The Reality Is Higher Rates Slow Growth

0
93


MAGGIE LAKE:


Hi,


everyone.


Welcome


to


the


Real


Vision


Daily


Briefing.


It’s


Wednesday,


June


22nd,


2022.


I’m


Maggie


Lake


here


with


Darius


Dale,


founder


of


42Macro.


Hi


there,


Darius.


DARIUS DALE:


Hey,


Maggie,


it’s


good


to


see


you.


How


are


you?


MAGGIE LAKE:


I’m


doing


okay,


dude.


Okay.


I


think


everybody


are


watching


the


Fed


still,


we


had


Jay


Powell


testifying


in


front


of


Congress


again,


reiterating,


trying


to


be


as


hawkish


as


possible,


committed


on–


strongly


committed


to


inflation.


But


it


was


really


interesting


to


watch.


The


stock


market


seemed


like


it


was


ignoring


for


most


of


the


day,


we


had


what


looked


like


a


little


bit


of


a


rebound


going


on,


but


it


dropped


out


a


little


bit


at


the


end,


they


rolled


over


back


into


the


red,


nothing


huge


in


terms


of


selling


but


just


interesting


to


see


that


negative


sentiment


or


just


lack


of


buyers,


I


guess,


in


the


last


half


hour


trade.


10Y


bond


yield


down


to


3.15.


We


have


crude


prices


lower.


Of


course,


crypto


getting


shredded


again.


What


did


you


make


of


the


market


action


today?


DARIUS DALE:


Yeah,


the


market


action


today


was


pretty


interesting.


So,


it’s


in


the


context


of


what


we’re


observing


here


in


the


process


at


42Macro


as


a


potential


market


regime


transition


from


what


we


call


inflation,


which


is


where


the


market’s


pricing


in


an


accelerating


inflation


and


growth


slowing


to


what


we


call


a


deflation,


which


is


where


the


market


is


pricing


in


these


simultaneous


decelerations


in


both


of


those


factors.


We


saw


pretty


significant


selloff


in


crude


although


we


rallied


off


the


lows,


another


big


drawdown


in


energy


stocks,


a


big


drawdown


in


crypto,


you’re


seeing


emerging


markets


take


it


on


the


chin.


So,


separate


and


apart


from


this


intraday


rally


in


stocks,


which


it


may


itself


be


incrementally


fueled


by


the


post


opex


dynamics.


Don’t


forget,


we’re


two


days


after


a


pretty


chunky


opex,


removed


a


significant


chunk


of


negative


gamma.


I


think


this


market


is


starting


to


sniff


out


this


move


towards


deflation


which


we’ll


unpack.


MAGGIE LAKE:


Darius,


when


you


say


deflation,


because


there’s


this


huge


conversation,


and


it


came


up


today


during


the


testimony


around


inflation,


the


idea


that


they’re


trying


to


bring


it


down.


But


just


because


the


rate


is


lower


or


is


decelerating


or


there


was


smaller


increases,


however


you


want


to


categorize


that,


that


it’s


still


going


to


get


stuck


at


this


really


elevated


level.


That’s


when


people,


especially


those


in


the


inflation


camp,


are


really


concerned


about.


When


you’re


talking


about


deflation,


is


it


possible


the


way


you


look


at


it


that


it


can


be


lower


but


still


stuck


at


a


high


level,


or


do


you


see


this


thing


going


back


down?


DARIUS DALE:


Yeah,


so


just


in


terms


from


a


risk


management


perspective,


our


core


process


at


42Macro,


at


least


on


the


fundamental


forecasting


side,


really


anchors


on


the


rate


of


change


of


primary


economic


variables,


like


the


rate


of


change


of


growth


in


the


economy,


the


rate


of


change


of


inflation,


or


the


second


derivative


is


what


I


mean


by


the


rate


of


change.


So


yeah,


the


trend


it


change


in


those


time


series


will


have


an


important


influence


on


dispersion


across


asset


classes,


both


within


and


across


asset


classes


we’ve


backtested


the


six


ways


this


Sunday.


But


when


you


think


about


it


from


the


perspective


of


the


Fed,


there


are


actual


targets,


levels


that


they’re


concerned


about,


not


just


in


reported


statistics,


but


also


in


market-based


measures,


in


terms


of


expectations,


etc.,


which


Powell


outlined


last


week,


and


further


outlined


this


week,


happy


to


unpack


those


as


well.


MAGGIE LAKE:


Yeah,


what


jumped


out


at


you?


We’re


hearing


this


similar


message


over


and


over


again,


I


know


everybody


parses


everything


they


say


to


look


for


any


changes.


Is


there


anything


that


jumped


out


at


you


today


from


the


testimony?


DARIUS DALE:


Yeah.


So,


from


the


testimony


specifically,


no.


I


thought


he


reiterated


everything


that


quite


frankly,


I


live


tweeted


about


during


last


Wednesday’s


FOMC


press


conference,


which


is,


this


is


a


Federal


Reserve


that


is


content


with


sending


the


economy


into


what


it


hopes


would


be


a


mild


recession


in


order


to


tackle


what


I


consider


and


I


think


Jay


Powell


himself


considers


to


be


an


inflation


disease,


it’s


willing


to


amputate


its


arm


or


its


leg


in


order


to


save


the


whole


body,


if


you


will,


from


the


spoils


of


inflation.


So,


I


think


he


did


a


decent


enough


job


reiterating


that


amidst


a


sea


of


nonsensical–


political


nonsense


around


gas


prices


and


regulation,


etc.,


etc.


These


semiannual


testimonies


are


always


fraught


with


politics.


But


when


you


read


through


the


tea


leaves,


there


wasn’t


actually


much


substance


in


terms


of


incremental


information


relative


to


what


we


heard


from


last


Wednesday.


MAGGIE LAKE:


Yeah.


And


it’s


been


interesting


to


watch


the


data


because


as


you


said,


this


conversation’s


really


turned


very


quickly


and


everyone’s


talking


about


recession,


because


we


saw,


as


many


had


been


predicting,


those


of


you


who’ve


been


worried


about


the


economy,


we’re


starting


to


see


some


of


those


early


warning


signs,


those


more


forward-looking


indicators,


whether


it’s


some


of


the


manufacturing


indicators,


or


some


of


the


early


housing


start


to


turn


really


in


the


last


week.


I


know


that’s


got


everyone


thinking


about


inflation.


I


want


to


play


a


clip


right


now


because


as


we’ve


been


discussing


the


Fed


and


how


behind


the


curve


they


may


or


may


not


be,


Tian


Yang


weighed


in


on


this


subject


in


a


recent


Expert


View


he


did


for


us


here


at


Real


Vision.


Let’s


listen


to


a


clip


of


that


and


then


we’ll


talk


on


the


other


side.


TIAN YANG:


Right


now,


the


market


narrative


is


very


much


that


yes,


the


Fed


is


behind


the


curve.


But


in


terms


of


how


fixed


income


markets


should


be


behaving


in


a


“normal”


hiking


cycle,


I


would


say


the


behavior


is


not


that


bad,


right?


Yield


curves


generally


bear


flatten


in


terms


of


this


hiking


cycle,


which


is


typically


what


you


would


expect.


If


you


look


at


some


of


the


longer-term


things


like


5Y


5Y,


if


you


look


at


term


premium,


these


things


haven’t


really


gone


to


crazy


levels,


so


for


sure,


there


has


been


a


lot


of


adjustment,


clearly,


bond


yields


need


to


reset.


But


you’re


not


seeing


the


typical


panic


that


you


will


see


at


the


federal


level.


If


they


truly


weren’t,


you


will


probably


see


term


premium


rise


a


lot


more,


you


actually


probably


see


a


curve


steepening


in


response


to


Fed


policy


action,


because


generally,


you


see


a


flattening


trend,


it


shows


that


at


least


the


market


is


going


to


give


the


Fed


some


credibility


that


the


Fed


is


serious


about


fighting


inflation,


to


the


extent


that


they


may


be


willing


to


engineer


a


recession,


hence,


you


get


the


curve


flattening.


As


of


right


now,


again,


these


are


things


that


we


want


to


watch


for


in


terms


of


whether


that’s


truly


a


change,


but


the


Fed


still


is


credible,


in


my


view,


because


they


might


be


behind


the


curve,


but


they’re


still


doing


things


to


address


it


and


the


market


is


giving


them


some


credit


for


it.


MAGGIE LAKE:


And


that


full


Expert


View


is


available


to


Essential


Plus


and


Pro


members


on


our


website.


So,


people


taking


the


Fed


at


face


value,


I


suppose


that


they’re


more


serious


about


it.


I


think


it’s


an


open


question


still


there,


is


how


much


they


can


actually


influence


what’s


going


on.


They’re


targeting


the


demand


side,


we


know


there


is


some


supply


side


issues


involved


here.


Where


do


you


come


down


on


this?


And


I


guess


the


question


is,


where


are


we


with


the


bond


market?


The


bond


markets


giving


them


some


credit,


but


is


the


Fed


leading


the


bond


market?


Or


is


the


bond


market


leading


the


Fed?


DARIUS DALE:


So,


right


now,


that’s


a


phenomenal


question.


And


by


the


way,


I


generally


agree


with


Tian’s


view,


he’s


another


data


driven


investor,


I


tend


to


side


with


a


lot


of


data


driven


macro


risk


managers.


But


just


going


back


to


your


question,


I


think


what


Powell’s


most


concerned


about,


and


he


articulated


this


several


times


particularly


in


the


last


week


or


so,


which


is


very


concerned


about


long


term


inflation


expectations,


and


the


volatility


associated


with


them


becoming


“unmoored”,


if


you


will,


to


borrow


a


phrase


from


our


friend


Jim


Bullard


yesterday.


Brian,


I


sent


you


a


chart


from


one


of


our


decks


that


says


Powell


is


fighting


to


maintain


control


over


the


bond


market.


And


what


this


chart


shows


in


the


top


panel


is


just


the


10Y


3M


yield


spread.


That’s


a


proxy


for


the


growth


expectation


of


the


economy,


if


you


will.


Powell


has


really


got


growth


expectations


at


least


still


reasonably


anchored,


because


we


have


not


seen


a


significant


flattening


of


that


curve


generally


via


bull


flattening,


if


you


will,


which


you


typically


see


into


a


recession.


But


on


the


bottom,


I


think


that’s


the


more


important


part–


or


sorry,


the


middle


panel


is


actually


the


more


important


chart,


which


shows


the


term


premium,


which


is


a


very


wonky


academic


measure


that


really


is


just


trying


to


assess


how


much


premium


investors


demand


for


holding


longer


term


maturities.


Once


you


X


out


things


like


the


expected


growth


rate,


the


expected


inflation


rate,


the


inflation


risk


premium,


etc.,


etc.,


what


you’re


left


with


is


the


term


premium.


And


right


now,


at


minus


six


basis


points,


we’re


only


in


the


eighth


percentile


of


that


on


all


daily


observations


going


back


to


the


early


1960s


on


this


metric.


And


so,


what


that’s


telling


you


is


that


the


bond


market


believes


the


Fed


still


has


credibility


with


the


bond


market


in


terms


of


its


inflation


forecast,


its


growth


forecasts,


and


ultimately,


its


desire


to


maintain


that


control


by


effectively


quashing


out


inflation


really


quickly


and


really


effectively.


Now,


if


at


any


point


in


time,


as


you


can


see


from


the


chart


going


back


to


the


mid


to


late


1970s


all


the


way


through


the


early


1980s,


the


Fed,


starting


with


Arthur


Burns,


really


lost


control,


Arthur


Burns


was


the


Fed


chair


back


in


the


1970s


who


really


let


the


inflation


genie


out


of


the


bottle,


which


obviously


Powell


is


trying


to


avoid.


He


really


let


that


genie


out


of


the


bottle,


and


you


saw


the


term


premium


widened


to


just


under


500


basis


points


over.


So,


if


you


think


about


just


without


any


change


in


growth


or


inflation


expectations,


you


could


have


the


10Y


Treasury


yield


gallop


three,


four


or


500


basis–


not


three,


four


or


five,


but


more


like


200


to


300


basis


points


higher


just


on


a


revision


to


the


term


premium,


which


again,


is


the


bond


market


pricing


in


the


uncertainty


around


Fed


policy.


This


is


what


Powell


is


hyper


concerned


about


because


again,


if


you


let


the


inflation


genie


in


the


bottle,


it’s


really


hard


to


get


that


back


in.


MAGGIE LAKE:


Yeah.


And


that


is


why


that


is


one


of


the


pillars


of


their


mandate,


price


stability.


It


was


last


of


the


four


because


of


the


disinflationary


slash


deflationary


period


we


were


in


but


question


on


bonds,


Gary


from


the


RV


site,


the


10Y


Treasury


rate


peaked


right


at


the


top


of


the


stock


market


in


early


2000


and


mid-2007,


per


the


title


of


this


interview,


why


do


you


think


rates


will


keep


going


higher


this


time?


I


would


say,


do


you


think


we’ve


seen


the


peak?


And


if


not,


what’s


going


to


keep


them


elevated?


Or


what’s


different


this


time


around?


DARIUS DALE:


Yeah,


I


think


that’s


a


difficult


question


to


answer


in


this


particular


juncture,


the


first


part


of


the


question,


which


is,


have


we


seen


the


peak


in


rates?


We’re


going


to


see


new


highs


in


rates


if


inflation


continues


to


misbehave.


We’ve


been


talking


about


this


for


the


past


month


or


so


about


the


potentiality


for


inflation


misbehaving.


It


did


misbehave


in


the


May


inflation


reading,


we


did


see


a


step


function


increase


in


terminal


Fed


Funds


Rate


expectations


and


policy


rate


expectations


across


the


curve.


And


ultimately,


that


big


shock


higher


in


the


UMich


five-year


forward


inflation


expectation,


which


really


spooked


the


Fed


is


obviously


filtering


its


way


into


the


bond


market.


So,


we


could


continue


on


in


this


process.


I


don’t


need


to


go


into


the


details


on


the


inflation


statistics,


that


will


tell


you


that


that


risk


is


still


very


much


on


the


table.


We


saw


a


broadening


out


of


inflation


data


or


inflation


pressure


in


the


most


recent


meeting,


the


May


reading


just


to


get


those


statistics


at


three-month


annualized


median


CPI,


which


is


everything


in


the


CPI


basket


on


the


median


basis,


accelerated


to


6.4%


on


a


three-month


annualized


basis,


fastest


rate


ever.


So,


the


broad


basis


of


inflation


is


a


real


issue


and


has


not


been


tamed


yet,


at


least


not


according


to


the


data.


As


it


relates


to


the


bond


market,


have


we


seen


the


highs


in


yields?


I


think


that’s


a


50/50


toss


up


right


now,


it’s


difficult


to


ascertain


that


at


the


present


juncture.


And


generally


speaking,


just


to


take


a


step


back


from


a


risk


management


perspective,


it’s


always


difficult


to


catch


falling


knives


in


any


market,


obviously,


catching


the


falling


knife


in


bond


crisis


here


so


just


be


careful


with


these


types


of


questions.


What’s


more


important


is


understanding


the


change,


the


potential


change


in


the


regime


that


could


be


potentially


favorable


for


the


bond


market.


And


that’s


something


we


do


on


a


daily


basis


at


42Macro.


Brian,


if


you


bring


up


that


chart,


deflation


is


now


the


second


most


probable


regime,


so


going


consistent


with


our


GRID


framework,


which


we


use


the


rates


of


change


of


growth


and


inflation


to


identify


what


regime


the


economy


is


in,


we’re


actually


using


market


signals,


core


market


signals


across


42


different


markets,


all


different


asset


classes,


to


nowcast


what


regime


the


market


is


in,


what


is


the


market


pricing


in,


and


it’s


been


consistently


pricing


in


inflation


has


been


the


highest,


most


probable


regime.


And


oh,


by


the


way,


there’s


504


unique


datapoints


that


go


into


that


process


every


day


to


determine


what


that


market


regime


is.


And


now,


what


we’re


starting


to


observe


is


that


deflation


is


now


the


second


most


probable


regime,


which


is


actually


consistent


with


our


forecasts,


which


are


calling


for


a


phase


transition


in


the


economy


to


deflation,


again,


growth


slowing,


inflation


slowing


by


mid


to


late


Q3.


And


so,


to


answer


the


question


just


very


succinctly,


if


we’ve


seen


the


highs


in


bond


yields,


it’s


coming


right


on


time.


I’m


not


certainly


seeing


the


highs


in


bond


yields


because


I


see


a


scenario


where


inflation


continues


to


surprise


to


the


upside


over


the


next


month


or


two.


And


if


that


happens,


we’re


going


to


see


another


step


function


increase


in


terminal


Fed


Funds


Rate


pricing.


But


if


we


don’t


see


inflation


surprise


to


the


upside,


then


it’s


very


likely


we


have


seen


the


highs


in


bond


yields.


MAGGIE LAKE:


Yeah,


and


that’s


what’s


so


hard,


because


this


is


you’re


trying


to


gauge


the


supply


chain


issues


in


some


way,


not


the


demand,


which


was


a


little


bit


clear.


It’s


hard


to


forecast


if


China


is


going


to


close


down


because


of


COVID.


These


are


the


things


that


keep


roiling


us,


I


think,


when


it


comes


to


trying


to


get


a


handle


on


that


and


why


so


many


have


gotten


the


timing


on


bonds


wrong.


There


are


people


who


think


bonds


are


a


good


buy


here,


but


it’s


just


so


hard


to


plug


in


the


timing


part


and


not


matter.


I


think


just


echoing


Darius’


sentiment,


be


careful


in


this


environment,


it’s


just


a


really,


really


difficult


one.


So,


the


same


question


we


get


all


the


time


as


you


know,


Darius,


when


it


comes


to


stocks,


it’s


that


same


feeling.


Are


we


through


the


worst


of


it?


Is


it


time


to


start


buying?


And


the


way


Galan


put


it


in


a


question


here


from


the


RV


site,


I


hope


I’m


saying


your


name


right,


Galan.


The


average


recession


has


roughly


25%


decline


in


S&P


earnings,


S&P


earnings


are


$204


as


far


as


I


can


see,


these


are


the


numbers


he’s


using


or


she’s


using.


The


average


multiple


on


the


S&P


500


is


15


times


over


time,


I


think.


So,


assuming


the


multiple


doesn’t


overshoot,


that’s


a


2300


on


the


S&P.


Do


you


think


this


is


worthwhile


thinking?


Thank


you


for


walking


through


your


thinking,


by


the


way,


so


we


can


understand


where


you’re


coming


from


with


that


question.


And


I


think


the


way


I


want


to


put


it


to


Darius


is


people


are


looking


at


this


decline


from


the


top


and


obviously


Galan


also


plugging


in


some


earnings


to


that.


But


I’ve


had


people


on


the


program


say


I


don’t


care


what


the


decline


is


from


the


trough


to


the


bottom


now


because


that’s


not


all


the


information


I


need


to


see


whether–


maybe


it’s


not


going


to


go


back


to


that


level.


You


got


to


plug


a


lot


of


other


data


in,


so


what


are


you


thinking


about,


Darius,


as


you


try


to


figure


out


their


trajectory


here


and


the


timing


for


the


S&P


or


for


stocks?


DARIUS DALE:


Absolutely.


So,


if


I


get


fired


from


my


day


job


of


helping


professional


and


retail


investors


manage


macro


risk,


I’ll


be


a


professor


somewhere


maybe


back


New


Haven


where


I


got


my


degree.


But


I


think


this


is


a


perfect


question


and


a


phenomenal


question,


Galan,


if


we’re


saying


your


name


right,


I


apologize


if


we


aren’t,


to


unpack


a


few


things.


I’ll


start


by


just


really


quickly,


S&P


earnings


on


a


next


12-month


forward


basis


which


you


should


be


using


to


help


value


the


market


on


a


forward-looking


basis,


are


currently


at


$220


per


share.


That’s


a


new


high,


we’ve


trended


higher,


we’ve


not


seen


any


significant


earnings


revisions,


and


we


continue


to


trend


higher


on


an


earnings


per


share


basis.


So,


that’s


an


issue


if


you


think


about


the


significant


growth


slowdown


that


we’re


likely


to–


that


we’ve


already


accumulated


in


terms


of


the


financial


tightening


we’re


seeing,


but


we’re


likely


to


experience


in


realized


terms


over


the


next


few


months.


A


couple


of


more


things


that


I’d


highlight


that–


again,


this


is


a


fantastic


question,


great


teaching


opportunity


here.


They


mentioned


the


word


average


several


times


in


that,


average


drawdown,


average


earnings,


average


multiple,


average,


average,


average.


Average


is


the


most


dangerous


word


in


finance,


write


this


down,


average


is


the


most


dangerous


word


in


finance.


And


the


reason


it’s


so


dangerous


is


because


most


time


series


spend


very


little


time


at


their


average,


the


average


itself


is


just


a


statistical


concept.


We


don’t


live


in


a


world


of


apparently


observed


averages,


we