We use these Macro Blog posts as a platform for informally flagging emergent developments or interesting incremental data.
This post builds on the theme of this morning’s Early Look (Early Look: Need A Bigger Bump) and further contextualizes recent reflationary developments … The Deuce being a reference to our 1Q18 Macro Theme, Reflation’s Rollover Part 2.
In statistics there is a basic concept referred to as the complement rule. Basically it says that sometimes it’s easier to determine the probability of something happening by determining the probability of it not happening and subtracting from 1.
Similarly, in risk management and macro contextualization space, sometimes it’s easier to characterize fledgling inflections or phase transitions by defining what’s not happening.
Let’s start by viewing recent developments through the lens of what had been the prevailing market dynamic:
The Reflation Trade discretely defined the Sept-Jan Period:
- $USD: The Dollar went straight down
- Oil: Oil went straight up
- Correlation Risk: Oil and Yields moved in virtual lockstep. As we re-highlighted most recently (Rate Risk Redux). The R-squared between Oil and 2Y yields was +0.95 over that period with inverse correlations to the dollar across Equities, Gold, Oil and the larger CRB complex carrying similar strength.
- Supply Angst: The prospect of higher inflation in concert with expansionary, debt-financed fiscal policy, Fed balance sheet unwind and reduced foreign demand for treasuries provided a convenient and congruous bond bear narrative.
- 'N Sync: Consensus awareness around ‘synchronized global momentum’ was still building
- Bond Yields and Inflation Expectations moved higher alongside the above collective.
The dynamics above came to a conspicuous head post the AHE print in the Jobs report. The question here is whether prices/expectations have over-discounted reality or whether they can persist in the context of the following constellation of market realities:
- $USD: The dollar is no longer going straight down (albeit immediate-term overbought right here).
- Oil: Oil is no longer going straight up (albeit immediate-term oversold right here).
- Divergence Emergence: We expect #GlobalDivergences to characterize 2018. These divergences are already occurring with respect to equity benchmark performance but we expect growth/inflation divergences, globally, to become more pronounced as we move through the year.
- Distortion Reversal?: suppose extreme weather in January did, in fact, reduce hours worked and inflate average earnings with lower-paid hourly wage workers working less due to those conditions. February would then show some modest backslide in AHE growth as lower paid wage workers are again fully incorporated in the averages. This is a balance of risk question - the issue is less about whether the larger trend remains towards rising wage inflationary pressure and more about whether the price response to the latest Jobs data reflexively overshot the underlying fundamental reality.
- Rates ↑ = Rate ↓ | As we’ve now observed, rates rising remains the catalyst for rates falling as too high/too fast begets increasing equity angst and renewed concern about the growth/inflation outlook .... all of which, ultimately, feed back negatively on yields.
- Comps: February represents the hardest comp for headline inflation. Dollar Up, Energy/Reflation down in February will only add to the base effect optics.
As we highlighted in this morning’s Early Look: If the inflation data rolls over in the coming months, his new central market planner in chief, Jerome Powell, can do a Dovish Hike in March, get bond yields to dip… and give US stocks a little rip.
The Refla’ja vu story remains a developing one but the prospects look a little tastier in the context of recent developments.
