The Macro Compass

If a couple of regional banks were so bad at managing their interest rate risk and deposit outflow risk to blow up in a few hours, how can we really be sure other banks won’t face similar problems?

Having run a large investment portfolio at a European bank and been part of the management for the Treasury department, I will try to use my practical experience to provide you with:

* A quick primer on how banks approach risk management of a large securities portfolio;

* A level-headed analysis of the damage that higher interest rates do to a banks’ balance sheet, and the resulting assessment of broad contagion risks;

* An update on inflation and the likely Fed reaction function in this environment.

Banks buy bonds for two main reasons: clipping coupons and regulation.

When you attract deposits and do nothing on the asset side, you are going to accumulate reserves at your domestic Central Bank.

But banks want to make money, and bonds generally yield more than Central Bank reserves (chart below).

Sum up regulation (LCR) forcing large banks to own ~20% of their balance sheet in liquid assets (read: bonds) and there you go: banks have huge investment portfolios to clip coupons and meet regulation.

How do banks approach the risk management of such gigantic portfolios?

A prudent bank hedges most if not all its interest rate risk coming from the securities portfolio with swaps.The bank buys bonds (receives fixed rate) and pays swaps (pays fixed rate) against them as a hedge.Banks earn the (credit) spread between bond yields and swap yields, and that’s it.

But now comes the trick: accounting.

Swaps are derivatives, and their standard accounting treatment is to directly hit the P&L of the bank hence causing quite some immediate volatility for the financial results of the bank.

Banks don’t like that at all.

That’s why the regulator allows for something called hedge accounting: if you buy bonds and put them in Available-For-Sale (AFS) and use swaps to hedge the interest rate risk, all that P&L volatility is gone.The small volatility of offsetting bonds and swaps hits the capital position of the bank.

Easy-peasy, no drama: little volatility as risks are hedged, and friendly accounting treatment (no P&L vol).

But what happens if you book bonds in Held-To-Maturity (HTM) instead?In the US, once you book bonds in HTM the accounting rules are such that hedging the interest rate risk on these bonds is quite punitive.

Swaps hedging HTM bonds do not receive the friendly accounting treatment and hence hit the P&L of the bank – but bonds don’t, which creates a massively inconvenient asymmetry and P&L vol that banks hate.

The result is that US banks end up NOT hedging the interest risk on HTM bonds.

This is important because the HTM losses accumulated on these bonds can be very large.

P.S. My spreadsheet failed me on Schwab. The bank’s capital is 25+ bn, not 8. Hence losses are about 50%+ of capital, not 171%.

Even for systemically important banks like Bank of America these losses could wipe out half of their capital!

So, are large US banks at risk of going belly up too?And given today’s inflation print, what will the Fed do?

Let’s dig in…

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Silicon Valley Bank went belly up in about 30 hours.And no, it’s not the Fed’s fault.

It’s the result of a very concentrated funding base, embarrassingly bad market risk management and a ton of moral hazard at play.

This piece will attempt at answering the questions all of us have been asking:

* What exactly went so wrong for a $200bn+ balance sheet bank to go down so fast?

* How serious are the spillover risks? Is the entire US banking system in trouble?

* How will the Fed and markets react?

Disastrous Risk Management

What SVB did with their investment portfolio is either a signal of enormous incompetence or of outright moral hazard at play – gamble away billions as policymakers will rescue you anyway.

I can’t believe incompetence reaches these levels, and there are some clear hints moral hazard was at play.

First of all: why do banks buy all these bonds?

Post GFC, regulators forced banks to own an amount of high quality liquid assets (HQLA) at least big enough to meet a stressed outflow of deposits for 30 days => Liquidity Coverage Ratio (LCR) above 100%.

What qualifies as HQLA?Reserves at the Central Bank, Treasuries, but also corporate bonds and MBS to a certain extent.

As a result of LCR regulation, banks all over the world have flushed their balance sheets with trillions of bonds. Such a large amount of bonds on the balance sheet also comes with risks though, right?

Interest rate risk comes to mind: if you purchase Treasuries and yields rise, you lose money.

That’s why banks hedge (!) the lion share of the interest rate risk coming from their HQLA investments.

The mechanism is simple.

When you buy Treasuries, you lock in a fixed yield you receive and rising interest rates represent a risk.To hedge that risk, you enter into an interest rate swap: this time, you pay away a fixed yield and receive variable payments in exchange.

There you go: you received a fix rate when buying Treasuries and you pay a fixed rate in the swap – a hedge.Treasuries generally yield a bit more than swaps, and that’s where you make your money (swap spreads).

In this example, SVB (A) would buy 10-year Treasuries and enter into a swap to hedge interest rate risk.

SVB (A) pays a fixed 10-year rate (OIS) in the swap, and receives the variable overnight Fed Funds rate for the next 10 years plus a spread (swap spread).This would allow SVB to hedge the interest rate risk and earn a small spread on their HQLA portfolio.

The problems?

SVB had a gigantic investment portfolio as a % of total assets at 57% (average US bank: 24%) and 78% was in Mortgage-Backed Securities (Citi or JPM: around 30%)…

…and most importantly they DID NOT hedge interest rate risk at all!

The duration of their huge portfolio before and after interest rate hedges was…the same?!

Effectively, there were NO hedges.

This means SVB was not applying basic risk management practices, and exposing its investors and depositors to a gigantic amount of risk.

Economically speaking, a $120 bn bond portfolio with a 5.6y non-hedged duration means that every 10 bps move higher in 5-year interest rate lost the bank almost $700 million.

100 bps? $7 billion economic loss.200 bps? $14 billion economic loss.Basically the entire bank’s capital wiped out.

As the tech/IPO boom faded, deposits stopped coming in 2022.Recently, depositors started taking their money away and forced SVB to realize this huge losses on bond investments to service deposit outflows.The concentrated nature of the deposit base and awful risk management meant SVB went belly up real quick.

Many people are now calling for a blanket bailout.But the evidence that moral hazard was at play are too big to be ignored.And we should not reward moral hazard.

Moral Hazard

Companies go belly up – it happens.Perhaps it was just huge incompetence at work, or bad luck.

But please consider the evidence that moral hazard played an important role.Here are 3 interconnected facts which are hard to ignore:

1.      The outrageous use of accounting tricks

HQLA investments can be booked either under the Available For Sale (AFS) or Held To Maturity (HTM) accounting regimes.AFS investment unrealized gains/losses do not hit the P&L of the bank, but they do show up in the capital position of the bank.Booking bonds in HTM instead prevents gains/losses from showing up at all – convenient, right?

See for yourself: SVB had a gigantic bond book and made an unusually large use of the convenient HTM accounting regime.

The unrealized losses as per Dec 2022 in the HTM portfolio alone amounted to $15 billion, enough to wipe out the bank’s capital but conveniently hidden through the abnormal use of this accounting trick.

You don’t book $90 billion of unhedged (!) bonds in HTM by mistake or incompetence – this is moral hazard.

2.      Not hedging: just ignorance, you say?

In December 2021, SVB had about $10 billion of interest rate swaps.Probably way too little to hedge the entire interest rate risk, but that’s not my point.

In their financial statement, they show a clear understanding of what these swaps are for (red box below).Fast forward to December 2022, and basically ALL these hedges are gone.

This is not just ignorance: a vast use of accounting tricks and a voluntary reduction of hedges.

3.      That urge to stay away from tighter regulatory scrutiny…

The reason why SVB could get around with this terribly risky business model was its size.

You see, banks with assets below $250 billion (and a few more requirements) are not subject to the tighter regulatory scrutiny like big banks: no liquidity ratios (LCR), no net stable funding requirements (NSFR) forcing you to diversify your funding base and light stress tests.

This allowed SVB to run wild with its investment portfolio and funding base concentration.

Well, what’s wrong about that?SVB isn’t the only bank with assets <$250 billion benefitting from this, right?

Yes, but would it help to know that SVB’s management repeatedly lobbied to increase the cap for lax regulatory scrutiny (here) and conveniently remained 20-30 billion below the $250 billion threshold?

It is hard to deny a decent amount of moral hazard was at play here.

So, should the government fully bail SBV out? Or only make uninsured depositors whole?

Is SBV a canary in the coal mine for a systemic banking crisis?

And what about the Fed reaction and the market impact?

Let’s dig in…

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Money creation is king.It leads economic activity and therefore financial markets performance.

That’s why despite following countless macro data, market practitioners often pay particular attention to indicators tracking ‘’money printing’’.

But money isn’t a trivial topic: how do we correctly measure money creation for the real economy?Which countries are printing more or less money today?What does this imply for growth and markets ahead?

This article answers all these questions by:

* Walking you through the principles behind the construction of my flagship Global Credit Impulse index;

* Providing you with the most recent money creation figures both at a country level (US, China, EU, UK) and at an aggregate level;

* Discussing the implications for economic growth and asset classes performance.

Let’s start with a 3-months old chart that speaks very loud about the importance of ‘’money printing’’:

The TMC Global Credit Impulse index (orange, left-hand side) accurately predicted the direction of travel for S&P500 earnings per share growth (blue, RHS) with a few quarters of lead time.

Back in late summer 2022, analysts were expecting EPS to grow healthily in 2023.Our flagship money creation indicator instead suggested 2023 EPS would contract and perhaps turn negative already by March.

Well, it turns out our flagship indicator was right.

But how do we actually measure real-economy money creation?

First, let’s set the record straight: commercial banks and governments print money we can use, not Central Banks – they print money for banks, also known as bank reserves.Here is how banks and governments print real-economy money:

When the banking system extends a loan or a mortgage, it creates a new liability for the consumer (loan/mortgage) but also a new asset (a new bank deposit).That newly created credit is money that didn’t exist before, and it is used to purchase a new car/house.

Bank credit creation = real-economy money printing.

When the government spends more money than it taxes us for (deficit), it blows a hole in its balance sheet and throws net wealth at the private sector.Lower taxes or stimulus cheques increase the real-economy money available for the private sector.

Government deficit spending = real-economy money printing.

Take a look back at the first chart: the more real-economy money sloshing around the largest economies in the world, the more economic growth ahead and vice versa. It makes sense, right?

We have established that bank credit creation and government deficits are key pieces of the puzzle to track real-economy money creation.

But what else is needed to build a proper money printing indicator?How has the TMC Global Credit Impulse index changed with the latest data update?And what does it mean for growth and markets ahead?

Let’s dig in…

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Hi everybody, and welcome back to The Macro Compass!

Economic data is surprising on the upside, and markets are busy trying to digest what this means for the Fed.

Terminal rates are now priced well over 5% in the US and now around 4% in Europe, and bond traders are quickly dismissing all cuts in 2023 too.

So, have we avoided a recession for good and how resilient is the global economy to higher interest rates? The answer to this question will be vital for portfolio performance in 2023.

Hence, in this piece we will:

* Discuss the recent upside surprise in macroeconomic data – how resilient is the global economy?

* Dig deep into Dr. Yield Curve – what’s this PhD in economic telling us now?

* Conclude with our assessment and portfolio construction going forward

Recently, macro data has been surprising on the upside: retail sales, PMIs, housing data all look better.

And this is why.

US financial conditions have materially eased from November to early February. A sharp loosening of financial conditions is often associated with an improvement in macro data with a 1-2 months lag.

The chart above proves the point: the US NAHB Housing Index (blue, RHS) readily responded to looser financial conditions (orange, LHS) with a small time lag exactly like it did in 2021 and 2022. The mechanism is easy to understand: lower interest rates and easier access to credit allow more home buyers to step in, hence leading to improved sentiment in the housing market.

Looser financial conditions also help companies and consumers via cheaper access to leverage, higher equity prices and a weaker USD and hence feed into better PMIs for instance.

Should we expect further upside surprises in economic data?

For soft indicators (e.g. PMIs) the lag is pretty short, while coincident indicators (e.g. labor market, industrial production) take a little longer to react – March might bring some more positive news…but.

Financial conditions have aggressively tightened again in the last two weeks. And March data releases cover February data, where the major seasonality boost from January could reverse.

The January Non-Farm Payroll numbers were boosted by a much lower amount of post-holidays seasonal layoffs than usual – February NFPs (released on March 10) could disappoint if seasonality trends reverse.

So, further upside surprises or not?

Lack of conviction is the name of the game recently. We went from pricing a 40-50% chance of a near-term recession in December to pricing away all 2023 Fed cuts in early February.

The results of this poll are very telling – I asked FinTwit whether they’d buy or sell 30y Treasuries here. Over 13,000 people replied and basically they have no clue.

I am showing you this so you can zoom out.

In this business we are often overwhelmed with information – or rather with noise, I should say.

This is why I like smoothing macro data: it allows me to take a step back from the noise of daily data and ever-changing narratives and have a panoramic view.

So, let’s:

* Look at the big picture for macro data;

* Ask the PhD in economics Dr. Yield Curve a couple of questions;

* Conclude with our assessment and portfolio construction going forward

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Hi everybody, and welcome back to The Macro Compass!

Most macro commentary focuses on the US.

But over the last few months, the real golden kid has been Europe.

Recently the EUR has appreciated 10%+ against the US Dollar, macro data seems to suggest a recession has been avoided and the European stock market is on a roll having outperformed the S&P500 and other peers.

For foreign macro practitioners, the complex European architecture and its many dimensions appear like an unattractive black box to analyze.

This is why in this piece, we will:

* Discuss the main drivers behind the recent European macro and market outperformance;

* Answer the big question: where do we go from here?

September 2022.

European stock markets in free fall, EUR/USD at 0.95 – will Europe be able to keep its lights on this winter? These worries were justified by the complex macro and energy picture back then.

But while not good at long-term policymaking, Europe is great at avoiding last-minute disasters.

The chart above shows the gargantuan amount of GDP per capita allocated by different European countries to households and firms in an attempt to fight the energy crisis.

On average, countries allocated ~5% of GDP per capita against the energy crisis: that’s a huge figure.

To put it in context, an entire year’s Italian fiscal deficit ranges about EUR 50-60 bn and Italy allocated over EUR 90 bn (!) solely to shield consumers and firms from higher energy prices. Wow.

Again, Europe is bad at long-term policymaking but good at emergency measures.

Using public finances to shield the private sector from a structural trade/commodity problem isn’t a viable long-term solution, but it sure works in the short term because it fixes terms of trade.

What’s that?

Terms of trade indices measure the relative performance of a country’s export and import prices.Better (higher) terms of trade = the value you get out of your exports is outperforming the value of the stuff you need to import from outside, and vice versa.

Terms of trade are important for the currency: deteriorating/improving ToT often involve a weaker/stronger currency since the country has to spend more/less to import the same amount of products.

I mean, this chart is quite telling: as soon as Europe massively intervened and terms of trade (orange) started improving, the EUR caught a relentless bid.

A stronger EUR and better sentiment underpinned the recovery in European risk assets too, but the kicker was that government intervention also killed the recessionary vibes.The extreme pessimism around the manufacturing industry was now less justified as input and energy costs were subsidized by governments, and so an immediate earnings recession had to be priced out.

European stocks staged a massive rally and outperformed many global peers.On top of it, soft macro data started validating this new narrative as PMI surveys saw more optimistic answers about future economic growth.  

This begs the question: where do we stand now, and what’s ahead for Europe?

The chart below is an eye-opener…

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Hi everybody, and welcome back to The Macro Compass!

There is a time to be long, a time to be short and a time to go fishing.

As inflation skyrocketed and the Fed turned hawkish, bonds were kryptonite for investors for most of 2022: it was time to be short.

Between October 2022 and today we have instead seen inflationary pressures somehow moderate but the economy hanging in there, with 10y Treasuries stuck between 3.50% and 4.00%: time to go fishing.

With long-dated Treasury yields once again approaching 4%, might this be the time to go long?

In this piece, we will:

* Look at history and identify what were the ideal conditions to buy bonds (you’ll be surprised);

* Focus on the present, and assess whether these conditions are met today;

* Answer the big question: is it time to buy bonds?

Let’s say you were looking for a 10%+ return by buying bonds and holding them for 12 months.Your objective is to capture that initial, vicious 100+ bps move down in 10-year Treasury yields.

Now imagine somebody asked you this question.

In hindsight, what were the prevailing conditions in that very perfect moment when to go long bonds and harvest a 10%+ return in the subsequent 12 months looking at the past 3 decades?

Don’t cheat.

You probably said ‘’when the Fed announced QE’’ or ‘’right at the beginning of the 2001 or 2008 recession’’.And while these periods were good for bonds, they didn’t deliver that banger return you’re looking for.

The best periods to buy bonds were when:

* Nobody wanted or thought he needed bonds at all;

* A few quarters before companies started losing money and people started losing their jobs.

Let’s talk about the chart and the table above.Buying 5-10 years US Treasuries in April 2000, March 2007 and October 2018 delivered a subsequent 12-month return north of 10% - in medium term bonds, that’s quite a banger return.

Notice: no QE was announced in the immediate aftermath, and neither we were in a recession already.Instead, the first common feature across these periods is that everybody hated bonds.

In April 2000 the Fed was still hiking rates as core inflation had upside momentum, animal spirits were still running wild in the Dot-Com space and the economy was holding on okay – nobody needed bonds.

In March 2007 we were in the midst of the US real estate miracle (read: bubble) with unemployment rate at cycle lows and the S&P500 in an unstoppable march higher – who needed bonds, again?

And do you remember October 2018? Ongoing QT, Powell talking about a higher neutral rate, and a strong labor market – nobody wanted bonds.

The second common feature is that the odds of negative EPS growth and higher unemployment rate were rising rapidly.

Basically, nobody wanted bonds but everybody would soon need them.

For all these period in the subsequent 4-5 quarters earnings growth didn’t look good, the labor market cooled off and core inflation stalled.Macro data was unequivocally showing a nominal growth slowdown, which in 2 out of 3 cases morphed into an outright recession (2001, 2008).

History shows the best moment to buy bonds is right at the intersection when nobody wants them, but macro data will soon remind investors they do instead need bonds.

So, with 10-year Treasury yields fast approaching 4% again…

…is it now time buy a truckload of bonds?

Let’s dig in together…

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This is a free full-length piece available to everybody.If you find it valuable, consider subscribing to the premium TMC service.On the premium The Macro Compass platform, we do the hard work to deliver high-quality macro insights, tools and actionable investment strategy week in and week out.Institutional-level macro strategy in plain English at a fraction of the cost.

Hi everybody, and welcome back to The Macro Compass!

The YOLO crowd is back with a vengeance.

Over the last month we have seen nearly bankrupt companies rallying 100%+ in a single day, and companies reporting awful earnings staging a 20%+ rally the day after.

In other words: YOLO is back, bro.

In this piece, we will:

* Look back & quantitatively assess the mechanics behind this big Meme Rally;

* Answer the big question: if bonds yields are rising and cash-like products now yield 5%, how on Earth is it that we are witnessing such a high-beta rally? And is this the start of a new bull market?

Let’s take a step back in time – precisely to early November 2022.

The leading narrative was that ‘’Powell is channeling his inner Volcker’’: as the momentum of core inflation kept increasing (orange), the Fed was revising their expectations for the terminal rate (blue) higher & higher.

The Fed was all about tighter financial conditions, which is jargon for less animal spirits: a stronger US Dollar, higher borrowing costs and lower multiples.Higher borrowing costs are lethal for very leveraged, interest-rate sensitive sectors like real estate, (unprofitable) tech and Meme/YOLO stocks.

Not only that: uncertainty around the Fed terminal rate led to highly volatile bond markets.Rising bond market volatility hurts risk sentiment as the backbone of many institutional portfolio (fixed income) doesn’t dampen overall portfolio volatility but instead contributes to it.

Hard to take additional risks in such an environment

But then, something abruptly changed.

We got a couple of ‘’disinflationary’’ prints, and before the recent revisions it even seemed that Powell’s preferred measure of sticky inflation (core services ex-housing) was decelerating on a trending basis.On the backdrop of these disinflationary prints, the bond market staged a relief rally...

…and Powell didn’t fight back, at all.

And this is when the magic starts to happen: mechanical buying flows from leveraged investors kick in on a very large scale.

Here is how it works.

Commodity Trading Advisors (CTAs), risk parity and volatility-targeting funds often use volatility as one of their buying/selling signals: the more implied volatility drops and realized volatility keeps declining, the more these accounts can lever up and buy.These mechanical flows can be very large – I estimate these systematic strategies could be easily lifting $1-2 billion (!) of US stocks per day, and the more volatility remains compressed the longer these buying flows last.

Why do these mechanical flows matter?Their model-driven, valuation-insensitive nature has a disproportionate effect on two type of stocks:

* The most shorted and hated stocks out there;

* The least liquid and more flow-prone sectors in the market.

Think back in November: what sectors qualify for this definition?Yes: homebuilders, Meme/YOLO stocks, unprofitable tech & co.

The short squeeze has been gigantic so far, and it’s well reflected in these two charts from Goldman Sachs.

Macro investors were caught very short Tech between November and January, and given the mechanical systematic buying flows we discussed above the need to cover shorts has been big.

Particularly over the last 2 weeks, the extent of short covering in Tech has been almost unprecedented.

To further validate this thesis, the worst performers in 2022 (left side of the quadrant) happen to be exactly the best performers of 2023 YTD (top side of the quadrant) with the YOLO guys standing out in the crowd.

Now, to the big question.

Our interactive Volatility-Adjusted Market Dashboard points to some interesting inconsistencies.

On a 1-month rolling basis, US front-end nominal rates have moved by over 2 (!) standard deviations and most importantly long-dated real yields trade above 100 bps – that’s quite a restrictive level.The US Dollar is strengthening against most major currencies.Bond, stock and FX implied volatility has stabilized and struggles to decline further.

Systematic vol-targeting accounts might have exhausted most of their buying needs, and yet…

…the Nasdaq and the Russell are 3-6% up over the last month.

Can this continue?

Look, there are two realities to face.

1)     Markets can remain irrational longer than we can remain solvent;

2)     Long-lasting bull markets require rapidly expanding valuations and/or strong earnings growth.

The Dot-Com bubble and the US housing market frenzy happened with Fed Funds around 5-6%, not 0%.Animal spirits can be hard to contain, but the Fed doesn’t really have a choice.

After the recent revisions, core services ex-housing CPI (the sticky inflation) is still running at over 4% annualized levels and the US labor market keeps adding jobs at an underlying realistic pace of 150-200k new jobs per month.

The Fed will be forced to keep risk-free rates at 5%+ for 9-12 months at least, which means the housing market and the real economy must handle 7-8% (!) borrowing rates for a long time to come.

Hard to make the case for rapidly expanding valuations.

On the growth front, check this: between 2010-2020 we barely managed to produce an average 2% real GDP growth with an average Fed Fund rate of 0.62%.

What makes you sure we will avoid a medium-term recession with Fed Funds at 5%+ for long?

I will have fun staying poor, but I don’t YOLO here.

If you found this piece valuable, consider subscribing to the premium TMC service.On the premium The Macro Compass platform, we do the hard work to deliver high-quality macro insights, tools and actionable investment strategy week in and week out.Institutional-level macro strategy in plain English at a fraction of the cost.

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Hi everybody, and welcome back to The Macro Compass!

We are at that funny phase of the cycle when we look at the most lagging macro indicator (inflation) to assess how late the Fed is going to be this time.

In 2021, a gigantic amount of fiscal stimulus and credit creation led to a red-hot economy and yet the Fed was still doing QE and imposing negative real rates – because you know, inflation was subdued.

As we speak, the economy is growing very slowly and the housing market is frozen.

Still, the Fed is likely to impose 100+ bps positive real rates and QT for much longer than needed while it awaits for the ultimate confirmation that they have damaged the economy for good.

And today’s CPI report sent another clear message in that direction.

To all the disinflationary soft landing cheerleaders out there: forget about it.

In this macro piece, we will:

* Have a deep look into the just-released CPI report, assessing its subcomponents according to Powell’s own approach and deriving the likely Fed’s response to these updated inflation figures;

* Draw our own conclusions on what this means for macro and markets ahead, with a particular focus on the bond and stock market and considerations on our portfolio strategy.

The CPI Report

How do you analyze inflation numbers?

Easy – like the Fed does.

It might not be the best way to do it, but it’s the only one that matters.

In a speech released a few months ago, Powell told us he divides inflation into three main categories: core goods, housing and services ex-housing inflation.

According to the Fed, this is how things stand:

* Core goods are in a disinflationary trend due to the post-pandemic economic recalibration back to services and to much easier global supply chains;

* Housing inflation lags what happens on the ground, so it’ll keep increasing for a bit and then start declining in line with much softer asking rents we have seen recently;

* Services ex-housing is where they pay most attention and want to see sustained progress to 2%.

Let’s analyze today’s inflation numbers under the Fed’s approach.

Core goods prices are still in a disinflationary trend, but that powerful impulse seems to be alleviating.

The excessive imbalance between sizeable goods inventories and rapidly declining demand had led to outright core goods deflation (orange and blue lines), but prices seem to be bottoming here.

Nevertheless, freight costs have materially decreased and as shown by the NY Fed the global supply chain keeps normalizing – both positive developments for a continued disinflationary trend in core goods.

Core goods inflation is still looking benign for the Fed, but the disinflationary tailwinds might be alleviating.

Now, to the hot topics: housing inflation, and most importantly Powell’s preferred measure which is Core Services Ex-Housing inflation.

There were important news on both fronts, and the messages coming from the bond market couldn’t be louder.

Let’s dig into it, and assess how medium-term investors should approach such a macro environment…

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Hi everybody, and welcome back to The Macro Compass!

Our base case remains negative EPS growth and higher unemployment rate from May/June 2023.

In other words: a recession. But what if we are wrong?

In this piece, we will:

* Refresh some of our key indicators to assess where are we in this macro cycle;

* Update the probability and timing of a US recession;

* Unveil our main tactical trade idea.

Labor Hoarding

During the pandemic, companies experienced serious staff shortages and faced major challenges when trying to hire new qualified staff.

These memories might still be very fresh – look at this chart, for instance.

The rapid deterioration in the US housing market (blue) would historically suggest big layoffs in the construction sector which would significantly move the needle for unemployment rate (orange).

Some back-of-the-envelope calculations suggest such a frozen housing market should involve roughly 1.5 million job losses in all sectors related to real estate (construction, financials, brokers, ancillary activities). These job cuts alone would put the US in recessionary territory.

And instead, the construction sector has been net hiring (?!) over the last 12 months.

The only reasonable explanation here is labor hoarding.

As companies experienced serious difficulties in hiring qualified staff during the pandemic and perhaps expect this housing market freeze to be short-lived, they are not actively laying off people as they fear it might be hard to get them back.

Two confirming factors: wage growth isn’t accelerating and the average workweek hours keep declining. If companies want to hoard labor even if activity slows down, to save costs they will decrease their employees’ working hours and be more mindful about bumping up wages.

Labor hoarding seems real, and it might well delay the start of a recession. Ultimately though, it’s a kick-the-can-down-the-road exercise.

2. Just Too Much Money? (TMC’s Global Credit Impulse)

Let’s now have a critical look at our flagship TMC Global Credit Impulse indicator, and how the Chinese reopening and stimulus interplay with it.

And after that, let’s discuss our tactical trade ideas…

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Hi everybody, and welcome back to The Macro Compass!

Last week, FOMO (Fear Of Missing Out) became the prevalent market narrative.

As data seemed to further validate the soft landing narrative and Central Bankers became ‘’data dependent’’, markets are FOMO-ing like it’s 2019 again.

But 2023 isn’t 2019 – for many macro reasons we are going to touch upon.

In this article, we will:

* Reflect on last week’s important macro data and Central Bank meetings;

* Dig deep into how markets reacted, what’s the new consensus macro regime being priced in and whether macro data will validate it or not;

* Assess how to best position portfolios in this environment.

Can You Smell The FOMO?

In 2019, the Fed pivoted hard and the economy managed a proverbial soft landing.The 2018 hiking cycle which Powell abruptly reversed with his early 2019 pivot slowed the economy down, but not nearly enough to result in a hard landing.

The S&P500 earnings growth was only +0.6% (but not negative), core inflation was stable around 2% and the US added 160k new jobs per month: low nominal growth, but not a recession – in other words, a soft landing.

But 2023 isn’t 2019 – for many macro reasons we are going to touch upon.

First, let’s picture the current market regime.

The chart above shows the TMC’s Market Regime Scrutinizer.

It measures the market-implied odds assigned to a US recession, soft landing or strong growth regime ahead.It is derived by scrutinizing option markets in fixed income, equity, and currencies and blending the resulting market-implied probabilities in this flagship TMC indicator.

Markets are currently pricing a US soft landing as the dominant probabilistic regime (~65% probability), and in recent weeks the left recessionary tail has been aggressively priced out (now ~15%) while the chance of a strong growth regime ahead has been bumped up to ~20%.

Even after the apparently very hot labor market data and ISM services, the bond market keeps screaming immaculate disinflation/soft landing as the main regime ahead.

* Inflation is priced to drop to 2.5% by year-end, and stay close to 2% in the long run;

* Fed ‘’soft landing’’ cuts are priced in: as inflation slows down but without a recession, the Fed can gently cut rates to neutral levels (2.50-2.75%) without resorting to recessionary cuts or being forced to keep rates higher for longer.

Bond markets assign only a ~15% probability to recessionary cuts, and a ~30% chance to Higher-For-Longer Fed Funds amidst strong growth and sticky inflation.As a result, the option-implied market points to a ~55% probability of a disinflationary soft landing.

When a disinflationary, immaculate soft landing becomes the dominant market regime it’s all about selling insurance and getting paid while…well, not much happens and the Fed is on a very predictable path.

And indeed, as the Fed is assumed to be on a more predictable path ahead bond volatility is getting crushed.Lower bond volatility is leading to a much better risk sentiment in equity markets.

Now, to the key questions.

Are macro data really validating the soft landing base case priced in by markets?Are Central Banks really on a predictable path ahead?And finally: is 2023 going to look like 2019, a year when the S&P rallied 30%+ with minimal volatility?

Let’s find out…

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