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Takeaway: Our models indicate the ECB is under the most pressure to act dovishly, followed by the Fed and then the BoJ, which should remain dormant.

To Borrow a Football Analogy…

If you’ve ever watched an NFL football game, you’ve likely heard the quarterback bark out something on the order of, “Mike’s 52! Mike’s 52!” or something along those lines pre-snap. This is because he’s communicating to his teammates who the play-side “zero” defender is, which is the defender from which the entire blocking scheme is anchored upon. Specifically, each offensive lineman, tight end, fullback, etc. is responsible to work either separately or in combination with his teammate(s) to block a specific “number(s)”.

For example, the center is responsible for blocking the “Mike”, or zero, defender; the play-side guard has the “Mike”, or zero, defender plus one; the play-side tackle has the “Mike”, or zero, defender plus two; and so on and so forth. These blocking relationships are simply inverted on the back side of the play.

To the passive observer, it would appear that the “fat guys” up front are merely responsible for colliding with the defenders lined up directly across from them. While this is generally true at lower levels of football (i.e. Pop Warner), the need to quantify defenders and communicate exact blocking assignments increases dramatically as one progresses up the ranks.

For example, our pro-style offense at Yale had 50 base plays and no less than 10 different formations to run them out of. Without adding a single wrinkle to any play (something that effectively increases our universe of potential plays to infinity) we had 500 unique plays to memorize, which is a number that favors a quantitative – rather than qualitative – approach to setting blocking assignments.

That is no different than macroeconomic analysis. Specifically, the need for market participants to quantify their conjectures stems from two core issues:

  1. Either implicitly or explicitly, every market participant has a macro view, but not everyone actually does or pays attention to macro research.
  2. For those that are doing the work, the use of varying analytical methodologies can lead to disparate views. Thus, recording deltas, inflections, etc. in a purely quantitative manner tends to lead to more reliable conclusions.

Our macro team obviously has a proclivity for quantitative analysis. This is mostly because our collection of four former hockey players, a former competitive body builder and a former football player is simply not smart enough to get by on “feel” and “storytelling” alone. Numbers simplify things for us.

Quantifying the Currency War

One topic that has become increasingly front and center on the minds of investors is the reemergence of the “Currency War” among G3 central banks. In light of the growing importance of this topic, we thought we’d add some good ol’ fashioned Hedgeye Macro quant to the discussion. The conclusions of our analysis are threefold:

  1. Our models indicate the ECB should continue to enact dovish policy and/or guidance, at the margins, and is currently under the most pressure to do so.
  2. Our models indicate the Fed should continue to enact dovish policy and/or guidance, at the margins, though it is facing less pressure than the ECB to do so at the current juncture.
  3. Our models indicate the BoJ should continue to remain neutral, at the margins, and is facing fairly subdued pressure to enact marginally dovish policy at the current juncture.

QUANTIFYING THE CURRENCY WAR AND THE SLOWDOWN IN GLOBAL GROWTH - MONETARY POLICY MODEL

QUANTIFYING THE CURRENCY WAR AND THE SLOWDOWN IN GLOBAL GROWTH - CURRENCY WAR MODEL

In chart #1 above, a low reading implies the need to ease, while a high reading implies the need to tighten. In chart #2 above, a high score implies a commensurately high amount of pressure to ease (i.e. engage in the “Currency War”), while a low score implies a commensurately low amount of pressure to ease.

Methodology

To arrive at the aforementioned conclusions, we built a quantitative model that transforms 10 relevant economic indicators into a standardized format that allows for cross-country comparative analysis:

  1. 5Y-5Y Forward Breakeven Rate (latest reading as a percentile of the trailing 6M sample): a higher reading indicates rising inflation expectations among market participants and vice versa
  2. Benchmark Equity Market (latest reading as a percentile of the trailing 6M sample): a higher reading implies rising stock prices and/or valuations and vice versa  
  3. Bloomberg Consensus 2014 CPI Forecast (latest reading as a percentile of the trailing 12M sample): a higher reading indicates rising inflation expectations within the academic economist community and vice versa
  4. Bloomberg Consensus 2014 GDP Forecast (latest reading as a percentile of the trailing 12M sample): a higher reading indicates rising growth expectations within the academic economist community and vice versa
  5. Core CPI YoY (latest reading as a percentile of the trailing 10Y sample): a higher reading indicates elevated structural inflationary pressures and vice versa
  6. Econ Surprise Index (latest reading as a percentile of the trailing 12M sample): a higher reading indicates an improving economic outlook and vice versa
  7. REER (latest reading as a percentile of the trailing 10Y sample): a higher reading indicates a perceived loss of structural competitiveness and vice versa; to maintain directional consistency, we invert this number to highlight the fact that policymakers are more likely to react in a dovish manner to a perceived loss of competitiveness
  8. Sovereign 10Y-2Y bps Spread (latest reading as a percentile of the trailing 6M sample): a higher reading indicates an improving growth outlook among market participants and vice versa
  9. Spot FX Rate vs. Basket of Peer Currencies (latest reading as a percentile of the trailing 6M sample): a higher reading indicates a perceived loss of cyclical competitiveness and vice versa; to maintain directional consistency, we invert this number to highlight the fact that policymakers are more likely to react in a dovish manner to a perceived loss of competitiveness
  10. Unemployment Rate (latest reading as a percentile of the trailing 10Y sample): a higher reading indicates a high degree of slack in the labor market and vice versa; to maintain directional consistency, we invert this number to highlight the fact that policymakers are more likely to react in a dovish manner to a cyclically or structurally depressed labor market

Converting each of these indicators into a percentile reading versus its respective trend allows us to consistently quantify the most likely path for a given central bank’s monetary policy (chart #1 above), and exactly how much “pressure” they are under to enact such policies relative to peer central banks at the current juncture (chart #2 above).

Central Bank Catalyst Calendar Through Year-End

As we re-learned amid yesterday’s melt-up and today’s melt-down, central banking catalysts matter big time as it relates to risk managing your gross and net exposures. The following is a chronological list of the most noteworthy central bank events through year-end:

  • October 11th at 12:00pm EDT: Mario Draghi holds a press conference in Washington D.C.
  • October 15th at 2:00pm EDT: Mario Draghi speaking in Frankfurt
  • October 17th at 8:30am EDT: Janet Yellen speaking in Boston on the [rampant] inequality she helped perpetuate via the Fed’s Policies To Inflate
  • October 29th at 2:00pm EDT: FOMC Rate Decision
  • October 31th overnight: BoJ Rate Decision
  • November 4th at 9:30pm EDT: Haruhiko Kuroda speaking in Tokyo
  • November 5th at 6:50pm EDT: BoJ releases the minutes of its October 6th-7th meeting
  • November 6th at 7:45am EDT: ECB Rate Decision
  • November 6th at 8:30am EDT: Mario Draghi holds a press conference regarding the ECB rate decision
  • November 19th overnight: BoJ Rate Decision
  • November 19th at 2:00pm EDT: Fed releases the minutes from its October 28th-29th FOMC meeting
  • November 24th at 6:50pm EDT: BoJ releases the minutes of its October 31st meeting
  • December 4th at 7:45am EDT: ECB Rate Decision
  • December 4th at 8:30am EDT: Mario Draghi holds a press conference regarding the ECB rate decision
  • December 17th at 2:00pm EDT: FOMC Rate Decision
  • December 19h overnight: BoJ Rate Decision
  • December 24th at 6:50pm EDT: BoJ releases the minutes of its November 18th-19th meeting

By Jove, these people keep us busy…

Investment Conclusion: Get Defensive Amid a Slowdown in Global Growth

All told, we continue to think global growth is slowing, as highlighted by our individual GIP outlooks for the four largest and most economically relevant economies in the world – i.e. the U.S., the Eurozone, Japan and China:

QUANTIFYING THE CURRENCY WAR AND THE SLOWDOWN IN GLOBAL GROWTH - UNITED STATES

QUANTIFYING THE CURRENCY WAR AND THE SLOWDOWN IN GLOBAL GROWTH - EUROZONE

QUANTIFYING THE CURRENCY WAR AND THE SLOWDOWN IN GLOBAL GROWTH - JAPAN

QUANTIFYING THE CURRENCY WAR AND THE SLOWDOWN IN GLOBAL GROWTH - CHINA

Please review the following research notes to the extent you’d like to dig deeper into any specific region’s GIP fundamentals:

In conjunction with our negative outlook, we continue to prefer defensive exposures from both an asset allocation perspective and from a equity style factor perspective:

QUANTIFYING THE CURRENCY WAR AND THE SLOWDOWN IN GLOBAL GROWTH - 7

On that cheery note, have a fantastic evening! Email us with any follow-up questions.

DD

Darius Dale

Associate: Macro Team