Why The Fed Needs To Front Load Rate Cuts

Darius recently joined our friend Charles Payne on Fox Business, where they discussed the outlook for the US economy, the impact of rate cuts, the significance of the Dollar, 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. What Is The Medium Term Outlook On The Economy?

While the slowing economy might seem concerning after a significant market rally, we believe growth is likely to surprise to the upside over the medium term.

Generally speaking, the preponderance of evidence points to an economy that is moderating and a labor market that is cooling but not collapsing.

When observing the leading indicators of the broader business cycle, we believe they do not suggest investors should expect a recession over the medium term, which is positive for asset markets.

2. How Would A 50 Basis Points Cut Affect The Global Economy?

The U.S. Net International Investment Deficit doubled in the five years through 2023, increasing from $10 trillion in Foreign-Owned U.S. Assets to $20 trillion. This means a large amount of unrealized capital gains may flow out of the U.S. if the Fed is not careful managing the pace of the dollar’s decline.

A 50 basis point cut next week would likely send a signal to international capital allocators that something might be wrong with the U.S. economy, causing them to book gains and return home with their capital.

In our view, we would not suggest starting with a 50 basis point cut. However, if data from the labor market and inflation support it, the Fed should accelerate the pace of easing between now and the end of March. Beyond that, their window to continue easing may close for a while due to accelerating inflation.

3. How Will The DXY Impact Asset Markets Over The Next 12 Months?

The dollar is typically the most dominant factor in driving the global economy and global liquidity.

We believe the dollar is poised to decline significantly over the next 12 months, which should provide a positive boost to global growth.

However, investors should remain cautious and continue favoring defensive sectors and factors within the equity and fixed income markets because this could also trigger the unwinding of popular trades, including the Yen carry trade.

By now, you’ve likely realized that piecing together an investment strategy from finance podcasts, YouTube videos, and macro “gurus” on 𝕏 is not delivering the results you know you deserve.

This kind of approach only leads to confusion from conflicting advice, frustration from mediocre returns, and exhaustion from the emotional rollercoaster of your portfolio swings.

If you don’t change your process, how can you expect to get better results?

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2025 Warning: Slowing Growth, Rising Inflation, and Productivity Could Squeeze Markets

Darius recently joined our friend Jeremy Szafron on Kitco News, where they discussed the recent decline in housing starts, the U.S. economy, 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. What Does The Recent Housing Market Data Indicate About The Broader Economy?

Recent housing starts and building permit data, along with last week’s NAHB homebuyer market sentiment report, suggest an accelerated decline in the housing market, with housing starts and building permit data at levels not seen since summer 2020. This is concerning because the housing cycle has historically been a persistent leading indicator of the broader business cycle.

As a result, we anticipate growth will slow in the coming months. However, we do not advise investors to position for a developing recession in the U.S. economy.

Specifically, the latest retail sales and industrial production data, and other persistent leading indicators of the business cycle, currently indicate a recession is unlikely to materialize over a medium-term time horizon (3-12 months). Instead, we are currently observing a meandering off the top of the growth curve, which we believe is likely to persist over the next year or so.

2. How Is The U.S. Economy Transitioning From Its Growth Cycle Upturn?

The U.S. economy has been in a growth cycle upturn since the summer of 2022 when we authored our ‘Resilient U.S. Economy’ theme. We are now observing an economy that is merely getting less resilient.

Current data suggests a softening labor market, potentially at a faster rate than in recent quarters. However, our comprehensive analysis of leading indicators—including jobless claims, temporary employment, cyclical employment, layoffs, discharge rates, productivity, and corporate profit growth—does not indicate an impending severe downturn that would pose significant market risk.

While growth is likely to slow over the medium term, we do not anticipate the U.S. economy will decelerate as rapidly as the consensus currently expects. As a result, we believe the rate cuts presently priced into the 2025 forward rate curve in the U.S. are unlikely to materialize. A reconciliation is likely to occur near the year, but for now, we maintain a relatively optimistic outlook for asset markets – especially through year-end.

3. What Economic Challenges Might Emerge In 2025?

Our research suggests the inflation cycle will hit its low in the coming months before rising throughout 2025. This scenario implies growth potentially slowing to a below-trend pace in early 2025, with inflation bottoming at a level inconsistent with the Fed’s 2% target before reaccelerating.

Concurrently, we might observe a moderation or significant slowdown in productivity growth. The combination of slowing growth, rising inflation, and reduced productivity could lead to a margin squeeze and a significant slowdown in earnings. From a timing perspective, we view the first half of next year as the period with the most market risk.

Investors will likely need to reset their expectations for 2025 earnings lower during this time. However, we do not believe the markets need to debate this excessively at present because, historically, markets typically focus only on the next one to three months.

That’s a wrap!

This kind of approach only leads to confusion from conflicting advice, frustration from mediocre returns, and exhaustion from the emotional rollercoaster of your portfolio swings.

If you don’t change your process, how can you expect to get better results?

Over 2,000 investors around the world confidently make smarter investment decisions using our clear, actionable, and accurate signals—and as a result, they make more money.

If you are ready to join them, we are here to support you.

When you sign up, you’ll get immediate access to our premium research and signals—and if we’re not the right fit, you can cancel anytime, without penalty.

Markets Turning From ‘Goldilocks’ Towards Deflation

Darius joined our friend Adam Taggart this week to discuss the risk of recession, inflation, the risk of a US fiscal crisis, 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. How High Is The Risk of Recession In The Next 3 to 12 Months?

While we agree with the consensus that the economy is late cycle, with a low unemployment rate of 4.3% and an inverted yield curve since October 2022, we do not currently see a high risk of recession in the next 3 to 12 months.

Our assessment is based on our econometric study of all the postwar economic cycles in and around recession. That process consisted of normalizing the policy, profits, liquidity, growth, stocks, employment, credit, and inflation cycles, and comparing current trends to historical patterns leading into and through a recession. Despite observing significantly tight policy, we have not experienced the typical breakdown in the corporate profit cycle, liquidity cycle, growth cycle, or stock market cycle that usually occurs a few quarters ahead of a recession.

The current constellation of these leading indicators suggests limited recession risk in the medium term. However, we will continue monitoring and flagging critical inflections in these indicators for our clients, as the US economy remains in a late-cycle condition.

2. What Is Driving The Risk of A US Fiscal Crisis?

We believe the risk of a US fiscal crisis is much closer than most investors realize.

Our assessment stems from a significant shift in the labor versus capital dynamic around 2000 – Employee Compensation as a share of Domestic Corporate Businesses Value Added dropped below trend and has remained there, primarily influenced by factors like China’s entry into the WTO, globalization, and domestic deregulation. This shift has concentrated corporate profits among the elite, creating an inequitable situation and fueling the rise of populism on both sides of the political spectrum.

Many do not realize that both political parties are contributing to a high probability of a fiscal crisis by the end of this decade. Democrats are implementing policies that inflate the incomes of the lower half of the income distribution, while Republicans are doing the same for the upper half. These forms of socialism require piling on debt, which in turn is pushing us toward a potential fiscal crisis.

3. What Is The Outlook For Inflation?

Per the same deep-dive empirical study highlighted above, we have found that inflation is the most lagging indicator of the business cycle.

Heading into a downturn, policy generally tightens first, followed by a breakdown in corporate profits and liquidity. Growth and stocks break down about one to two quarters later, followed by employment and credit. Inflation usually breaks down below trend 12 to 15 months after a recession starts.

As a result, we believe it is very unlikely that inflation returns durably to trend without a recession in the US economy. We do not, however, believe price stability is the Fed’s priority in a Fourth Turning regime. Maintaining order in global sovereign debt markets amid structurally elevated public debts and deficits is far more important.

That’s a wrap! If you found this blog post helpful, explore our research for exclusive, hedge-fund-caliber investment insights you can act on today.

Cooling Inflation Could Create A ‘GOLDILOCKS Vibe’ In Asset Markets

Darius joined our friends at Mornings With Maria on Fox Business last week to discuss inflation, rate cuts, the resilient US economy, and more.

If you missed the interview, here is the most important takeaway from the conversation that has significant implications for your portfolio:

Many positive fundamental catalysts are driving the market’s strong performance. Growth has been resilient, the labor market remains robust, and inflation is increasingly behaving in a manner that allows the Federal Reserve to consider policy rate cuts.

While the economy has been resilient, we believe it is likely to slow over the medium term. However, our research indicates growth is likely to surprise to the upside, and inflation is likely to surprise to the downside. This combination could cause the current GOLDILOCKS Market Regime to persist.
That said, current market conditions are not an all-clear signal for investors. We are in an adverse spot in the positioning cycle, with various metrics indicating we are in the late innings of the market cycle. Many indicators we track in our 42 Macro Positioning Model are flashing red for medium to longer-term risks despite optimistic calls for the S&P to reach 6000.
The U.S. economy has experienced a K-shaped recovery, where different segments of the population recover at different rates. The top third of income earners account for 51% of total consumer spending, while the bottom third accounts for only 15%. This disparity has significant political ramifications for this year’s election, and when considering the direction of the stock and bond markets, it is crucial to view the economy in aggregate terms.

That’s a wrap! If you found this blog post helpful, go to www.42macro.com/research to gain access to 42 Macro’s proprietary trading signals, asset allocation recommendations, and portfolio construction pivots.

Renewed Fears Of A No-Landing Scenario

Darius joined our friend Nicole Petallides on Schwab Network last week to discuss 42 Macro’s risk management signals, the resiliency of the US economy, the outlook for asset markets, and more.

If you missed the interview, here is the most important takeaway from the conversation that has significant implications for your portfolio:

The Divergence Between Fed And Treasury Policy Creates A Complex Environment For Investors And Requires An Increased Reliance On Risk Management Signals Over Fundamental Predictions

When policymakers are not in sync, investing becomes more challenging. In an environment where all central banks row the boat in the same direction, investors experience a more favorable landscape. However, when signals across global growth, inflation, and policy are inconsistent, managing risk becomes significantly more complex.
The US consumer remains resilient, continuing to spend robustly. Our “Resilient US Economy” theme, which we authored in September 2022, is supported by the strong consumer balance sheets and income dynamics we have seen recently. This resilience has been a key driver of the risk-on Market Regime investors have experienced since November.
While the market impact of the policy divergence between the Treasury and the Fed remains uncertain, successful investing does not require you to predict the future; what it does require is an effective risk management system, which can help you navigate these uncertain times and stay on the right side of market risks. If you would like to add our proven risk management overlay to your investment process, we are here to help.

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.

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How Do Retail and Institutional Investors Differ?

Darius recently hosted our May 2024 Pro to Pro Live to discuss the current Market Regime, the US consumer, key differences between retail and institutional investors, 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. Investors Should Position According To The Current Market Regime

Our 42 Macro Risk Management Process transforms complex market dynamics into a clear and straightforward three-step approach:

Position for the Market Regime
Prepare for regime change using quantitative signals with our Macro Weather Model
Prepare for regime change using qualitative signals via our fundamental research

We have remained in a REFLATION Market Regime since March. However, our quantitative and qualitative risk management processes indicate a growing probability of transitioning to a risk-off INFLATION Market Regime.

Investors should understand the key portfolio construction considerations for each Market Regime. If you need help understanding these high-impact portfolio pivots, we are here to help.

2. The Difference Between Retail And Institutional Investors

The key difference between the average retail investor and institutional investor lies in their approach to market signals. Institutional investors have robust observational processes that allow them to adjust their positions when signals change.

In contrast, retail investors usually build their portfolios based on their [oft-erroneous] predictions about the future, and when data disconfirms their narratives, they lack a robust-enough observational process to help them reposition their portfolio in time to make or save money.

We offer our clients these robust observational tools, helping them recognize when market and/or economic conditions shift so they can adjust their portfolio positions accordingly.

3. The West Village-Montauk Effect Is Contributing To The Resiliency Of The US Consumer

The “West Village-Montauk Effect” can be summarized as follows: With a substantial stock of savings, there is less pressure to save a significant portion of your disposable income.

We are witnessing this effect in relation to the US consumer. Since the close of 2019, households have experienced a boost in wealth:

Household cash reserves have surged by 135%.
Household net worth has increased by 34%.
Nominal disposable personal income has increased by 27%.
Inflation has surged by 21%.

To date, this business cycle features household cash, net worth, and nominal disposable personal income each having grown at rates that have exceeded inflation.

That’s a wrap!

If you found this blog post helpful, explore our research for exclusive, hedge-fund-caliber investment insights you can act on today.

What Comes Next for the Economy?

Darius joined our friend SpotGamma last week for their ‘PNL for a Purpose’ interview series to discuss our Macro Weather Model, Liquidity, the US economy, 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. Our Macro Weather Model Currently Indicates A Poor Three-Month Outlook For Asset Markets

At 42 Macro, we monitor several crucial economic cycles simultaneously. We track five Real Economy Cycles: growth, inflation, the labor market, corporate profits, and fiscal policy. Additionally, we track five Financial Economy Cycles: liquidity, credit, interest rates, and investor positioning from both a fear and greed perspective.

We have developed our Macro Weather Model to systematically assess our position within these cycles and their potential impact on asset markets over the medium term.

Currently, our Macro Weather Model forecasts a bearish outlook for both the stock and bond markets, a bullish outlook for the US Dollar, and a neutral outlook for commodities and Bitcoin.

2. Up Until Recently, The Treasury Department Had Been Contributing To Positive US Liquidity Dynamics In This General Election Year

We track US Liquidity via our 42 Macro Net Liquidity model, which is calculated by taking the Federal Reserve Balance Sheet and subtracting the Treasury General Account (TGA) Balance and the Reverse Repo Program (RRP) Balance.

Since Q2 2023, the Treasury has been drawing down the RRP balance to finance itself, reducing the balance from $2.5 trillion to $506 billion. This reduction has positively influenced asset markets.

However, since last month, the decline in the RRP balance has stalled out and is no longer supportive of liquidity, contributing to the recent correction observed in asset markets.

3. A “No Landing” Remains Our Highest-Probability Economic Scenario For The US Economy On A NTM Time Horizon

We forecast growth and inflation using our statistical models, which predict growth to be above consensus and inflation to remain above the Fed’s 2% mandate over the next year.

While we are not concerned about a recession, we are wary of the potential for asset markets to reprice the forward rate curve, similar to what happened in 2022. Currently, significant rate cuts are being priced in: two cuts in 2024, two in 2025, one in 2026, and one or two more for the longer term.

However, the forward rate curve could flatten over the medium term if the Federal Reserve and Treasury ceased supporting asset markets with dovish net financing policies and dovish forward guidance.

That’s a wrap!

If you found this blog post helpful, explore our research for exclusive, hedge-fund-caliber investment insights you can act on today.

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!

If you found this blog post helpful, go to www.42macro.com/research to unlock actionable, hedge-fund-caliber investment insights.

Could The Election Make Assets Explode?

Darius joined our friend Anthony Pompliano this week to discuss the Q2 Quarterly Refunding Announcement, US Liquidity, the outlook on asset markets, 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. Janet Yellen Sent A Hawkish Message To Investors Via The Q2 Quarterly Refunding Announcement

This week’s release of the Q2 Quarterly Refunding Announcement sheds light on the Treasury’s net financing estimates for both the current and upcoming quarters, projections for the Treasury General Account (TGA) balance, and more.

Within the announcement, two key data points stand out: the Privately Held Net Marketable Borrowing totals for the current and next quarters, and the Treasury General Account Target Balance. For the current quarter, the Federal Reserve estimates a need to borrow $243 billion in net marketable borrowing from the private sector, marking a $41 billion increase compared to the previous Quarterly Refunding Announcement.

Looking ahead, projections for privately held net marketable borrowing for the next quarter have surged to $847 billion, representing a significant $604 billion uptick from the preceding quarter. This increase coincides with a notable $100 billion raise in the TGA account target balance. These figures paint a picture of a Treasury issuing a decidedly hawkish signal to market participants.

2. US Liquidity Dynamics Shifted Negatively In April

We track US Liquidity via our 42 Macro Net Liquidity model which is calculated by taking the Federal Reserve Balance Sheet and subtracting the Treasury General Account (TGA) Balance and the Reverse Repo Program (RRP) Balance.

Throughout much of 2023, the Treasury adopted a net financing strategy aimed at accessing the surplus funds held on the Federal Reserve’s balance sheet, primarily through the reduction of the RRP balance. Beginning last year at $2.5 trillion, the RRP balance has steadily decreased to its current level of $506 billion. This move notably bolstered asset markets.

However, since the start of April, both the RRP and TGA balances have shifted in a manner less supportive of liquidity, actually draining it. This trend has contributed to the recent correction observed across asset markets.

3. The Backdrop For Asset Markets Is Becoming Less Bullish At The Margins

Our “Resilient US Economy”, “Green Shoots Globally”, and “China Front Loading Stimulus” themes persist, all of which are supportive of asset markets.

However, our “Sticky Inflation” theme is now a dominant driver of asset markets. Moreover, the US Dollar has broken out to a bullish condition according to our Volatility Adjusted Momentum Signal. This is significant as the Dollar’s movement is inversely correlated with global liquidity on a coincident basis.

Presently, we are witnessing a transition from a simultaneous dovish stance in both Fed and Treasury policy towards one that is net neutral, given the Treasury’s hawkish pivot this week. This shift represents a less bullish environment for asset markets.

That’s a wrap!

If you found this blog post helpful, go to www.42macro.com/research to unlock actionable, hedge-fund-caliber investment insights.

Have a great day!

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 Median CPI stands at 5% on a 3-month annualized basis, approximately double its pre-COVID trend.
The Trimmed Mean CPI stands at 4.4% on a 3-month annualized basis, more than double its pre-COVID trend.
The Median PCE Deflator sits at 4.1% on a 3-month annualized basis, approximately double its pre-COVID trend.
The Trimmed Mean PCE Deflator, also on a 3-month annualized basis, stands at 3.7%, more than double its pre-COVID trend.

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!

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!