
  3. At-trend or above-trend fiscal spending

Presently, productivity is above-trend, money markets have effectively already priced in rate cuts, and we are likely to see above-trend fiscal spending in the current election year.

In the event of a recession, our analysis suggests that it is unlikely to materialize until 2025 at the earliest.

2. We Believe The No-Landing Scenario Is Likely to Become The Modal Outcome Over The Next One to Two Quarters

While a soft landing signifies achieving at or below-trend growth, facilitating the return of inflation to the Fed’s 2% target, a no-landing scenario entails sustaining growth at or above trend levels, preventing disinflation from bottoming at 2%. Conversely, a hard landing is a scenario where the economy enters into a recession.

In the past four months, there has been a notable decrease in the likelihood of a hard landing. Meanwhile, the probability of a no-landing scenario is on the rise, although a soft landing remains the modal outcome for now.

However, we anticipate that the no-landing scenario is likely to become the modal outcome over the next one to two quarters. This expectation stems from our belief that nominal real economic growth is poised to surprise to the upside through the first half of this year across major economies worldwide.

3. The Fourth Turning Will Have Significant Implications For Investors’ Portfolios

Last fall, our team performed an empirical deep dive on the Fourth Turning, a theory sparked by Niel Howe, mentor and former colleague of 42 Macro CEO Darius Dale. While there may be some erosion in our reserve currency status during the Fourth Turning, we maintain the belief that the United States is unlikely to lose its position as the world’s reserve currency.

Moreover, we could experience a strengthening dollar as lenders and borrowers around the world favor financing in other currencies at the margins, resulting in a continuation of the underlying dollar short squeeze that has been ongoing since 2014. If we do, it would likely necessitate the Federal Reserve to counteract through measures such as currency debasement and financial repression.

Regardless of your outlook on asset markets in the long term, we emphasize the importance of focusing on the current and upcoming Market Regime as the optimal path to navigate through these growing uncertainties.

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!

What The Pivot to A REFLATION Market Regime Means For Asset Markets

Darius sat down with Julia La Roche last week to discuss the recent transition to REFLATION, inflation, rate cuts, and more.

If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio: 

1. REFLATION Is Now The Top-Down Market Regime

Last week, we experienced a Market Regime shift from the perspective of our 42 Macro Global Macro Risk Matrix from GOLDILOCKS to REFLATION. 

REFLATION introduces a distinct set of Market Regime guidelines that investors should consider for their portfolio construction:

Given that both GOLDILOCKS and REFLATION are both risk-on regimes, investors may not need to make significant adjustments to their portfolios for this particular regime transition.The big pivot investors must make in a GOLDILOCKS-to-REFLATION phase transition is being incrementally longer of Risk Assets relative to Defensive Assets. 

2. “Sticky Inflation” Is Likely To Be A Consensus Theme By The End of The REFLATION Market Regime

The January CPI Report revealed signs of sticky inflation:

Given the apparent lack of restrictiveness of the current policy in place by the Fed and the resilience of the labor market, a return to 2% inflation seems unlikely at this current juncture.

Moreover, a divergence between CPI and PCE Deflator statistics has emerged in recent months. We believe this divergence is likely to persist for another one to two quarters, allowing the “immaculate disinflation” theme to continue and asset markets to rally during this period.

3. Money Markets Are Pricing In A More Aggressive Rate Cutting Cycle Compared to The Fed’s Dot Plot Projections

The conventional wisdom among average investors is that rate cuts are only observed when the Federal Reserve begins to lower the policy rate. However, the reality is more nuanced – asset markets, not just in the US but across major economies, are deeply influenced by broader financial conditions rather than solely relying on the observed level of the policy rate. 

At 42 Macro, we review policy rates set by the Fed, ECB, Bank of England, and Bank of Japan, as well as the overnight index swap rates relative to the policy rate, which reflects market expectations regarding rate hikes or cuts over the next 3, 6, 9, and 12 months. For the past six months, we have consistently observed negative spreads across OIS curves for the Fed, ECB, and Bank of England. 

From our standpoint, this suggests that the rate cuts have effectively already occurred. Looking ahead to the next quarter or two, we anticipate observing incremental evidence of eased financial conditions.

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!

Navigating Shifts In Global Liquidity

Darius sat down with Gordon Johnson last week to discuss the macro outlook for asset markets, the fourth turning, China, and more.

If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio: 

1. US Liquidity Is Likely to Peak Around Midyear 

The Federal Reserve has significantly increased the supply of Treasury bills, accounting for 69% of the total net marketable borrowing on a TTM basis through the first quarter. 

This has led to a reduction in the RRP and an injection of liquidity into the financial system, supporting asset markets. However, this trend is likely to shift in Q2, with the proportion of Treasury bills in net marketable borrowing dropping to 49% on a TTM basis. 

As a result, the drain on RRP will likely be halted, potentially impacting the favorable liquidity conditions supporting the stock market’s recent positive performance.

2. During The Fourth Turning Regime, Inflation Is Likely to Remain Elevated

Our research indicates that Headline CPI typically exhibits faster growth during Fourth Turning regimes, averaging 2.1%, in contrast to the 1.2% observed during the First, Second, and Third Turnings. 

As a result, we anticipate a shift towards a more inflationary climate over the next decade, diverging from the relatively stable price levels experienced in recent decades.

Consequently, this evolving landscape is likely to prompt the Federal Reserve to engage more actively in debt and deficit monetization, a trend we believe is likely to intensify over the coming decade.

3. China’s Structural Liquidity Trap

China is currently facing a structural liquidity trap, similar to the situation Japan encountered starting in the early 1990s. In this structural liquidity trap, additional credit growth in China is not effectively fueling economic expansion. Instead, it is primarily being used to roll over existing debt, allowing them to refinance current obligations.

Moreover, the expansion of the PBOC’s balance sheet has been largely driven by China’s foreign exchange reserves, a trend that halted in 2015. That said, incremental policy adjustments such as reducing the reserve requirement ratio (RRR), cutting loan prime rates, and bolstering medium-term financing are creating positive global liquidity conditions. 

These policy measures have had a positive impact on asset markets and have been contributing to the current GOLDILOCKS Market Regime. 

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!

Green Shoots or Rising Risk?

Darius sat down with Ash Bennington last week on Real Vision’s Daily Briefing to discuss the probability of a soft landing, the outlook for asset markets, and more. 

If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio: 

1. The Recent Inflection in The Sovereign Fiscal Balance to Nominal GDP Ratio Indicates A Slightly Less Bullish Outlook for Asset Markets

Our models indicate asset markets are becoming less bullish at the margins.

We have seen a notable shift in the Sovereign Fiscal Balance to Nominal GDP Ratio, transitioning from a negative to a positive trend. This shift indicates a reduction in the fiscal stimulus that has previously bolstered the resilience of the US economy. 

While these changes signal a more cautious outlook for asset markets at the margins, they do not pose significant concerns at the current juncture.

2. The Probability of A Soft Landing Remains High

Recently, we have witnessed a rebound in productivity growth.

This upswing in productivity is significant because to achieve a soft landing, at least two of the following three conditions are typically required:

  1. Sustained at-trend or above-trend productivity growth
  2. Supportive monetary policies from the Federal Reserve
  3. At-trend or above-trend government expenditures

Encouragingly, all three conditions have been met in recent months, significantly boosting the likelihood of a soft landing. As of now, the outlook remains positive, with few indicators suggesting the GOLDILOCKS regime is likely to change in the short term.

3. Throughout 2024, Strength Across The Major Global Economies May Cause An Upside Surprise in Asset Markets 

The latest January Global Composite PMI data indicates a bottoming in the UK, Eurozone, Japan, and Global PMIs, signaling a collective upswing in economic activities across these regions.

Additionally, signs are emerging that point towards potential factors that may lead to growth surprises, which in turn could bolster asset markets vis-a-vis a weakening dollar, enhanced global liquidity, and improved earnings projections.

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!

The Massive Stock Market Rally Is Pricing In A Soft Landing

Darius sat down with Mike Ippolito last week to discuss the private sector balance sheet, how the election year will impact asset markets, Bitcoin, and more.  

If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio: 

1. The Private Sector Balance Sheet Has Remained Resilient

Currently, household balance sheets are exceptionally flush with cash reserves. 

Similarly, household leverage is cyclically depressed, and the Debt-Service Ratio for households is structurally depressed. 

In fact, the last time the U.S. witnessed such a substantial proportion of cash on both corporate and household balance sheets was in the 1950s. 

These levels of cash on balance sheets underpin the resilience of the U.S. economy, and we believe the recent monetary tightening we have experienced to this point has been mostly noise. 

2. Both The Election And Fiscal Policy From Yellen Will Likely Be Supportive of Asset Markets This Year

Historically, election years tend to be positive for asset markets, with the 12-month returns leading up to elections averaging around 8%. 

Interestingly, when a Democrat incumbent is in office, the median return doubles to approximately 15% in the 12 months leading up to the election. 

We believe investors can anticipate positive outcomes for asset markets throughout 2024, with election optimism being a contributing factor. 

Additionally, when considering the Treasury’s recent decisions to support liquidity, we can expect continued positive outcomes in asset markets until that changes.

3. We Believe Bitcoin Will Experience Positive Inflows As Long As We Remain In A Risk On Regime

As long as the economy is in a GODLICKS or REFLATION regime, we can anticipate capital inflows into the cryptocurrency market. 

Additionally, we have experienced a significant increase in liquidity since October that has notably benefited Bitcoin. 

Since then, global liquidity has been on an upward trajectory, supported by liquidity from both the commercial banking sector and the non-banking financial sector.

Furthermore, leading indicators for the liquidity cycle suggest that we are likely to continue seeing positive drivers for liquidity in the medium term. 

However, it is important to note that a shift in the narrative surrounding inflation could pose challenges for asset markets.

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!

A Glimpse Into How 42 Macro Models Work

Darius sat down with Markets Policy Partners last week to discuss the details behind a number of 42 Macro models, inflation, and more.  

If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio: 

1. A Look Into How 42 Macro Nowcasts The Current Macro Regime

Our Global Macro Risk Matrix is designed to provide a current snapshot of the market regime from a top-down perspective.

This is important for investors because in order to be consistently profitable, they should align their positioning with prevailing market conditions.

Our process evaluates 42 distinct markets, including broad baskets of assets such as equities, volatility instruments, commodities, currencies, and various fixed-income measures like rates, spreads, and yields, and incorporates a volatility-adjusted momentum signal to assess each market’s performance.

We update the data daily and aggregate the scores for each market. 

Finally, the regime that accumulates the highest total score is identified as the prevailing top-down market regime.

2. Our Macro Weather Model Systematically Nowcasts Momentum Across The Principal Components of Macro

Understanding the current macro regime is just the starting point. 

To be successful, investors must also anticipate the duration of the current market regime and anticipate the transition to the subsequent market regime – especially when a “RORO” phase transition (i.e., risk-on-to-risk-off or vice versa) is increasingly likely. 

The Macro Weather Model is our process for analyzing several principal components of macro and translating those components into a 3-month outlook for major asset classes, including stocks, bonds, the dollar, commodities, and bitcoin.

This model monitors indicators that reflect both the real economy cycles and financial economy cycles:

3. Our Models Indicate Inflation Will Likely Trend 100 to 140 Basis Points Higher This Decade Compared to The Previous One

Since 2020, most forecasting models used on Wall Street, including DSGE and auto-regressive models, faced significant challenges in predicting inflation due to such an unprecedented surge in various economic indicators stemming from the COVID-19 pandemic.

During the decade from 2010 to 2019, core PCE maintained an underlying trend of approximately 1.6%. 

However, our models predict that Core PCE will likely average somewhere between 2.6% to 3.0% throughout the 2020-2029 decade. 

An increase to those levels is likely to cause concern for the Fed and may lead to structural policy adjustments in the future.

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!