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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What does the future hold for the US economy?

Darius sat down with Warren Pies on Pro to Pro Live last week to discuss the business cycle, fiscal stimulus, inflation, and more.

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

1. This Has Been An Income-Driven Business Cycle, Not A Credit-Driven Business Cycle… Focus on Income, Not Credit

The current business cycle has been driven by income growth rather than credit expansion. 

This is significant because income-driven growth is typically seen as more sustainable than growth fueled by excessive borrowing.

Additionally, capital misallocation and adverse selection are common precursors to a recession. 

Today’s economy is currently showing no meaningful signs of either.

Although a yield curve inversion has been a reliable indicator historically, we believe assuming that it guarantees a recession may be foolish.

2. Fiscal Stimulus Has Been A Major Contributing Factor to The Resiliency of Household Income… This dynamic Is Dissipating At The Margins

To get an idea of where fiscal policy is headed over the medium term, investors can observe:

• Individual income taxes, which comprise approximately 49% of the federal revenue, decreased by 15% YoY. This decrease contributed to extra cash on household balance sheets.
• The cost of living adjustment increased 8.7% in 2023 and is projected to be 3.2% in 2024.
• The year-over-year nominal delta in the federal budget deficit peaked at +$834 billion in June and decreased to +$320 billion in November. However, we believe it will remain positive, and fiscal stimulus will continue to support the economy, especially with a general election coming next year.

Although the direct impacts of fiscal stimulus on household income may be reducing, fiscal policy still leans towards supporting economic growth.

3. Textbook Core PCE And Super Core PCE Disinflation Are Supportive of Market Expectations For Rate Cuts Throughout 2024

The most recent Core PCE reading indicates an increase of 2.3% on a 3-month annualized rate of change basis and an increase of 2.5% on a 6-month annualized rate of change basis. That is positive.

The most recent Super Core PCE reading indicates an increase of 2.6% on a 3-month annualized rate of change basis and an increase of 3.0% on a 6-month annualized rate of change basis. That is also positive. 

The recent softening in labor market conditions, specifically in terms of a reduction in labor demand indicated by total job openings and not total employment, is significant and suggests that the labor market is cooling without a considerable increase in unemployment.

The current economic environment is likely to continue as long as these trends in inflation measures and labor market conditions persist, along with the fiscal dynamics mentioned above. 

We believe this environment will be one where moderate inflation, a balanced labor market, and supportive fiscal policies create a stable economic backdrop.

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! 

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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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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! 

If you found this blog post helpful:

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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! 

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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:

• The rise of interest rates
• The blow-up in Crypto
• The increase in layoffs at tech companies
• Office space occupancies leveling off at 50%
• The regional banking crisis

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:

• Banks learned from the Great Financial Crisis that the rapid withdrawal of liquidity from real estate would hurt them, so they are more patient with borrowers and more lenient with covenants.
• The “Goldilocks” economy continues to be resilient, supporting the real estate sector.

3. Commercial Real Estate Investment Volume Is Drying Up

Investment volume is down significantly YoY across commercial real estate:

• Multifamily: -70%
• Industrial: -48%
• Office: -63%
• Retail: -65%

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:

• Core CPI decelerated to 2.4% on a 3-month annualized basis – the lowest reading since 2021.
• Core Goods CPI inflected negative to -1.9% on a 3-month annualized basis.
• Shelter Inflation materially impacted Core CPI as it declined from just over 5% to 4.4% on a 3-month annualized basis.

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:

• First, the market will become comfortable with inflation settling above 2%. This is likely a 2024-25 phenomenon. 
• Then, when the unemployment rate is high enough, and with enough political pressure, the Fed will officially increase its target to 3%, ultimately paving the way for it to resume QE and lower interest rates. This is likely a 2025-26 phenomenon. 

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 @42Macro and @42MacroWeather.
3. Have a great day!