“The whole world is simply nothing more than a flow chart for capital”
- Paul Tudor Jones
Suppose someone wishes to get from point A to point B. First, they must move halfway. Then, they must go half of the remaining way. Continuing in this manner, there will always be some small distance remaining, and the goal would never actually be reached. In this way, motion from any point A to any different point B would seem an impossibility.
The above, if you are unfamiliar, is the basis for Zeno’s famous Dichotomy Paradox. It was a brief topic of discussion for our family at dinner a few months ago.
Last night, my 7 year old daughter surprised me with her own insightful (self-serving) variant.
Here’s how it went down:
Lila: Remember that Zeno problem? … It’s kind of like school.
Me: Oh yeah, why’s that?
Lila: So, you don’t really do anything on the last day of school .. so they shouldn’t even have it. But then the day before would be the last day of school and we wouldn’t do anything that day. Then the day before that would be the last day and, you know, blah, blah, blah. So, basically they should just make today be the last day.”
Me: Wow!
It’s been officially dubbed “Lila’s Conjecture”. She doesn’t know what it means but it sounds fancy and formal so she’s embraced it and is going to pitch it this morning on her zoom call.
Besides being independently and objectively incisive, that conceptual framework also neatly captures the policy-liquidity argument underpinning both the latest iteration and decade, long post-GFC BTFD.
That is, if policy has proven that it will remain faithfully employed in the service of suppressing financial market volatility and backstopping prices, why wait for any actual policy announcement? Fully optimized and extended to its logical conclusion, just do the “B” before the “D” even really happens.
Simple and Sirenic. An ideal ‘strategy’ for an instant gratification, low attention span world.
Back to the Global Macro Grind ….
Unfortunately for Powell, modern domestic policy is fraught with paradoxes.
Since today features both the Fed and CPI, let’s focus on the policy-prices paradox in the context of current conditions:
First, let’s simply acknowledge that trade-offs are always inevitable as policy makers weigh balance of risk.
In taking steps to support the credit markets and staunch accelerating cross-asset vol in March, the Fed helped avert a potentially apocryphal spiral which, at the time, threatened another credit/financial crises with acute risk for full, on depression era outcomes for both wall street and main street.
Whether and to what extent the action was appropriate always devolves into moral hazard and counterfactual arguments so lets just agree to agree that for an institution charged with maintaining financial system stability, not acting was a non-starter.
Now, an inherent side effect of large-scale interventionism is a distortion of the price discovery mechanism in markets and a further perpetuation of “zombie” dynamics.
Again, I’m not moralizing or rationalizing that reality from any specific direction. It’s simply a fact that without a lifeline and managed interest rates many companies would not be a going concern.
A company that is otherwise operating unprofitably or inefficiently represents excess supply. Excess supply represents a disinflationary force and a productivity drag ... which perpetuates slower growth … which perpetuates the low rates which helped cultivate the problem in the first place.
This is not new. It has been a decade’s long phenomenon as the Fed has iteratively gone from Point A halfway to “no more tools in the toolkit” (point B).
Where we are in that Zeno-fic journey remains open to debate but, as we’ve seen repeatedly (lower highs and lower lows in rates, Fed overtightening in 2018, etc), it’s impossible to extricate from this cycle without letting gravity take hold.
It’s the secular policy paradox playing out underneath the ongoing, cyclical policy shiftings.
It also sits as part of the decision calculus today as the Fed weighs its potential re-entry into active yield curve control … a discussion which sits at the nexus of a number of converging dynamics that the market is struggling to sort through:
- CPI: While idiosyncratic COVID containment dynamics will manifest as inflationary spikes across a small cross-section of series, the disinflationary/deflationary bonanza cultivated by the largest negative demand shock in living memory will drive Quad 4 pressure from the price side. A mechanical bounce (similar to employment) will accompany re-opening efforts but catastrophic job loss, trudging behavior renormalization and ongoing global dislocations should remain in the driver’s seat vis-à-vis inflationary pressures nearer-term. Policy has a sneaking tendency to flow through prices before any leak bucket flow through to real growth so the prospect for stagflationary conditions remains elevated. The inflation debate (on the back of deglobalization, ongoing fiscal stimulus and MMT-style monetization) will be one to have and, indeed, its one currently being debated conspicuously in prices. ….
- Curves & Rotations: Curve steepening and the nascent but remarkable rotation out of low-vol, slowflation allocations into higher beta, cyclicals have emerged as different expressions of the same dynamic. Whether Fed tapering into a deluge of treasury supply catalyzed the first steepening effects in the curve is somewhat irrelevant as it’s become inextricably bound up into one express narrative. In short, what we’ve observed is re-opening optimism, further juiced by (expectedly) positive macro data, oil reflation and systematic strat re-leveraging playing out against a backdrop of fledgling fiscal-monetary cooperation. The steepening curve and rotation to cyclicals both reflect optimism around the prospects for recovery/growth and for the prospects of the broader DM fiscal policy shift to jumpstart some inflationary mojo.
- YCC: Amidst increasing Treasury supply and to the extent curve steepening continues to manifest, Yield Curve Control becomes increasingly relevant to the policy discussion as will speculation around what upper threshold on the long-end will force the Fed into action. Implicit in YCC with rising inflationary pressure is negative real yields, further financial repression and further moneta. And as we’ve seen recurrently, too far too fast for yields ultimately feeds back negatively to equities and forces the Fed’s hand anyway.
Of course, all of the above is simply the prevailing context surrounding a debate which again just boils down to whether Growth and Inflation are going to accelerate or decelerate.
After the mechanical RoC bounce associated with re-opening, we think stagflationary conditions will define the nearer-term reality.
With the VIX back above @Hedgeye TREND (26.05), HY OAS holding north of 500bps and the 10Y failing to breach TRADE 0.92%, consider today’s Chart of the Day. While there have been some investible, counter-trend periods, I’ll leave it to you to count the number of Value over Growth (secular) head fakes over the past decade+.
And to bring us full circle, it’s important to formally highlight that while Zeno’s paradox is logically and superficially seductive, it is discretely not true.
Or, perhaps more apropos as a market analogy, it’s mostly true for a while (you can indeed, go halfway between points A and B many times) before blowing up spectacularly in the end.
Immediate-term @Hedgeye Risk Range with TREND signal in brackets:
UST 10yr Yield 0.57-0.93% (bearish)
SPX 2 (bullish)
RUT 1 (bearish)
NASDAQ 90 (bullish)
Healthcare (XLV) 99.92-104.13 (bullish)
Tech (XLK) 95.79-103.44 (bullish)
Utilities (XLU) 58.06-63.00 (bullish)
REITS (XLRE) 33.85-38.30 (bullish)
Financials (XLF) 22.35-27.13 (bearish)
Shanghai Comp 2 (bearish)
Nikkei 215 (bullish)
DAX 115 (bullish)
USD 95.87-98.90 (bearish)
Oil (WTI) 32.30-40.49 (bearish)
Gold 1 (bullish)
AMZN 2 (bullish)
FB 220-240 (bullish)
Best of luck out there today,
Christian B. Drake
Macro Analyst
