Who Cares What The Fed Thinks?
Darius joined our friend Maggie Lake last week on Real Vision’s Daily Briefing to discuss the resilient US economy, the Fed, inflation, 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 Resilient US Economy Does not Require Rate Cuts, But The Fed Wants To Cut Rates Anyway
Last week’s FOMC statement and press conference, led by Fed Chair Jerome Powell, were surprisingly dovish. Notably, the Fed announced a significant reduction in its balance sheet runoff policy, scaling down from $60 billion monthly to just $25 billion in its Treasury portfolio. Powell also downplayed recent increases in inflation and dismissed the likelihood of further rate hikes.
Additionally, we track the Fed’s dot plot alongside Fed funds futures pricing across different durations. Currently, futures indicate expectations for two rate cuts in 2024, followed by another two in 2025, less than a full cut in 2026, and subsequent cuts until the floor Fed funds rate is reached. Powell attempted to support that dovish market pricing in his press conference remarks.
It is clear to us that the Fed wants to ease monetary policy.
2. The Q2 QRA Sent A Hawkish Message To Investors
The Q2 Quarterly Refunding Announcement indicated Janet Yellen and the US Treasury Department are moving away from relying on bills for financing.
In the announcement, the Treasury stated that the proportion of bills in all Net Marketable Borrowing over the trailing 12 months until Q3 2024 would be 34%, marking the lowest share since Q1 2023.
This move suggests that the Treasury is extending its financing policy further along the yield curve. We believe this shift is intentional and aimed at sending a clear, hawkish message to market participants.
3. A “No Landing” In The Economy = A “No Landing” In The PCE Deflators
In the March PCE release, Supercore PCE Inflation increased to 5.4% on a three-month annualized basis, a level near the highs of the readings over the past three years. This uptick signals a textbook reacceleration pattern, where the three-month rate of change surpasses the six-month rate of change, which outpaces the YoY rate of change.
Turning to forward-looking indicators, the Employment Cost Index accelerated to 4.4% on a QoQ SAAR basis, 200 bps faster than its 2015-2019 trend.
If productivity growth decelerates and wage inflation persists, it could indicate the sticky inflation we have observed over the past couple of months may continue, and we may settle at a level of structural inflation higher than the Fed’s 2% target.
That’s a wrap!
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Fed’s Policy On Inflation Is A ‘Step In The Wrong Direction’
Darius joined our friend Maria Bartiromo on Fox Business last week to discuss the Fed’s policy on inflation and what it means for asset markets.
If you missed the interview, here is the most important takeaway from the conversation that has significant implications for your portfolio:
The Fed Is Kowtowing To Fiscal Dominance, And We Believe It Will Accept Higher Than 2% Inflation Over The Long Term
- The FOMC has stated that it would need greater confidence that inflation is moving sustainably towards 2% before easing policy. However, recent data hasn’t provided that needed confidence; instead, it suggests a prolonged timeline for achieving 2% inflation. If higher inflation persists, the Fed has stated they will maintain the current level of interest rates for as long as needed, rather than tightening further.
- When we refer to the monetary authority “kowtowing” to fiscal dominance, we are describing a situation where the Federal Reserve is being influenced by the government and fiscal policymakers. In 2023, the Federal Budget Deficit grew by $364 billion. The Fed is accepting the increased government spending will continue and inflation will remain elevated.
- Our analysis of prior economic cycles found that periods when the monetary authority kowtows to fiscal dominance are structurally bullish for risk assets like stocks and crypto and structurally bearish for assets like the bond market.
That’s a wrap!
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What Will Push Powell to Cut?
Darius joined Maggie Lake on Real Vision’s Daily Briefing this week to discuss the resiliency of the US economy, Immaculate Disinflation, Bitcoin, 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 US Economy Remains Resilient
In September 2022, we authored our “Resilient US Economy” theme, and the prevailing data today continues to support this narrative.
Furthermore, our research indicates that the Fed is likely to implement easing monetary policies over the medium term. This confluence of factors—a robust economy operating at or above trend coupled with supportive monetary measures—has fostered a bullish environment for asset markets.
We believe asset markets are likely to continue performing well until either our “Resilient US Economy” theme dissipates or the “Immaculate Disinflation” theme concludes, forcing the Fed and Treasury to officially pivot to hawkish forward guidance and net financing policy.
2. Recent Labor Market Data Indicates Evidence of Sticky Inflation
The Feb JOLTS report confirmed that “Immaculate Slackening” persists, but investors should be worried by the apparent bottoming in turnover:
- The Private Sector Hires Rate ticked up from its cycle low to 4.1%
- The Private Sector Quits rate remained unchanged at 2.4%
An increase in employee turnover could disrupt the “Immaculate Disinflation” narrative. Because workers who change jobs tend to have faster wage growth, the bottoming in these indicators suggests that we may be running out of steam concerning the disinflation we have observed in wages.
Despite the February JOLTS report supporting sticky inflation, we continue to believe the “Immaculate Disinflation” theme is likely to persist for another quarter or two.
3. Bitcoin’s Current Correction May Worsen If The “Immaculate Disinflation” Narrative Dissipates
After rallying 75% from Feb 1st to March 10th, Bitcoin is currently in a consolidation period.
We anticipated this pullback. Over the past month, we have highlighted several extended tactical positioning indicators in our positioning model to our clients, such as the AAII Bulls Bears Spread and AAII survey, that suggested markets were likely overbought.
If the “Immaculate Disinflation” narrative loses steam, the current correction could deepen. If that occurs, investors would need to pull forward their timeline expectations of a transition from a risk-on REFLATION Market Regime to a risk-off INFLATION Market Regime.
That’s a wrap!
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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:
- Increased the 2024 Real GDP forecast by 70 basis points to 2.1%, 2025 by 20 basis points to 2.0%, and 2026 by 10 basis points to 2.0%
- Lowered 2024 and 2026 Unemployment Rate projections to 4%
- Increased 2025 Headline PCE Inflation by 10 basis points to 2.2%
- Increased 2024 Core PCE Inflation by 20 basis points to 2.6%
- Retained three projected Fed Funds Rate cuts in 2024
- Increase 2025 and 2026 Fed Funds rate projections by one hike each to 3.9% and 3.1%, respectively
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!
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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!
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Is Your Portfolio Ready for the Next Big Market Shift?
Darius sat down with Cem Karsan on 42 Macro’s Pro to Pro Live last week to discuss corporate profits, inflation, recession, and more.
If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio:
1. The Treasury Continues To Starve The Market Of Coupon Supply
After analyzing the composition of the Treasury’s Net Marketable Borrowing, we found only 27% of the total issuance consists of coupons.
Treasury Secretary Yellen continues to meet the excess demand for T bills in the RRP Balance, which currently stands at approximately $600 billion.
This marks the lowest TTM Coupons to Net Marketable Borrowing ratio since the first quarter of 2018.
2. Corporate Profitability Is Broadly Improving, Reducing The Need For Corporations to Shed Costs And/Or Pass On Price Increases to Consumers
Our Corporate Profitability model, which tracks the spread between Gross Domestic Income growth minus the spread between Unit Labor Cost growth and Productivity growth, shows that Corporate Profits bottomed a few quarters ago and have improved since.
We believe corporate profitability will perform better than consensus expectations over the next one to two quarters.
As a result, we believe this may increase the potential for stock buybacks, providing a buffer against any potential downturn in asset markets.
3. Although We Believe Stagflation Is The Most Probable Outcome In The Long Term, Markets Do Not Have to Price That Outcome In Now Or All The Time
Last fall, our team performed an empirical deep dive on the Fourth Turning and its implications for investor portfolios.
Our findings indicate that real GDP growth is usually weak during fourth turnings, while inflation tends to be higher.
From a long-term perspective, we believe stagflation is the most probable outcome. However, markets do not have to price in stagflation immediately or all the time. Right now, asset markets are pricing in a soft landing. That will change at some point over the medium term.
We advise investors to avoid pigeonholing themselves to ‘one camp’ and instead align their positioning with the camp that will make them money for as long as it remains the modal outcome.
That’s a wrap!
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Is It Time To Get Risky in Crypto?
Darius sat down with Paul Barron on the Paul Barron Network last week to discuss the “soft” vs. “hard” vs. “no” landing debate, Bitcoin ETF, earnings, and more.
If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio:
1. Near Textbook Disinflation in The Super Core PCE Deflator Suggests That The Fed May Safely Land The Inflation Plane At 2% In The Coming Quarters
The likelihood of a soft landing for the economy has increased, as highlighted by last week’s PCE report.
Notably, the 3-month annualized rate of inflation change stands at 2.1%, and the 6-month rate is at 1.9% – figures that align closely with the Federal Reserve’s target inflation rate of 2%.
These readings suggest that year-over-year inflation is set to decline towards 2% in the upcoming quarters.
This downward trend in inflation is reinforcing the soft landing scenario currently being priced into asset markets.
2. We Believe Upcoming Earnings Reports Will Outperform Recent Quarters
Signs of enhancement in corporate profitability are already evident.
Our Corporate Profitability model, which tracks the spread between Gross Domestic Income growth minus the spread between Unit Labor Cost and Productivity, shows that Corporate Profits bottomed a few quarters ago and have improved since.
According to the model, earnings are expected to continue improving.
Should this trend persist, it will act as a tailwind for asset markets.
3. The Impact of The Bitcoin ETF Will Take Time to Materialize
The approval of a Bitcoin ETF is likely to have a long-term positive impact on BTC, as it will introduce structural inflows into the asset class.
However, it is important to note that these benefits will not be fully captured immediately upon the ETF’s approval.
We believe that much of the anticipated impact is already factored into current prices, due to market participants front running the event.
That said, the ETF is not the sole influencer of Bitcoin’s price. Factors such as inflation, economic growth, policy changes, and liquidity also play crucial roles in determining Bitcoin price trends.
Investors aiming to stay informed about Bitcoin’s future trajectory should monitor these metrics closely.
That’s a wrap!
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Did the Fed Just Take a Victory Lap?
Darius recently sat down with Maggie Lake on Real Vision‘s Daily Briefing to discuss the labor market, the Fed, corporate profits, and more.
If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio:
1. Labor Hoarding Has Spared The Business Cycle So Far… How Long Will It Persist?
In early 2022, the gap between labor demand and supply reached a peak of approximately 6 million.
Since then, it has steadily decreased to around 2.4 million – this is significant because it helps alleviate wage pressure in the labor market.
Additionally, for the first time in the time series, a significant divergence has emerged between the JOLTS Total Job Openings and the Household Survey Total Employment figures.
The slack in the labor market being created for almost two years now is coming from an abundance of job openings rather than a decrease in total employment.
This could pave the way to a soft landing, because the high number of unfilled jobs will likely reduce the upward pressure on wages, helping to moderate inflation without drastically increasing unemployment rates.
2. Surging Productivity Growth Is Supporting Rising Expectations of A Soft Landing
In late October, productivity growth came in at approximately 5% on a quarterly basis and 2% year-over-year, and these figures have since been revised upwards.
Corporate profits, which bottomed a few quarters ago, are now returning to more normalized levels.
This recovery in corporate profitability suggests that there is less pressure on corporations to reduce labor costs or to pass on price increases to customers, supporting the expectations of a soft landing.
3. Investing Is Not About Predicting Outcomes. It Is About Being Positioned to Take Advantage of What Happens In Asset Markets.
The Federal Reserve is aware that the effects of monetary policy are subject to long and variable longs.
As a result of the positive inflation, labor market, and productivity outcomes we have seen, we believe the Fed recognizes there is no need for further tightening.
Returning to 2% inflation without disrupting the labor market would be a highly favorable outcome – especially in a general election year that features an incumbent president.
However, as an investor, it should not matter whether the economy “soft”, “hard”, or “no” lands.
Instead, what is important is the trajectory that asset markets take to the ultimate outcome, and being positioned accordingly.
Over the past six weeks, 42 Macro clients have made a ton of money being positioned for, first, the pain trade higher in stocks and bonds, and, second, the eventual market regime transition to GOLDILOCKS. Our models will signal in real-time when it’s time to book these “soft landing” trades and begin betting on either the “hard” or “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.
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3. Have a great day!
Immaculate Disinflation?
Darius sat down with Maggie Lake last week on Real Vision’s Daily Briefing to discuss Immaculate Disinflation, Soft Landing, the Consumer, and more.
If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio:
1. There Is A High Probability That We Continue to Experience Downward Momentum in Inflation Over The Coming Months And Quarters
The Core PCE Deflator, which is the Federal Reserve’s preferred gauge for inflation, alongside the Supercore PCE, are both showing clear signs of deceleration.
The deceleration is evident as the 3-month annualized rate of change is below the 6-month rate, which in turn is lower than the year-over-year rate.
Additionally, the 3-month SAAR of Core PCE inflation is hovering around 2 to 2.5%, a range that aligns with what the Federal Reserve is comfortable with.
Given these trends, there is a high likelihood that we will see continued downward momentum in inflation in the upcoming months and quarters.
2. Asset Markets Recently Transitioned to A Goldilocks Regime That May Prove Easy To Sustain Into 1H24
Our research indicates that the economy transitioned to a “Goldilocks” regime approximately two weeks ago.
We believe the economy can remain in the Goldilocks regime over the next few quarters, provided we avoid slowing to a below-trend pace in real GDP growth.
Current consensus estimates forecast a growth of 1% quarter-over-quarter (QoQ) annualized for the fourth quarter and a more modest 0-0.5% QoQ annualized for the first and second quarters of the coming year.
If GDP growth aligns with these dovish projections in the forthcoming quarters, it could heighten investor expectations for a soft landing of the economy.
3. Recent Data Show The Consumer is Stable
Last week, we received updated Personal Consumption Expenditures and Income data that show the consumer is holding up well:
- Real PCE growth slowed to 2.1% on a 3-month annualized basis, a figure slightly below trend pace
- Good consumption decreased to a below-trend 1.9% on a three-month annualized basis
- Services consumption decreased to an at-trend 2.1% on a three-month annualized basis
- Real personal income increased slightly to a below-trend 1.2% on a three-month annualized basis
If the labor market remains stable, consumers should continue to fare well.
That’s a wrap!
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Is Goldilocks Going to End Soon?
Darius sat down with Mike Ippolito last week on the On The Margin podcast to discuss the FOMC, interest rates, inflation, and more.
If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio:
1. We Believe The Projections From The September FOMC Meeting Are Wishful Thinking
In the September FOMC meeting, the FED hiked its 2024 and 2025 median dot plot estimates by 50 basis points.
- The Fed raised its median Real GDP estimates by more than double for 2023 to 2.1% and by 40bps for 2024 to 1.5%.
- The Fed lowered its median unemployment rate estimate by -30bps to 3.8% for 2023, -40bps to 4.1% for 2024-25, and sees unemployment at 4.0% in 2026.
Despite these hawkish revisions to its growth and labor market estimates, the Fed still sees Core PCE decelerating by 3.7% by year-end, 2.6% by 2024, 2.3% by 2025, and 2.0% by 2026.
We disagree with the Fed’s projections and believe they will need to engineer a recession to bring down inflation to below-trend levels.
2. The Fed Will Likely Need to Cut Rates More Than What The Market Is Currently Pricing
The current Fed Funds futures pricing shows the expectation that the Fed will begin cutting rates mid-2024 – we believe this current pricing is misguided.
Our research shows that a recession is the modal outcome, so we believe the Fed will need to cut by more than what is currently priced.
The 10-year three-month treasury yield curve, an indicator that has successfully predicted a recession eight out of the nine times it has inverted since its inception – and eight of the last eight – continues to be deeply inverted and supports our view.
3. Inflation Will Likely Trend Higher In The Coming Months
Our research shows that the median Core PCE delta in the year leading up to a recession is +5 bps, suggesting Core PCE is generally ‘flat to up’ in the year preceding a recession.
Additionally, the three-month annualized rates of the different indicators of the inflation basket have halted their downward trend. Although the headline YoY numbers may continue to decelerate, we are seeing increases in specific indicators like:
- Energy inflation increased to 25.4% on a three-month annualized basis after spending approximately one year compounding negatively.
- Core PPI Less Food Energy and Trade Services increased to 3.3% on a three-month annualized rate in August.
We believe that many of the indicators that make up the inflation basket will trend higher in the next few months and will not decline to below-trend levels until we go through a recession.
That’s a wrap!
If you found this blog post helpful:
- Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.
- RT this thread and follow @DariusDale42 and @42Macro.
- Have a great day!