“If you don’t know where you are going, you’ll end up someplace else”
- Yogi Berra
Futures are again bathed in pleasant hues of green, equity related headlines remain dotted with delightful ‘highest since’ descriptors, SPX still has a sultry 20% upside to new ATH’s on an inflation adjusted basis and labor remains resilient which means people still have jobs which means billions in passive (inflation amplified) 401K flows remain on asset price inflation autopilot.
Good Morning!
New Day, Same Macro Grind …..
I won’t flood your frontal cortex with yet another CPI review, but I’d like to contextualize a couple notables along with considering a selection of derivative implications.
With Core CPI printing a 4-handle, the roll in Shelter/OER inflation officially in motion and Core Services Ex-shelter (and all its variants) notching a 4th month of meaningful sequential and Y/Y deceleration, it was pretty much all clean ‘progress’ with respect to the policy jihad.
The update on real earnings growth was similarly favorable.
Behold, (+) Real Earnings! …. Real Hourly Earnings growth held positive for a second month, accelerating to +1.2% Y/Y while Real Weekly Earnings Growth snapped a record 26-month streak of negative growth, improving to +0.6% Y/Y in June.
This is unquestionably positive. It should also come with some relevant context …..
- The negative spread between inflation growth and earnings growth – which lasted a record 26-months – represents a cumulative loss of purchasing power. In other words, if you could by 100 things in 2019/20 … you could by 85 of those same things in May of 2023 given the lost purchasing power. With the increase in real income growth, you can now buy 86 of those things (those numbers are for conceptual purposes only). Less Bad is good and the return to a positive spread is encouraging but only if it persists. ….
- …. Note also that if it does, in fact, persist, it will likely mean core CPI and core services inflation remain sticky, which means tight policy persists, which means elevated debt service obligations decrement the discretionary consumption capacity associated with that positive real income growth.
- Positive real wage growth is only a partial story. The units matter and here we’re talking about the purchasing power associated with 1 hour of work. But presently, the number of hours individuals are working is falling. A decline in total (nominal) weekly earnings due to working less sits as a negative offset to the gain in real income growth with respect to consumption capacity. How those two factors net as the cycle evolves remains TBD.
Dollar Dilemma’s … Yesterday’s slide in the dollar and real/nominal rates was (almost exactly) the same as the reaction accompanying the false dawn CPI deceleration back in October/November. It effectively carries the same consideration set as well.
- It gives some breathing room to China to support stimulus measures instead of supporting the currency (and a convenient $USD softening development following Yellen’s visit to China visit for the conspiracy theorists eh!), but ….
- A weak dollar is, of course, reflationary. As the $USD goes down, things priced in those dollars go up. Which is cool if you own those things … but if you have to buy those things (commodities) … or are charged with preventing the price of those things from going up too much or too fast… it’s less great.
- It’s also less great if base effects are set to become progressively unfavorable ....
- June was the peak comp and as we push into 2024, anything greater than 0.2% M/M on avg will mean inflation will reaccelerate on a Y/Y basis.
(Penrose) Staircase of Consternation? In addition to a weaker dollar cultivating higher commodity prices and a prospective base-effect supported CPI reacceleration, if dollar weakness reflects an expectation for an end of the tightening cycling and is thus greeted with some celebratory asset and discretionary consumption purchases, it would exaggerate the inflationary and financial conditions loosening impulse …. Forcing the fed to again overtly reaffirm its hawkish posture, stiff-arming the macro-policy interpretation that the exuberance was predicated on to begin with.
Healthy Tensions: If one were explicitly aspiring to devise a counterintuitive cycle extension strategy, the prevailing countervailing dynamics that have defined this sloth-ian cycle would perhaps define that strategy. It’s fascinating because it works at cross purposes across multiple channels – which is precisely what makes it effective.
Give people an unprecedented amount of money then raise rates at the fastest pace in history. Give money markets RRP access, allowing the income side of higher rates to give households a progressively diminishing cushion against that policy/credit tightening and negative real income growth.
More income on the savings side vs less lending on the credit side also supports sticky services pricing at a time of broadening growth deceleration which supports higher policy rates in the face of that growth deceleration.
That healthy tension between contra forces slows the evolution of the cycle, makes it less clear what is the dominant driver at any one time (hence the oscillation between soft-landing optimism and hard-landing angst) while also ostensibly increasing “barbell risk” (the risk for both soft & hard landings).
If offsetting forces slow the cycle & policy is calibrated accordingly then the soft-landing runway expands. But to the extent plodding improvement on the inflation side & relative resilience on the consumption side catalyze higher-er policy rates (tightening into an accelerating slowdown), then the slowly-then-trap-door lower scenario become increasing probable.
It also becomes increasingly probable (and the cushioning dynamics above cease) as the cycle detethers from savings/income and retethers to policy/credit – a transition we think we are in the heart of now.
Meanwhile ….
Chinese Export growth further collapsed to -12.4% Y/Y, EU industrial production accelerated (to the downside) at -2.2% Y/Y and every country Composite Output PMI slowed for the first time ever in June (outside of the pandemic trough).
And elsewhere across the recent high-frequency data-verse:
Consumer: Lazy Short isn’t a risk management process, except perhaps in Retail (XRT) which remains the proud sponsor of infinite & interminable deceleration. After a relentless 19-month leak lower, Redbook Retail Sales printed negative Y/Y (-0.4% Y/Y) for the first time yesterday. Reminder, the Redbook series is reported nominally, so the underlying reality is, in fact, worse than the headline. Across the sector, both estimates & guidance for 2H23 continue to not be marked to macro reality.
Credit: The consumer squeeze appears to have transitioned to crescendo mode as a boycott in auto loans drove non-revolving consumer credit down m/m in June for the first time since the heart of the pandemic while revolving credit (credit cards) rose just +0.7% sequentially (decelerating -30bps to +12.9% Y/Y). Meanwhile, the interest rate on that revolving credit breached 22%, marking yet another higher, multi-decade high. So, households have accelerated revolving credit growth at the fastest pace in decades, are paying the highest interest rate on that debt in a generation, excess savings for Main street is now exhausted, real weekly earnings are (still) negative, an income/consumption shock sits conspicuously in queue alongside student loan payment resumption, survey data show an increased reliance on credit to maintain spending and consumer spending is going to …. Durably inflect alongside, and in support of, expectations for an imminent inflection in the profit cycle?
NFIB/Earnings: Alongside a 2Y low in Output Prices & Hiring Plans (both = demand signals), Small Businesses reported Actual Sales changes fell to a new cycle low at -10 while Actual Earnings held just north of cycle trough levels. To reiterate the obvious here … the inflationary environment worked to optically support reported top and bottom line results as nominal growth in sales/profits helped mask the underlying deterioration in real terms. Disinflationary trends, while ostensibly a positive with respect to policy implications, in combination with ongoing consumer and capex demand deceleration and a widening spread between input costs & output prices (i.e. sticky wage costs vs worsening pricing power) will continue to pressure (and potentially amplify) the profit cycle lower over the coming quarter(s).
Pretty Much Right Now …. We explored the impact timing associated with policy tightening on consumption across historical cycles in our 3Q Macro Themes Presentation. If we map the lag from when the tightening cycle begins to where, on average, the consumption inflection/deteriorate begins, that zone is effectively right now.
Is it reasonable that the evolution of the current cycle plays out comparably slower given its stubbornly plodding cadence thus far? Sure. But we think that cadence begins to accelerate as push through the 2 transition dynamics described above.
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets
UST 30yr Yield 3.80-4.09% (bearish)
UST 10yr Yield 3.72-4.10% (neutral)
UST 2yr Yield 4.64-5.05% (bullish)
High Yield (HYG) 73.54-75.25 (bearish)
SPX 4 (bearish)
NASDAQ 13,456-13,951 (bullish)
RUT 1 (bearish)
Tech (XLK) 169-175 (bullish)
Shanghai Comp 3169-3261 (bearish)
Nikkei 31,586-34,033 (bullish)
DAX 15,440-16,155 (neutral)
VIX 13.05-17.03 (neutral)
USD 100.01-103.23 (neutral)
Oil (WTI) 68.43-76.91 (neutral)
Copper 3.65-3.91 (bearish)
Bitcoin 28,999-30,895 (bearish)
Best of luck out there today,
Christian B. Drake
