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:

If the labor market remains stable, consumers should continue to fare well.

That’s a wrap! 

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Why We Are Likely To Have A Worse Recession Than Investors Now Anticipate

Darius sat down with Julia La Roche last week to discuss inflation, the Fed, and the likelihood of a recession.

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

1. A Recession Has A High Probability Of Commencing Over The Next 6-9 Months

Our team has conducted extensive backtests on recession timing after the inversion of the 10-year/3-month treasury yield curve.

We found the 13 – 18 month forward interval has the highest probability of GDP contraction and a rise in the unemployment rate.

The 10-year/3-month yield curve inverted in October 2022, indicating the period between Nov-23 and Apr-24 has the highest probability of the start of a recession.

2. Inflation Will Likely Bottom At A Level Inconsistent With The Fed’s 2% Mandate

Our research suggests Core PCE will likely trend 50% – 100% higher throughout this decade.

In the last decade, the underlying trend of Core PCE YoY was 1.6%. We project that trend will increase to somewhere between 2.5% to 3.1% over the next decade, and prolonged conflict in the Middle East may cause a spike in commodity inflation and push it even higher.

We believe the Fed will need to revise its inflation target upwardly to between 2.5% and 3% to account for the upcoming higher trend. 

3. Sticky Inflation Will Force The Fed To Sit On Its Hands 

Wall Street survey data shows an increasing number of investors believe the probability of avoiding a recession is high.

We challenge that view. We believe a recession is likely to begin with inflation measures tracking at levels uncomfortably higher than the Fed’s 2% inflation target. That means the Fed will likely be forced to sit on its hands and maintain higher rates until inflation declines.

If that happens, the recession will likely be worse, and asset markets will likely decline further than most investors now expect – after having been dead wrong the US business cycles and asset markets all year.

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.

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:

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! 

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What is the Outlook for Commercial Real Estate?

Darius recently sat down with Nick Halaris to explore the current state of US commercial real estate.

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

1. A Commercial Real Estate Disaster May Be On The Horizon

Over the past couple of years, there has been a confluence of factors that have negatively impacted the real estate sector:

As a result, US commercial property prices are back down to pre-covid levels. Although they have declined substantially since the COVID-19 blow-off top, they will likely decline even further.


 

2. Commercial Real Estate Distress Levels Are On The Rise… Albeit Slowly

Distress levels in US commercial real estate have been accelerating since mid-2020 but are not yet at levels seen in the Great Financial Crisis because:

3. Commercial Real Estate Investment Volume Is Drying Up

Investment volume is down significantly YoY across commercial real estate:

Sellers are hesitant to sell because they expect inflation will increase again, increasing the value of their properties back to 2022 levels.

Buyers are hesitant to buy because their existing exposure is declining in value and interest rates are pricing them out of further investment.

Transactions are sparse as a result. The waiting game continues….

That’s a wrap! 

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Will Inflation Come Back HOT?

Darius recently sat down with Anthony Pompliano to discuss inflation, its direction, and its effect on asset markets.

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

1. Headline CPI Is Accelerating Again, Primarily Due to Energy

Last month, the 3-month annualized growth rate of headline inflation spiked from just under 2% to 3.9%.

A material increase in energy inflation drove the move. 

Until last month, the three-month annualized rate of energy inflation had been negative for approximately one year; the August CPI report indicated an energy inflation increase of 25.4% on a 3-month annualized basis.

We expect the increase in energy inflation to persist as Brent crude oil continues its upward momentum.
 

2. Core CPI Continues to Decelerate, Primarily Due to Shelter

While Headline CPI is increasing, Core CPI, a measure that excludes some of the most volatile components like food and energy prices and therefore provides a clearer view of the underlying trend in inflation, is decreasing.

Last Wednesday’s report showed that:

3. Producer Price Inflation Is Back on The Rise Again And May Also Represent The Vanguard of Sticky Inflation

PPI, which measures price changes from the producer’s perspective, accelerated to 4.2% on a 3-month annualized basis – the highest value since the first half of last year.

Leading underlying measures of inflation like Super Core PPI are beginning to show upside momentum and we are starting to see the first signs that inflation is potentially bottoming out.

The return of inflation is negative for asset markets – with it comes a stronger dollar and greater bond market volatility, both of which are headwinds for any increase in global liquidity.

 
That’s a wrap!


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“No Landing” = No Liquidity, Says The US Dollar

The US Dollar Index is poised for its ninth consecutive weekly advance — the longest winning streak since 2005 as the global currency market rerates economic resiliency in the US and derates the economic outlooks in Europe and China. The reason why FX and interest rate volatility are drags on global liquidity is because when net international investment surplus economies like Japan and the Eurozone see their currencies weaken, it makes it harder for their financial intermediaries to create the dollars required to capitalize investments around the world. FX and interest rate volatility complicate that process and slow down the creation of new dollar supply at the margins.

Growth of the world’s demand for dollars is more stable due to the refinancing requirements of the existing stock of cross-border financing that is denominated in USD — roughly 50% of the total, with ~65% of cross-border loans and ~80% of international debt securities issued by entities that have no organic access to dollars. Thus, fluctuations in the supply of new dollars have an outsized influence in driving FX trends because of the relatively inelastic demand for dollars versus a more elastic dollar supply curve. More FX and interest rate volatility = marginal dollar supply falls faster than marginal dollar demand = stronger dollar. Less FX and interest rate volatility = marginal dollar supply rises faster than marginal dollar demand = weaker USD. This process is reflexive and feeds on itself until exogenous factors like central bank pivots inflect the trend. This is why price momentum in the currency market tends to trend.

Will Bitcoin Crash Before The Halving?

Darius recently sat down with Anthony Pompliano to discuss global liquidity, bitcoin, the Fed, and more.


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

1. The Years Leading Up to Bitcoin Halvings Are Extremely Volatile. 

When we analyzed the past Bitcoin halvings from November 2012, July 2016, and May 2020, we found that in the years leading up to the halving, Bitcoin tends to have three drawdowns of more than -20% on a median basis.

All drawdowns in the year leading up to halvings have a median decline of -27%. 

We believe Bitcoin will be much higher in a few years, but it will likely require a rough path to reach its destination. 

2. Over The Next Year, Liquidity Will Determine Bitcoin’s Path.

On a median basis, Bitcoin increases 144% in the year leading up to halvings.

These increases have closely followed global liquidity cycles; the liquidity cycle bottomed in 2012 and 2015, years leading into the halvings where Bitcoin increased 384% and 144%, respectively.

However, in 2019, when liquidity conditions were less favorable than in 2011 and 2015, Bitcoin failed to see a similar price increase. 

The increase that year was only 20%, and the drawdowns were more significant than in the previous pre-halving years.

The amount of liquidity in asset markets will decide Bitcoin’s path over the next year.

3. We Believe The Fed Will Be Forced to Increase Their Inflation Target From 2% to 3%

The change will likely come in two phases:

That’s a wrap! 

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

Darius recently sat down with Nick Halaris to discuss proper risk management, the labor market, inflation, asset markets, and much more.

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

1. Investors Are Doing A Great Disservice To Themselves By Not Being Bayesian

At 42 Macro, we use three core tenants to form our systematic macro risk management process:

We urge our readers to infuse proper risk management in their investment strategies. We welcome you to use our tools if you want to gain a systematic edge in the market: https://42macro.com/sampleresearch.

2. Labor Hoarding Has Contributed To The Resilience Of The US Economy

The most recent US Total Labor Force SA reading was 167 million people – a value below its trendline since 2009. 

Conversely, Gross Domestic Income recovered its trendline approximately 18 months ago and remains above it. 


The discrepancy in strength between the two indicators suggests there is a large amount of cash in the economy that can be used to demand goods and services but insufficient labor to supply those goods and services.

3. History Tells Us The Fed Must Break The Economy to Achieve Its Price Stability Mandate

We analyzed every recession since 1969 and found that, on a median basis, core PCE inflation is almost always flat-to-up in the year leading up to a recession.

Historically, inflation does not break down without a recession.

Both this study and our HOPE+I framework confirm that inflation is a lagging indicator, and we believe it will again fail to fall below the Fed’s 2% target without a recession.

That’s a wrap! 

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Evidence Of A Potential Wage-Price Spiral

The ~150,000 member United Auto Workers (UAW) union has declared “war” on Detroit’s big three auto makers GM $GM, Ford $F, and Stellantis $STLAM IM, threatening a strike by September 15 if the companies fail to acquiesce to demands that include a +46% wage increase and a decline in the work week to 32 hours. If a new collective bargaining agreement cannot be achieved by the deadline, the strike will be joined by Unifor — Canada’s largest labor union with ~315,000 total workers and ~18,000 auto workers.

Stories like this are supportive of our view that the narrative around inflation is likely to shift from “immaculate disinflation” to “sticky inflation” within 3-6 months. We have been keen to call out the elevated probability of a soft landing in the US economy. While a soft landing is not our modal outcome, we believe it is a scenario worth educating you on because a soft landing in the economy is highly likely to result in a soft landing in inflation relative to the Fed’s 2% target — which Powell went out of his way to quadruple down on last Friday at Jackson Hole.

No firm on global Wall Street has had a more accurate view on the resiliency of the US economy than @42Macro has for the past year and, as a result, a better call on bonds. We still see more fixed income volatility in the months ahead because we believe the consensus narrative surrounding inflation is likely to deteriorate before the recession hits.

What is Making the U.S. Economy so Resilient?

This week, Darius sat down with Maggie Lake from Real Vision to discuss the resiliency of the US economy, the housing market, and much more.

If you missed the interview, we have you covered. Here are three takeaways from the conversation that have significant implications for your portfolio: 

1. The Resiliency of the US Economy Will Likely Continue 

Our research shows the US economy has nowcast itself into “GOLDILOCKS” for the past five months. GOLDILOCKS is a regime marked by growth trending higher and inflation trending lower.

The strength of the economy will likely continue because:

2. New Home Sales Are Surging Because The Existing Home Sales Market Has Been Starved of Supply

Today, homeowners are unwilling to sell their homes and trade their ~3.5% mortgage (the effective mortgage rate nationally) for the current market rate of ~7%.

This supply shortage is causing a spike in new home builds:

3. “Bidenomics” Is Also Contributing to Our “Resilient US Economy” Theme

The US economy is experiencing a record non-war, non-recession budget deficit under the current administration.

Last year, the deficit was -3.7% of GDP. 

Today, it is -8.4%.

That 470 basis point difference equates to approximately $1.3 trillion of incremental fiscal stimulus supplied to the US economy, further contributing to its resiliency. 

That’s a wrap! 

If you found this blog post helpful:

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