“You will never convince someone that he is wrong; only reality can.”
-Nassim Taleb
With a big ramp in both Oil and bond yields in the past 24 hours, is the idea of reflation rolling over AFTER it already rolled over to higher-lows in March wrong? Yes. Thankfully we didn’t miss making that call.
Expounding on the whole ‘being wrong’ part of our profession, Taleb goes on to point out that “actually, to be precise, reality doesn’t care about winning arguments: survival is what matters.” –Skin In The Game (pg 14)
To be precise in macro, one should simply change as the data does. In our rate of change vernacular, US inflation is currently #accelerating against easing base effects. We have headline US inflation re-accelerating to new cycle highs here in Q2.
Back to the Global Macro Grind…
Inasmuch as it wasn’t wrong to risk manage both positioning and inflation expectations peaking at the end of January 2018, we don’t think it’s going to be wrong to be long of inflation here in Q2.
Don’t forget that our predictive tracking algos have us in Quad 2 for Q2. What is Quad 2? A: When both year-over-year growth and inflation are accelerating at the same time.
The problem with Quad 2 is that the Fed tends to get hawkish (late cycle) on a lag to late cycle economic data. Never forget that inflation (especially wage inflation) is a late cycle economic indicator.
For those of you who missed us making the pivot from Reflation’s Rollover to a re-acceleration in both headline and inflation expectations, that starts on slide 34 of the Q2 Macro Themes presentation that we made in the first week of April:
By slide number:
34. Reflation’s Rollover Part 2 Is Now Rearview
35. Expect Late Cycle Pricing In Core Inflation
36. Base Effects To Reverse
That last point on slide 36 is worth explaining in more detail. When I write “easing base effects” what I mean by that is that in the comparative period from the year prior, the “comps” (comparative period) get easier.
There are 2 things in addition to Oil prices accelerating year-over-year which have easing base effects:
- Wireless = 2% of the US (CPI) Inflation basket weight
- Medical = 7% of the US (CPI) inflation basket weight
The “Wireless Wars” (price wars that started in Q2 of 2017) have a -12% year-over-year “comp.” Meanwhile Q3 of 2017 marks the ALL-TIME LOW in Medical Inflation (“comping” against ACA in the year prior).
Shorter-term (short end of the curve) the bond market gets this. At 2.42% this morning, why else would the UST 2yr Yield be at its highest level since 2008? Short term rates are predicting proactively predictable behavior by the Fed.
As the Fed sees these reports, they will call them what the bond market already has. The Question now is does the Fed get too hawkish too late in the US economic cycle?
A: The Fed usually does
We’ll see how nimble Powell is but to me the UST 10yr Yield looks pretty darn nimble in the meantime. Why isn’t the long-end of the US Treasury curve breaking out to where it was in 2008?
A) Is it pricing in the peak of the US GDP cycle here in Q218?
B) Is it pricing in the “miss” (vs. headline GDP expectations) we see coming next week?
C) Is it pricing in the Sword of Damocles for US Yields (European Bond Yields) having its ongoing impact?
I could go on and on with more questions on what Mr. Market sees globally vs. locally, longer-term vs. short-term, etc… and I will… that’s why I wake up and write this rant with new rate of change information every day.
As you can see in today’s Chart of The Day, our predictive algo not only has inflation re-accelerating to the cycle peak in Q2 but rolling over again in Q4. Maybe that’s what the bond market is looking at. God forbid our forecasts continue to be right!
All the while, I think the best thing you can do to “not be really wrong” is be nimble when trading rates, inflation expectations, and related securities. After all, the easiest way not to be wrong is to not stay wrong for long.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.75-2.90% (bullish)
SPX 2 (bullish)
NASDAQ 6 (bullish)
Energy (XLE) 69.24-74.58 (bullish)
REITS (RMZ) 1030-1063 (bearish)
Industrials (XLI) 71.79-76.50 (bearish)
VIX 14.31-23.33 (bullish)
USD 88.80-90.10 (neutral)
EUR/USD 1.21-1.24 (neutral)
Oil (WTI) 64.70-69.85 (bullish)
Gold 1 (bullish)
Copper 2.99-3.20 (bearish)
Best of luck out there today,
KM
Keith R. McCullough
Chief Executive Officer
