“Higher Interest Rates Cause Inflation ….my belief is: interest rates are the mother and father of all evil.”
-Recep Tayyip Erdogan
As director of #Dopameme strategy @Hedgeye my niche directive is straightforward.
Meme-ify the complex in a way that it optimizes dopamine activity such that it amplifies reader interest, neuro-chemically accelerates their capacity to internalize the message/conclusions while remaining eagerly (& chemically/hormonally) primed for the next quantum of memetic macro awareness on offer.
For your part, dear reader, you, by fate or by design, have reconciled yourself to analytical toiling within the deepest circles of cognitive dissonance.
Memetically, you occupy the purgatorial divide between the two pictures below … perpetually unclear on which direction you’re going and unconvicted in the data meant to inform you on that direction.
In a world perpetually replete with asterisks, caveats, real & faux nuance, recurrent large-scale data revisions, conflicting indicators, serial policy interventionism, divergent flow vs fundamental dynamics, social & professional echo chambers, information asymmetries, structural bias, frequent counter-typical/counterintuitive idiosyncratic relationships, conspiracy theories that turn out to be true like half the time, a secular decrease in the signal-to-noise ratio and secular increases in apathy, polarization, distrust, social frictions, inequality & Fourth Turning endgame dynamics …..
Amidst the symphony of conflictions, the core challenge for any analyst is to cultivate enough mental & process alacrity to gracefully dance with that dissonance.
That’s where we’ll start this morning …..
Back to the Global Macro Grind ...
To consider this in a more tractable/less abstract way, let’s reframe the approach …
Q1: What do the following have in common? XLK, INDIA, BTC, ETH, MSFT, AMZN, SOL, AVAX, COIN, META, ETHE, MSTR, NFLX, NVDA
A2: All are/have been BULLISH TREND @HEDGEYE
Q2: What is our TREND Fundamental View on The Cycle?
A2: Bearish
*Again, Bearish = slope of the growth line is negative with an expectation for further RoC slowing. We remain ‘recession’ and good/bad (absolute) agnostic.
Q3: What are the current Market Structure/Flow dynamics?
A3: Neutral to Bullish
*Dealer gamma is currently positive, CTA flows have been net bullish and should realized vol remain muted (higher probability with positive gamma insulating vol/price), 1M realized will drop over the next week and likely inject some positive directional flow from vol sensitive strats.
How to interpret the above within the context of organizing and systematically operating in cognitive dissonance?
- Foremost, we remain market and #VASP Signal-dominant.
- The Tier1 Alpha market structure data informs and complements the (very) immediate-term TRADE Signal
- The flows-informed VASP signal drives our tactical positioning (TRADE)
- Changes in the TREND Signal front-run economic/Quad inflections
- During a TRENDING regime, our Fundamental Cycle View and the TREND Signal act in a two-way communication loop – each informing the other with confirming/disconfirming evidence.
- Our Fundamental Cycle view (continued TREND slowing) & our Positioning/Risk Management (ie Bullish XLK/Crypto/etc) can and often diverge, but …..
- AND THIS IS KEY: The SIGNAL and the Fundamental View diverge in a systematic and reconcilable way.
So, The SIGNAL distills out the noise and solves for the superficial, daily conflictions while driving tactical shifts in gross/net positioning and/or sector/style factor allocations. And the interplay between the SIGNAL and our Fundamental View solves for the cognitive dissonance associated with different durations potentially carrying divergent positioning/allocation implications.
Again, the SIGNAL and the Fundamental View diverge in a systematic and reconcilable way.
Now let’s quickly turn our attention to our headline quote and the macro-policy experience of your favorite autocrats favorite autocrat.
It’s a small digression but its relevant to this mornings discussion and independently instructive.
Consider the following setup: The below is a necessarily simplified explanation but it sufficiently captures the predominate drivers ….
Country A = low growth, low inflation, disinflationary pressure & a promise of protracted accommodative policy & low interest rates.
Country B = moderate growth, comparatively higher but stable inflation, higher interest rates (aligned with growth/inflation conditions) and a relatively stable currency (or a CB with a proclivity for maintaining/defending that stabilization)
Given these relative growth & interest rate differences and a reasonable expectation for continued currency stability (i.e. covered interest rate parity may not hold):
→ a person or company in Country A or Country B could borrow in Country A’s currency and invest in Country B’s higher yielding currency to capture the interest rate differential. Those funds could also be used for capital investment in country B.
→ In any case, the net effect is money flowing into country B’s financial markets and/or Country B’s economy while keeping Real Rates in Country B attractive for domestic investment.
→ The net effect is, of course, stimulatory (increased asset prices, increased collateral value, increased borrowing, increased investment, increased real economic activity)
→ growth and inflation remain elevated as do interest rates.
→ The economy is growing, the interest rate differential persists and the same conditions that attracted capital to begin with remain roughly similar.
→ more capital flows into Country B and not only are investors able to net the interest rate differential, but the currency actually appreciates because of the progressive growth in demand for it.
→ and around the self-reinforcing carry flow dynamics go … until they reverse and unwind in dramatic fashion.
The takeaway with respect to the focus of our discussion is that high interest rates and the associated interest rate differential in Turkey attracted the initial carry trade capital which progressed in reflexive fashion … driving asset price inflation, domestic credit creation and boom conditions which drove protracted inflationary pressure.
In effect – and in counterintuitive and non-conventional fashion (relative to the conventional macro/policy experience in DM economies) – Erdogan is (at least partially) justified in the view that high interest rates were the root cause of inflation.
Remember comrades … in the funhouse mirror of macro, everything is obvious & nothing is what it seems!
I have a lot I want to hit on but I’m running out of time & words so this will bring us to the part of the note where I I highlight some notables and simply declare a bunch of important stuff to be true – with the hook that we’ll review it all comprehensively next week on our 4Q23 Macro Themes update call.
- Consumer: The Consumer & Credit Cycle Capitulation is (fully) in motion
- For the infinity’ish time this year, yesterday featured: SPX up, Equal Weighted SPX down, Russell 2000 Down, negative Sector Breadth and >50% companies down on the day.
- Is rates down, IWM down a sign of economic strength? … how about Chinese stocks selling off on stimulus announcement & South Korea full reversal lower after the short-sale ban?
- “EVAPORATED”: How about the Quad 4 signal embedded in oil collapse or the S&P Global PMI where the contractionary readings in October were punctuated by the commentary “demand-pull inflation pressure has evaporated, even in the service sector”.
- WARN: Chewy & Sleepnumber just hit the WARN list with layoff announcements. Is there a more stealth but quintessential signal on discretionary consumption demand than a material slowdown in mattresses and dog treat spending(?)
- TGA: Janets QRA puppeteering served to ease financing stress on the long-end and will fill the TGA coffers. As we push into 2024, we’ll likely get to indulge in two scenarios: 1. A Jan announcement of higher total & coupon issuance due to growth ↓/Tax revs ↓ and/or 2. Conspiratorial political narrative around TGA drawdown and liquidity flood to help financial/economic conditions ahead of the election.
- Seasonality et al: We get asked if ‘seasonality’ and all sorts of other phenomenon are incorporated into our models or expectations. The answer is No … and Yes. To the extent "seasonality" (or anything else) manifests or matters, the impact will flow through price/volume/volatility measures. Therefore, it will be, directly or indirectly, captured and reflected in the #VASP Signal.
- Mind the Monthly Cadence: Shock-tober has been undefeated in high-frequency data terms with almost ubiquitous decelerations (both sequential & Y/Y). October is likely to flash a monthly Quad1/Quad2 as the Y/Y comps are decidedly easier and a reverse in the UAW distortion supports sequential strength in NFP/Manufacturing Production/Select Regional Surveys. The Cycle will be back in the drivers seat from there with RoC hitting the comp wall in January.
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets
UST 10yr Yield 4.45-5.00% (bullish)
UST 2yr Yield 4.85-5.14% (bullish)
High Yield (HYG) 71.15-74.41 (bearish)
SPX 4077-4399 (bearish)
NASDAQ 12,463-13,759 (bullish)
RUT 1 (bearish)
Tech (XLK) 160-177 (bullish)
Energy (XLE) 82.14-86.90 (bearish)
Utilities (XLU) 58.21-62.70 (bearish)
VIX 14.23-21.49 (bullish)
USD 104.80-106.98 (bullish)
USD/YEN 149.70-151.99 (bullish)
Oil (WTI) 75.01-82.80 (bearish)
MSFT 339-370 (bullish)
AAPL 165-185 (neutral)
NVDA 403-480 (bullish)
Bitcoin 34,119-37,193 (bullish)
Best of luck out there today,
Christian Drake
