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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 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!

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!

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!

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! 

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!

Should Investors Be Positioning For Turbulent Times Ahead?

Darius joined Charles Payne on Fox Business last week to discuss the market outlook, investor positioning, and more.

If you missed the interview, here is the most important takeaway to help you navigate upcoming trends in asset markets: 

Recent Data Was Supportive of GOLDILOCKS Continuing to Persist, And We Believe Equities Have Room To Run 

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!