So, somewhere between the emerging global growth de-synchronization that we flagged back in January, the inflation scare/short vol implosion in early February and her continued WTF sequestration of Spring, Mother Macro decided to generally just start kitchen sinkin’ shit, globally.
The Eurozone and broader DM Eco Surprise Indices (below) are evident enough but if you’d like the underlying detail we profiled the latest EU and China data HERE and the latest domestic developments HERE.
Suffice it say, the macro churn has picked up recently as the inimical trinity of base effects, organic fundamentals and geopolitical risk have conspired to drive rising cross-asset cross-currents, particularly on the price side.
Elevated churn invariable brings rising dissensus and she remains a two-faced temptress - progenitor of both opportunity and uncertainty. Here, we thought we’d quickly attempt to facilitate identifying the former by contextualizing the latter.
It's not intended to be a comprehensive treatment of any specific factor but to simply macrosplain the developments over that last week+ within the context of our current outlook:
- 1Q18 | Reflation’s Rollover: Our call was for Inflation and Inflation expectations to crest into peak February CPI comps and subsequently rollover. Admittedly, it was a little bit of thread-the-disinflationary-needle dynamic as we expected price growth to reaccelerate again as we moved through the year. Inflation expectations and nominal yields did, in fact, roll-over conspicuously (and globally) alongside relation’s peak and the more discernible emergence of global divergences.
- 2Q18 | Inflation Acceleration: Our call was for inflation to reaccelerate against easy base effects across oil/energy, the all-time lows in Medical inflation and the sharp declines in wireless pricing associated with the cell phone price wars that begin in 2Q17. Late-cycle wage pressure remained a potential but latent upside risk.
- Geopolitical Juice: Russia is a key commodity producer, particularly of aluminum, palladium and nickel. The Russian sanctions, particularly those targeting key figures controlling metals/commodity production have driven step function increases in prices across the commodity complex. Meanwhile, the conflict in Syria, hawkish Saudi rhetoric and the rising specter of oil sanction on Iran are juicing oil prices at the same time that inventories are falling and pipeline constraints are plaguing shale producers.
- We’ll, That Was Quick....: The base effect dynamics supporting a reflationary impulse were already on display in the March CPI report and the geopolitical externalities above have only amplified the market price effects. The reflationary impact of energy will emerge more discretely as we move through 2Q18 and as comps for energy commodities move from 29.8% Y/Y (February 2017) to +0% Y/Y (June 2017). Oil is currently tracking up +24% Y/Y on a monthly average basis in April and will be up 46% Y/Y in June if we hold current price levels.
- Correlation Risk: This all matters because Oil and Yields are again moving in lockstep, particularly on the short-end. The R-squared between Oil and 2Y yields was +0.95 over the Sept-Feb reflation period – with 10Y yields, swaps and breakevens all plotting similarly. That relationship is tightening again here. Moreover, as we highlighted this morning, investors have rapidly shifted their directional expectations and the volatility surface has shifted higher for Oil linked indices and is now is now positively skewed in USO. It is more expensive to bet on upside in crude oil than it is to bet on downside – We really haven’t seen a sustained bullish tilt like this since the summer of 2014
- What Goes Up….? The inflationary/interest rate dynamics above must also be balanced against the reality that interest rate differentials on the short-end (i.e. 2Y Treasury-Bund spreads) have pushed to all-time wides and that rates rising remains a primary 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.
In other words, it’s not a coincidence that major Benchmarks continue to dance around their @Hedgeye Trend lines at the same time as our GIP Model continues to dance along the Quad 2/Quad 3 border (recall, the preferred allocations in those two quadrants are almost antithetical to each other) and the market struggles to price those conflictions, all against a backdrop in which consensus is only now beginning to acknowledge and embrace our #Global Divergences call.
While recent dynamics have pulled forward some of the fundamental developments we expected to evolve over the balance of the year – particularly with respect to inflation - Bigger Picture, our outlook remains largely unchanged. We expect domestic growth to peak in 1H18 and inflation pressure to build through mid-year alongside a further fracturing in the harmonized global growth storyline with slowing growth and Quad 3/Quad 4 outlooks characterizing Europe, China and EM broadly.
