"Over the years, those who have seemed to me to be the most happy, contented, and fulfilled have always been the people who have lived the most outgoing and unselfish lives."
- Queen Elizabeth II
I have to admit, I was a little sad when I heard Queen Elizabeth II passed. That's not a political statement, but was just my immediate reaction. Perhaps it had to do with growing up in Canada as a part of the Commonwealth. Or maybe just another realization that as times go on, the course of nature always plays its role.
Whether you loved her or were critical of her actions, Queen Elizabeth had been the United Kingdom's monarch for longer than many of us have been alive. In fact, she was Queen for roughly 30% of the time that the United States has been a country. That’s a long time for things not to change.
However as the pages of history turn, so too do the regimes of the market. Since roughly 1980, interest rates have been going lower in the United States (and globally for the most part). Then post the GFC, we had a long period of zero interest.
Now, of course, a new paradigm is at play. Inflation is back to levels last seen in the 1980s and interest rates are going higher. Alongside this is the strength of the U.S. dollar with the greenback now at 20-year highs versus the Euro and 25-year highs versus the Yen.
It is possible that this new rate and currency regime will be short lived. That would require central bankers to get inflation in check. Just as most global bankers considered inflation transitory just over a year ago, the same cohort now believed it is longer term in nature. Conversely, at Hedgeye we have inflation decelerating quicker than consensus expects into 2023, but alongside this growth is also decelerating faster than consensus . . .
In the short run, one thing does seem more certain, which is that the Fed seems very unlikely to pivot. If you don’t believe me, consider Chairman Powell’s comments from earlier this week:
“History cautions strongly against prematurely loosening policy. I can assure you that my colleagues and I are strongly committed to this project and we will keep at it until the job is done.”
He is not exactly mincing words on the idea of a higher for longer interest rate regime. While that will bring some pain, we should be content in the fact that if we get the rate of change of growth and inflation right, we will get a lot of other things right.
Back to the Global Macro Grind…
As we’ve discussed fairly frequently, the immediate term transmission mechanism for rate hikes is the U.S. housing market. We’ve seen this in spades over the last couple of months with 30-year mortgage rates now sniffing at 6.0% and near the highest levels since 2008. As a result, since the start of the year demand for houses has shriveled.
This week’s mortgage purchase applications declined sequentially for the 5th week in a row and on a monthly basis the index hit 198. To put in context, and shown in the Chart of the Day, this is a level that is just above the depths of the pandemic and down ~-36% since the start of the year. As far as Fed Operation Break Sh*t goes, that mission is being accomplished in the housing market.
Currently, there are almost six additional rate hikes priced into Fed Funds Futures, which means the Fed is likely to tighten by an additional 150 bps by year-end. While some of this is already priced into the mortgage market, it wouldn’t be a total stretch to see 7% mortgage rates in 2022 as this plays out. This means that there is more downside to come in U.S. housing.
Housing matters for a couple of key reasons. For starters, it is a key component of GDP. In aggregate, housing drives between 15 – 18% of GDP. Within that, 3 – 5% is residential investment and 12 – 13% is consumption spending (rents, owners implied rent, etc). Particularly on the residential investment side, the housing recession will be a major headwind to GDP.
Secondly, houses are the key component of most consumer’s balance sheet. So as home prices accelerate, they feel richer and their discretionary spending increases. Conversely, as demand slows, inventory builds, and home prices begin to decelerate, or even go negative, the consumer feels poorer and is likely to spend less on the margin.
In as much as the unravelling of the housing market and slowing of recent high frequency data in the U.S. is concerning, Europe is in much more of a quagmire. In Europe, the high frequency data isn’t just slowing, it's falling of a cliff. The Sentix Economic Index earlier this week came in at -31.8 for September, which was worse than August. Withing this the expectations index fell to -37.0, which was the lowest level since December 2008 . . . the peak of the GFC.
Unfortunately, the pain may just be beginning in Europe. As of the most recent reports, CPI is at +9.1% Y/Y and PPI is at +36% Y/Y. While the ECB did increase rates by 75 basis points this week to a rate of 0.75% on the deposit facility, to the extent the ECB is serious about fighting inflation financial conditions will likely have to tighten much, much quicker from here.
As dismal as some of this sounds, rest assured we can be content in the fact that there are opportunities to make money in any market regime, even if global #Quad4. On that note, our current top ranked Macro ETFs longs as of yesterday are: UUP, DXJ, AMLP, XLE, XLU, UNG, GLD, BWX, TAN.
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets:
UST 10yr Yield 3.02-3.40% (bullish)
UST 2yr Yield 3.34-3.56% (bullish)
High Yield (HYG) 73.25-75.91 (bearish)
SPX 3 (bearish)
NASDAQ 11,289-12,206 (bearish)
RUT 1 (bearish)
Tech (XLK) 128-139 (bearish)
Utilities (XLU) 73.55-77.58 (bullish) `
Shanghai Comp 3161-3275 (bearish)
Nikkei 27,301-28,402 (bullish)
DAX 12,602-13,133 (bearish)
VIX 22.74-28.38 (bullish)
USD 108.20-110.52 (bullish)
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
