“The latest economic indicators suggest some moderation in the pace of growth”
- Mario Draghi, 4/26/18
“Moderation”, of course, is just a cloaked policy maker euphemism for “slowing” …. as Draghi was forced to acknowledge the data our #Global Divergences call has been flagging for almost 2 quarters now.
What didn’t moderate was U.S. GDP which accelerated +30bps to +2.9% Y/Y, marking a record 7th consecutive quarter of accelerating growth in 1Q18.
It was a good run. That was also probably the Peak.
Maybe 7-quarters of lazy long have dulled analytical alacrity or perhaps it’s simply a collective dearth of dragon energy sufficient enough to digest and internalize the latest cross-asset global macro cascade of developments but – based on our inbox flow - investors continue to struggle with an intuitive understanding of emerging and prevailing Inflation and $USD dynamics.
#DOLLAR BOTTOMING:
Tops are processes and traversing global macro phase transitions are invariably choppy, but our 2Q18 Macro Themes, and our “Dollar Bottoming” theme in particular, were dedicated to detailing those exact dynamics.
We’ve been updating and re-detailing our thoughts around those themes recurrently but let’s do it one more time within the context of the latest data and market prices and to help crystallize things ahead of the weekend.
Inflation isn’t the lone protagonist in the current global macro story but she’s a central character and one around which we can suitably build a larger narrative arc.
Inclusive of the many supporting characters and fringe dynamics, the larger factor flow remains basically this:
→ Inflation: Oil (along with broader commodity/metals inflation associated with Russian sanctions, hawkish Saudi rhetoric, Iran sanction, Venezuela concerns, escalation in Yemen conflict and tight domestic inventories), the beginnings of late-cycle wage inflation and fledgling breakout in core price growth are driving inflation expectations (which, in turn, drives policy expectations)
→ Inflation Expectations drive Real/Nominal Yields higher
→ Rising nominal yields have pushed rate differentials to all-time highs (i.e. Treasury-Bund spreads)
→ Concurrently, Global Divergences have manifested more discretely (i.e. the fracturing of the harmonized growth narrative as growth slows across China, EU and large swath of EM) supporting a more favorable relative growth outlook for the U.S.
→ All of that is occurring with the spec short position in the dollar at multi-year highs (all-time highs in Net long EUR/USD spec futures and options positioning)
Distilling it down another level:
Realized inflation and inflation expectations are rising → Accelerating price growth and the associated hawkish policy implications are driving nominal yields higher domestically → Higher domestic yields are driving all-time highs in DM rate differentials → Alongside this (but not necessary independent of it) global growth is beginning to slow and the relative growth outlook in the U.S. is improving → all of this alongside the largest spec short position in the dollar in years.
If you’re keeping score, that = rising domestic inflation, rising rate differentials, prospective monetary policy divergence (Fed more hawkish vs. China/Europe acknowledging “moderation”) and an improving relative growth outlook collectively supporting a bottoming in the dollar at the same time that consensus is positioned for the exact opposite.
Again, this isn’t new. This is the emerging factor constellation we flagged as carrying a rising probability a month ago.
NEXT VERSE, SAME AS THE FIRST:
The point here is that rising wage and core inflation (1Q18 ECI accelerated to a cycle high this morning, we'll get PCE inflation Monday and AHE next Friday) and should be supportive of yields nearer-term, helping to maintain or further propagate the flow dynamic described above.
There are obviously derivative implications associated with all of this. For example, to the extant a bottoming dollar equates to a weaker Euro and/or Yen, the DAX and Nikkei probably like that. On the other side, our underweight EM view doesn’t shift under the baseline expectation for higher yields and some prospective (further) dollar mojo.
And with Boston sitting comfortably 4 games ahead of NY in the AL East and 70-degrees and sunny on tap for CT this weekend, we’ll leave it there for now. A select visual tour of the dynamics described above below …..
