Have Rates Peaked?

“Don’t confuse what you wish were true with what is really true.”
-Ray Dalio 

I spend a lot of time in meetings, on calls, and on email trying to answer client questions. At this stage of my career, I have no problem answering “I don’t know, but we’ll work on that and get back to you” or deferring to Mr. Market’s opinion. 

No matter what you think could or should be true, the market’s closing prices tell the truth about your returns. Is it true that we’re expecting core, headline, and US wage inflation to #accelerate to new cycle highs in the coming months? Yes.

But it’s also true that Mr. Market just signaled that the UST 10yr Yield is going to make lower-highs on that. Moreover, it’s true that consensus (market positioning in futures & options contracts) is net SHORT -258,386 10yr US Treasury contracts. 

Back to the Global Macro Grind… 

The truth inherent in our price/volume/volatility signal is our process’ truth inasmuch as the reported rate of change data is. What makes a market is someone else’s signal, optimal valuation model, etc. opinion. 

“Don’t overweight 1^st-order consequences relative to 2^nd-order and 3^rd-order ones.” 
-Ray Dalio 

Yes, that’s Dalio’s opinion on good #process. It also happens to be the one that we’ve back-tested exhaustively and subscribe to. Is it possible that Mr. Market has been discounting 75 month highs in headline inflation for the past 9 months? 

Yes. Of course the market discounts future reported results. That’s why having an accurate measurement and mapping #process to come up with the right forward outlook for the rate of change in both growth and inflation is so critical. 

To review yesterday’s headline US inflation report: 

1. Headline Consumer Prices Inflation (CPI) for MAY #accelerated from 2.5% in APR to +2.8% year-over-year growth
2. That’s the highest level of reported inflation going back to 2012 (after the all-time high for the CRB Commodities Index) 

This is how the rates of change within the report looked: 

1. Breadth:  The acceleration wasn’t a function of some singular component. Breadth continued to pickup with Shelter, Wireless, Medical, Apparel, Energy, etc. (i.e. key consumer cost centers) all #accelerating sequentially
2. Core Goods & Services:  For a sustained pickup in the Fed’s preferred inflation gauge (Core PCE) we need to see a pickup in Core Services inflation, less deflation in Core Goods prices growth or both - we got both in the May CPI data as Core Services Growth and Core Goods Prices growth both #accelerated sequentially
3. Next Verse, Same as the First:  With (headline/core/energy) comps continuing to ease through ~July, base effects will continue to support #accelerating inflation into 3Q, at least 

So, since the Fed’s forecasts are based on a lag to lagging economic data that they didn’t predict would #accelerate to the peak-cycle levels we’ll see come July and August, the fundamental analyst is probably right in predicting a hawkish Fed. 

But what about the Portfolio Manager and/or Chief Risk Manager of market expectations? 

As you can see in today’s Chart of the Day, our proprietary predictive tracking algo is now-casting at least a -100 basis point drop from peak-cycle headline inflation to where the market will be reacting to incoming data within 6-9 months. 

As importantly, the Swords of Damocles hanging over long-term interest rates, globally (Europe and Japan) are going to: 

1. See European headline inflation fall back below 1% by Q4 of 2018… and
2. See Japanese headline inflation collapse back into #DEFLATION by Q1 of 2019 

Damn you Mr. Market. Is that why the Swiss and Japanese 10yr Yields are trading at -0.01% and 0.04%, respectively, this morning? Is that why the top-end of the @Hedgeye Risk Range on the UST 10yr has fallen to 3.01% this morning?

All the while, instead of our profession having someone known as the JGB Bond King or Swiss Star of Sharpe Ratios, all consensus has done for the last 20-30yrs is call these long-term Lower-For-Longer (inflation) asset allocations “too expensive”! 

What has been super expensive for decades now is marketing “breakouts in inflation” as the rates of change in inflation are peaking. For hedge fund managers trying to be famous on one BIG call (after it happened), that is… 

If you’re looking for a data-driven reason why rates (on the long-end of the curve) may have peaked, here’s ours: 

1. China, Europe, and EM #Slowing
2. #GlobalDivergences
3. USA #PeakCycle? 

I don’t have the LONG long-term Treasuries, REITS, and Utes macro call on yet. But this is how I’m thinking about setting up for Quad 4, globally, in Q4 of 2018. I just need Mr. Market to signal he’s done getting us paid on long US growth exposures first. 

Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now: 

UST 10yr Yield 2.84-3.01% (bullish)
SPX 2 (bullish)
RUT 1 (bullish)
NASDAQ 7 (bullish)
REITS (RMZ) 1081-1131 (bullish)
VIX 10.72-15.28 (bearish)
USD 93.10-94.50 (bullish)
Oil (WTI) 64.04-67.80 (bullish) 

Best of luck out there today,

KM

Keith R. McCullough
Chief Executive Officer