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Takeaway: Recent data supports our expectation that inflation will quash US consumption growth, while developing quant signals challenge that view.

Each day one of our summer interns, Kevin Brooke – the offspring of Yale Hockey legend Bob Brooke – compiles a blog run for our team. The purpose of the blog is find insightful macroeconomic or financial market analyses that challenge (or support) our existing macro themes, as well as those thought pieces that are generally informative.

Today Kevin hit a home run with two of the better pieces I’ve seen in recent weeks:

  • Commodities Reverse Their Gains!: CLICK HERE to access the article
  • Here’s Why Americans Are Having a Lot Less Fun This Summer: CLICK HERE to access the article

In discussing the latter data point first, we are most welcoming of this incremental evidence of our #ConsumerSlowing theme, as it shows a net percentage of Americans are spending more on Groceries (49%), Gas/Fuel (46%) and Utilities (35%). Per the cited Gallup Survey, those expenditure categories were the three largest in terms of the net percentage of Americans feeling the effects of cost-push inflation.

TACRM ASKS: “CONSUMER SQUEEZE OR CONSUMER SNEEZE?” - 1

Interestingly enough, those three expenditure categories just so happen to be the three inputs to our Hedgeye Macro Consumer Squeeze Index, which continues to show #InflationAccelerating eroding domestic purchasing power.

TACRM ASKS: “CONSUMER SQUEEZE OR CONSUMER SNEEZE?” - CONSUMER SQUEEZE INDEX

On a prospective basis, we obviously need to see incremental commodity price appreciation in order for cost-push inflation to threaten the outlook for consumer spending in a material way (a la 2008 or 2011).

One key driver of our forecast for said price appreciation is #DollarDevaluation. Specifically, we think the Fed is gearing up to surprise investors by introducing directionally-dovish monetary policy, at the margins, as we progress through the back half of the year. Refer to the following pieces to review that thesis in full:

Today in the Federal Reserve’s Semiannual Monetary Policy Report to the Congress, FOMC Chairwoman Janet Yellen continued to “connect the dots” on an outlook for easier monetary policy:

  • “The housing sector, however, has shown little recent progress. While this sector has recovered notably from its earlier trough, housing activity leveled off in the wake of last year's increase in mortgage rates, and readings this year have, overall, continued to be disappointing.”
  • “Although the economy continues to improve, the recovery is not yet complete. Even with the recent declines, the unemployment rate remains above Federal Open Market Committee (FOMC) participants' estimates of its longer-run normal level. Labor force participation appears weaker than one would expect based on the aging of the population and the level of unemployment. These and other indications that significant slack remains in labor markets are corroborated by the continued slow pace of growth in most measures of hourly compensation.”
  • “Although the decline in GDP in the first quarter led to some downgrading of our growth projections for this year, I and other FOMC participants continue to anticipate that economic activity will expand at a moderate pace over the next several years, supported by accommodative monetary policy, a waning drag from fiscal policy, the lagged effects of higher home prices and equity values, and strengthening foreign growth… As always, considerable uncertainty surrounds our projections for economic growth, unemployment, and inflation. FOMC participants currently judge these risks to be nearly balanced but to warrant monitoring in the months ahead.”
  • “Of course, the outlook for the economy and financial markets is never certain, and now is no exception. Therefore, the Committee's decisions about the path of the federal funds rate remain dependent on our assessment of incoming information and the implications for the economic outlook. If the labor market continues to improve more quickly than anticipated by the Committee, resulting in faster convergence toward our dual objectives, then increases in the federal funds rate target likely would occur sooner and be more rapid than currently envisioned. Conversely, if economic performance is disappointing, then the future path of interest rates likely would be more accommodative than currently anticipated.”
  • “In sum, since the February Monetary Policy Report, further important progress has been made in restoring the economy to health and in strengthening the financial system. Yet too many Americans remain unemployed, inflation remains below our longer-run objective, and not all of the necessary financial reform initiatives have been completed. The Federal Reserve remains committed to employing all of its resources and tools to achieve its macroeconomic objectives and to foster a stronger and more resilient financial system.”

If you’ve subscribed to our research for longer than one day, you’ll no doubt have realized that quantitative, market-based signals tend to front-run our interpretation of or expectations for underlying fundamentals, while our those same underlying fundamentals help instruct our outlook for market prices. It’s a dynamic, reflexive process that tends to generate “Circular Reference Warnings” among the linear, Consensus Macro forecasting community.

Right now, those quantitative signals aren’t as supportive as they were even 2-3 weeks ago. Looking to our Tactical Asset Class Rotation Model (TACRM for short), we’re seeing a SELL signal in FX for the first time since late APR and the third-consecutive week with a SELL signal in Commodities, after having been squarely in BUY territory since mid-FEB.

TACRM ASKS: “CONSUMER SQUEEZE OR CONSUMER SNEEZE?” - TACRM Summary Table

Refer to the following presentation for more insight into TACRM’s quantitative signaling capabilities: http://docs.hedgeye.com/HE_TACRM_2014.pdf.

It’s worth noting that TACRM’s BUY and SELL signals aren’t necessarily meant to generate absolute returns (although the backtest data on slides 15-20 of the aforementioned presentation suggests TACRM is quite good at doing just that); rather, these signals are relative to the other asset classes (e.g. BUY Fixed Income & Yield Chasing in lieu of XYZ asset class, which would have a commensurate SELL signal).

Additionally, it’s also worth noting that within our hierarchy of quantitative risk management signals, TACRM sits squarely below Keith’s multi-factor, multi-duration model that is core to each of our fundamental views. Regarding those signals, the key levels to watch are:

  • WTI Crude Oil: we need to see it hold sustainably below these levels in the coming weeks for us to consider materially altering our economic outlook
    • Threatening Bearish TREND = 101.89
    • Threatening Bearish TAIL = 100.27
  • CRB Index: we need to see a sustained breakdown below the TREND line for us to consider materially altering our economic outlook
    • Threatening Bearish TREND = 297
    • Squarely Bullish TAIL = 291
  • Gold: we need to see a sustained breakdown below the TREND line for us to consider materially altering our economic outlook
    • Squarely Bullish TREND = 1281
    • Squarely Bearish TAIL = 1324
  • USD Index: we need to see a sustained breakout above these levels line for us to consider materially altering our economic outlook
    • Squarely Bearish TREND = 80.71
    • Squarely Bearish TAIL = 81.19

TACRM ASKS: “CONSUMER SQUEEZE OR CONSUMER SNEEZE?” - CRUDE OIL

TACRM ASKS: “CONSUMER SQUEEZE OR CONSUMER SNEEZE?” - CRB INDEX

TACRM ASKS: “CONSUMER SQUEEZE OR CONSUMER SNEEZE?” - GOLD

TACRM ASKS: “CONSUMER SQUEEZE OR CONSUMER SNEEZE?” - US DOLLAR INDEX

Our process is dynamic and, if nothing else, mentally flexible. We aren’t wed to any thesis, so if the facts change (i.e. commodity inflation reverses and the Fed is supportive of a stronger USD),  we’ll change with them.

Hope this is helpful and thanks for the questions,

DD

Darius Dale

Associate: Macro Team