“The only thing worse than getting old is not getting old.”
- Jay-Z
In a redemptive capstone to an otherwise inauspicious “vacation” week featuring a multi-day power outage, heavy tree damage, sick pets, sick family and a multitude of small annoyances, we celebrated my youngest sons first birthday last night. #MrOne-derful
The only gift that mattered was the new basketball hoop.
“Shoot” was his first word and, at 7-months old, shooting was his first “skill” …. one he proceeded to extrapolate across dimensions by “shooting” everything … shooting blocks into their bin, shooting toys into the toybox, shooting spilled food back into the dish.
Of course, shooting everything into where it came from is also called ….. “cleaning up”!
A quintessential case study in positive externalities and unintended derivative effects.
Back to the Global Macro Grind ….
With respect to pervasive and often unintended derivative and network effects, the $USD remains the “shoot” at the center of an integrated factor-asset multi-verse … the nexus of the macro cosmos and nebular nursery where all manner of cross-asset implications are birthed.
As has been on conspicuous display over the past 2 months, the gravity of a phase transition in the dollar is massive, distorting space for any factor constellation orbiting it.
Indeed, phase transition gravity is difficult to ignore, particularly as $USD levered exposures get pulled through the event horizon as dollar correlations build to 1.
Anyway, a post-vaca return to the desk is always a good time to redux bigger picture dynamics, so let’s do that with a view towards the inflation data that headlines this weeks high-frequency docket:
Inflation Tug-of-War:
- The disinflationary/deflationary bonanza cultivated by the largest negative demand shock in modernity has obviously shown up in Headline inflation reading, domestically and globally.
- Monetary Policy conjured a prolific reflationary response to that disinflationary shock. Recall, however, that both the magnitude and direction of impact of that policy on price growth is duration sensitive.
- In the short term, it serves as stabilizing agent and reflationary impulse for prices, but ….
- The serial/secular attempt to reflate cultivates the converse effect over the longer term. That is, to the extent a decade+ of reflationary/repressive policy has incentivized financial engineering and malinvestment and perpetuated zombification ... it cultivated excess supply and lower investment, thus serving as a disinflationary impulse.
- In the present instance - if, in the midst of a simultaneous supply and demand shock, you give people a bunch of money to buy things while production of those things is constrained, it will (eventually) show up in prices …
- … which is exactly what we’ve observed. While disinflation has defined headline price growth, the reality of right now remains rampant price inflation for the things households actually need to buy (like food).
Policy, of course, has played an increasingly active role and the scale of policy response has been both unprecedented and appropriate:
- As we’ve highlighted for months now, the Fed/Fiscal response (in response to both the pre-virus slowdown and the COVID activity cliff) needed to go big enough to drive a reflationary impulse globally such that the policy and growth divergence could compress, ROW could take the handoff with a protracted run of global Quad1/Quad2 capable of driving durable $USD pressure.
- Weak dollar policy has a proclivity to flow through prices before flowing to real economic activity which is why input/commodity prices tend to move first and stagflationary conditions can predominate in any early transition out of Quad 4.
- And if production is suppressed at the same time that the dollar is falling, commodity input prices are rising, health/safety regimes are more expensive, supply chains remain pressured and deglobalization is ascendant, then you risk some measure of protracted inflationary/stagflationary shock.
- With respect to inflation expectations, the newfound fed-fiscal cooperation remains the fulcrum factor.
- Of course, “cooperation” and “partnership” are just euphemisms for outright monetization and capital must flow, except where it can’t flow ... the conventional ebb & flow into bonds has been perturbed as policy makers are determined to only let rates flow downhill.
Positioning and Considerations:
- For those inclined to believe the fiscal flow is incendiary for inflation, can you really convictedly short bonds into a structurally damaged, over-levered financial-economic complex where policy makers have overtly presaged the implementation of yield-curve control and a willingness to tamp down any vigilante-ism?
- Relatedly, what represents rational, non-bubble upside in the price of gold or inflation hedge assets if the prospect of lower forever & yield curve control (partially or fully) invalidate bonds as a means for expressing a view on inflation?
- Simmering under the surface of the policy response is the notion that a credible inflation/reflationary threat carries the risk that the indomitable outperformance on slowflation allocation (growth, tech, momentum) may finally give way to the ever elusive rotation to cyclicals, value, small caps, etc.
- With the dollar and real-yields rising, gold falling and (-) momentum/cyclicals/small caps outperforming over the past two sessions, rotation angst is again percolating.
- The angst isn’t unfounded, as we observed back in May/June. Positioning and market structure dynamics being what they are ...another bout of cyclical rotation optimism risks (another) violent reversal as factor vol picks up, driving reflexive, cascading effects across any/all long duration equity expressions.
In the beginning of June, I was the recipient of all sorts of pointed sarcasm for suggesting the latest pro-cyclical rotation was, once again, more head fake than harbinger.
That harrowing short-term, counter-trend move ultimately fizzled, breathing fresh life into the duration infatuation and all its variant equity expressions.
I also offered a gentle reminder that markets remain under homeostatic, self-regulation. As we’ve seen time and again, too far-too fast in rates dead ends in growth concerns and ultimately feeds back to the growth/earnings outlook in equities, short circuiting the reflation optimism that catalyzed and propagated the move to begin with.
As it relates to any emerging rotation consternation associated with the last two days of price action, here is KM’s commentary from this morning:
- 10YR (long bonds) – sov yields up, globally, this AM (10yr Bund Yield +3bps to -0.50%), but the USA only navel gazers will see this as a read-through on the V-shapes they so desperately want. Top-end of my UST 10yr Yield Range = 0.62% so you buy more Treasuries (TLT), Utes (XLU) and REITS (XLRE) on that – this has happened to bond yields in the 1st week of every month, since April! #LowerHighs
- GOLD (long) – finally letting whoever completely missed it in? That’s cool too… because both Silver (long) and Bitcoin (long) hit new highs yesterday and I’ve been waiting to buy more of those (neither are at the low-end of their Risk Ranges, yet, so be patient) whereas buying more Gold in the $1 range (depending on where Gold Vol trades this AM) would be a gift for whoever had the discipline/process to sell-some at the top-end of my Risk Range when UST 10yr Yield was hitting all-time lows (last week)
- TECH (long) – not sure I’d call yesterday’s buying opportunity a “gift”, but I did signal buy on yesterday’s intraday lows in Software Stocks (IGV) instead of QQQ, mainly because IGV got to the low-end of its Risk Range (because heavyweights ADBE and MSFT did) and QQQ didn’t – stay long Treasuries, Tech, Commodities, China, EM, etc. for more #Quad3 in Q3 Stagflation
Immediate-term @Hedgeye Risk Range with TREND signal in brackets:
UST 10yr Yield 0.51-0.62% (bearish)
SPX 3 (bullish)
RUT 1 (bearish)
NASDAQ 10,491-11,241 (bullish)
Tech (XLK) 108.42-117.64 (bullish)
REITS (XLRE) 35.27-37.07 (bullish)
Utilities (XLU) 59.66-61.79 (bullish)
Financials (XLF) 23.45-25.27 (bearish)
Shanghai Comp 3 (bullish)
Nikkei 210 (neutral)
VIX 21.49-29.29 (bearish)
USD 92.51-93.93 (bearish)
Oil (WTI) 39.85-42.94 (bullish)
Nat Gas 1.85-2.40 (bullish)
Gold 1 (bullish)
Best of luck out there today,
Christian B. Drake
Macro Analyst
