The U.S. Consumer Won't Quit with Darius Dale

Name: The U.S. Consumer Won't Quit with Darius Dale
Uploaded: 2023-06-16T17:52:36.000Z
Duration: 1 h 8 min 14 s

Foreign

The video starts with a music intro and then the host introduces Darius Dale, founder of 42 Macro. They reflect on the hectic week that just passed.

Summary of the Week's Events

The week was characterized by a Fed meeting and a lot of economic data.

Inflation decelerated, which supports the Fed's "hunting for bigfoot" posture.

The dollar has probably run its course in terms of moving down, and is likely to be grinding higher in the coming months.

Money markets are already pricing in an expectation that further inflation data will cause the Fed to pause at their July meeting.

Factors Driving Dollar Higher

It starts with where we're headed from the perspective of data that will drive central bank reaction functions and what's priced in with respect to those data.

US inflation saw a significant move down on a three-month annualized rate of change basis, which supports the Fed's "hunting for bigfoot" posture.

Most people look at year-over-year inflation, but they should also consider sequential front-run years. There will likely be a significant drop off next month in June with respect to year-over-year inflation due to base effects.

Money markets are pricing in twice as much easing by the Fed as they see out of the ECB over the next two years. This is unlikely given that European recession is already happening and European inflation tends to lag US inflation by two quarters.

Terminal Policy Rate

Money markets are pricing in twice as much easing by the Fed as they see out of ECB over next two years.

The European economy is in recession and European inflation tends to lag US inflation by two quarters.

Undervalued Dollar on a Carry Basis

The speaker discusses the year-over-year basis point Delta in the real one-year real interest rate and the year-over-year percentage change in the nominal effective exchange rate. They argue that most currencies are generally on the trend line, but the US dollar is undervalued due to its strong carry.

US Dollar Carry

The US has the strongest carry in terms of all major currencies.

The market has run with this dollar bear narrative at least in the short term, which may be too far.

The market thinks that the Fed may just be on hold now or that rate hikes are done.

Market Expectations

The market is already effectively bought into this story that the Fed has effectively done.

You're seeing maybe a half of a rate hike priced into the terminal fed funds rate, whereas ECB's move up substantially and continue to trend higher.

We believe that we're setting up to see a series of upside inflation surprises throughout 2023 at least until the market kind of catches up to where we are.

Business Cycle Timing Models

The speaker discusses their business cycle timing models and how they predict when recessions will occur. They also explain why they believe there will be upside inflation surprises throughout 2023.

Recession Predictions

Since fall last year, they thought Q4 of this year had highest probability for recession, followed by Q1 next year.

Consensus is calling for recession to commence in Q3, but if that's wrong, it's likely that as we get past those easy base effects in June on inflation and start to get into the July data and beyond, we're going to start to see a firmness of inflation.

Going back to chart four, they believe that they are setting up to see a series of upside inflation surprises throughout 2023 at least until the market kind of catches up to where they are.

U.S. Business Cycle

They show the median trailing 10-year Delta adjusted z-score of a basket of indicators that represent particular cycles in the economy.

Housing breaks down around 18 months ahead of recession, orders take down about 10 months ahead of recession, production and profits break down around six months ahead of recession, employment tends to break down right as the recession is starting, and inflation tends to break down kind of six to eight months after the recession starts.

We've already had a lot of transitory disinflation going back to some of the inflation that we saw last year was in D transitory but we're going to get to the part of the movie where you're just not going to get significantly more positive inflation outcomes without having a significant drawdown in an overall labor market and an increase in

The Fed's Hike and the US Economy

In this section, the speaker discusses the possibility of a Fed hike in July and how it may affect the US economy. They also talk about factors that are currently propping up the consumer.

Possibility of a Fed Hike

A June data point is expected to be dovish, so if there is no hike in July, it is unlikely to surprise markets.

The speaker believes that without question, there will be a Fed hike by September meeting or perhaps even November meetings.

Factors Propping Up Consumer

The University of Michigan consumer sentiment rose to a four-month high today, which is interesting and feeding into that conversation about the economy being stronger.

Labor market dynamics have been holding up and propping up consumer spending. Manufacturing as a share of the economy has declined significantly. It's only about 14% of GDP and 14% of labor force.

Another factor that's been supportive is the amount of cash on household and corporate balance sheets - we're about three percent of total assets which is very high compared to previous years.

Housing Market Resilience

In this section, the speaker talks about why housing has proven to be quite resilient despite economic shocks.

Housing Market Resilience

Interest rates for mortgages are still down around three and a half percent despite marginal margin rate for anyone in the market to buy a home from effectively zero to seven percent which has put upward pressure on demand for new homes.

Housing has proven to be quite resilient due to interest rate shocks ironically.

The longer we push out the recession, it does not delay it but rather increases the risk that it's more severe for some reason.

The Impact of Consensus on Recessions

In this section, the speaker discusses whether exceeding consensus or expectations for a recession will make it harsher. They also discuss the impact of tightening on the severity of a recession.

Exceeding Consensus and Harshness of Recession

There is concern that if there was strength that exceeded consensus or those who were looking for it, it would mean a harsher recession.

However, there is no historical evidence to support this view.

Tightening and Severity of Recession

The severity of a recession depends on the amount of tightening seen.

If the Fed has to keep going with tightening, then they weren't at restrictive territory yet.

The actual level of the neutral fed funds rate is an important factor in determining the severity of a recession.

Factors Affecting Toughness and Magnitude of Recession

In this section, the speaker discusses what makes a recession tough in magnitude and how much tightening affects its severity.

Toughness and Magnitude

What makes a recession tough in magnitude is obviously the amount of tightening that we see.

Tightening and Severity

The severity of a recession depends on the amount of tightening seen.

Impact of Prompting Fed to Keep Going

In this section, the speaker discusses why some people worry about prompting the Fed to keep going with increasing risk when there's strength beyond consensus.

Prompting Fed to Keep Going

Some people worry that if there is strength beyond consensus, it will prompt the Fed to keep going and increase the risk of piling on.

However, if the Fed has to keep going with tightening, then they weren't at restrictive territory yet.

Impact of Restrictive Territory on Business Cycle

In this section, the speaker discusses how being in restrictive territory affects the business cycle and how long remaining in such a territory impacts it.

Restrictive Territory and Business Cycle

What happens after you get to restricted territory and how long you remain in a restrictive territory really has an impact on the actual business cycle.

Neutral Fed Funds Rate

In this section, the speaker discusses what is meant by neutral fed funds rate and its importance.

Definition of Neutral Fed Funds Rate

The neutral fed funds rate is an important factor in determining the severity of a recession.

It refers to what's the actual level of the neutral fed funds rate.

Analysis of Cash Balances

In this section, the speaker discusses cash balances analysis and its implications for determining neutral fed funds rate.

Cash Balances Analysis

There's tons of cash in corporate and consumer balance sheets.

The question arises as to what's a neutral fed funds rate.

This is something that we're gonna be chewing over a lot over summer.

Impact of New Inflation Measuring

In this section, the speaker discusses how the new inflation measuring impacts current numbers and whether it makes them look better or worse.

New Inflation Measuring

The FED changed inflation measuring to look just one year back instead of two.

It's not necessarily making things better or worse.

The Deltas of the data have been positive outcomes on the inflation front that historically very not they typically do not happen this far ahead of a recession commencing.

Impact of Employment Confidence and Cash Balances

In this section, the speaker discusses employment confidence and cash balances in relation to inflation.

Employment Confidence and Cash Balances

We continue to see employment confidence compounding at nearly five percent quarter over quarter annualized.

There's also some significant chunk of that (inflation) that is very not transitory.

There's going to be some residual impact on that for years to come in terms of resetting that amount of cash that's just sloshing around the US economy higher.

Impact of Public Debt Growth on Inflation

In this section, the speaker discusses how public debt growth affects inflation.

Public Debt Growth and Inflation

Bipartisan support inflated public debt by 6.4 trillion dollars in two years ended 2021.

Almost 52% was monetized by Fed with outright treasury securities purchases.

This is why we're having an inflation episode and why we're going to continue to see sticky structural core inflation.

Difficulty of Reducing Inflation

In this section, the speaker discusses how difficult it is to reduce inflation.

Difficulty of Reducing Inflation

Getting from nine to four was pretty easy because there's a lot of transitory inflation.

Going from four to two that's going to take quite a while and the FED acknowledged that in terms of funding out.

Fed Hiking and Housing Crash

In this section, the speaker discusses concerns about Fed hiking and its impact on housing.

Fed Hiking and Housing Crash

Some people worry about the Fed keeping their foot on the hiking slamming the break more than they perhaps needed to as this plays out.

The answer is not mass unemployment and a housing crash.

Consumer Outlook

In this section, the speaker discusses the current state of the consumer outlook and how it relates to job growth, real incomes, and savings.

Consumer Outlook

The most recent month saw a 1.7% increase in inflation, which is close to an 18-month high.

Real incomes are improving as a result of the disinflation process.

Job growth is leading to more people being employed.

Household and corporate savings are supporting consumption.

The speaker advises against getting too bearish on the consumer at this time.

Business Cycle Downturn

In this section, the speaker discusses how business cycle downturns occur and what factors contribute to them.

Business Cycle Downturn

Interest rate-sensitive sectors of the economy break down first during a downturn.

Companies that support these sectors start to see their profits decline and may need to right-size their business with employment layoffs.

The stock market is not a concern until there are real layoffs in the labor market.

Market crashes associated with recessions are called phase two credit cycle downturns because they tend to price in the credit cycle.

Markets tend to peak around one month ahead of the trough in unemployment rates.

Stock Market Behavior

In this section, the speaker discusses recent stock market behavior and what it means for investors.

Recent Stock Market Behavior

Stocks have been flying due to positive flow and concentrated returns from large mega-cap tech companies.

Long-only money managers benchmarked against these companies are underperforming by definition.

A gamma squeeze has occurred where dealers are forced to chase with hedges as investors who are underweight in these companies are finding their only way to get involved is to buy.

The speaker advises that stocks are pricing in a behavior dynamic that is important for investors to understand.

Hedging Process and AI Investing

In this section, the speaker discusses the hedging process and its impact on the market. Additionally, there is a discussion about AI investing and diversification.

Hedging Process Tends to Mark the Low in the Market

The hedging process tends to mark the low in the market.

Overbought signals are present in NASDAQ Mega Cap Growth Tech.

A bearish crowding signal was observed on Tech and Cues today morning.

This is not a good spot to be taking risks.

Reverse of Hedging Process Likely to be True Here

The reverse of hedging process is likely to be true here.

It's not a great spot to put on risk if we do correct over the next few months.

Markets are forward-looking and have already priced in dubbage FED for next July.

Realization that inflation will probably be stickier than expected.

Concerns About Reach for Anything AI Related

Jonathan Cohen expressed concern about reach for anything AI related.

Diversification makes sense but invest with conviction.

Diversification may lead to bubbles in AI investing.

Can Rally Broaden Out?

In this section, there is a discussion about whether or not the rally can broaden out.

Rally Unlikely to Broaden Out Materially

It's unlikely that rally will broaden out materially on a trending basis.

If we rallied into year-end, it's probably not going to be a very broad rally.

Expecting a rally to materially broaden out with that on the rise is usually not high probability outcome.

How Should You Participate in This Market?

Don't buy it today; wait for correction.

A lot of signals have lined up in support of a correction.

Longbow has a doomsday dozen meter with different indicators that they put in there.

If the market is down 8 to 10 percent sometime this summer, it's probably a good time to buy the dip.

TGA Build and RRP

In this section, there is a discussion about whether or not TGA build is still an issue going forward.

TGA Build Still an Issue Going Forward

Yes, TGA build is still an issue going forward.

It's being dramatically offset by significant decline in RRP.

The reverse people facility balance declined more than the TGA balances increased.

The Impact of T-Bills on the Market

In this section, the speakers discuss the impact of T-bills flooding out of the RRP and how it has been supportive of the market. They also talk about how sustainable this trend is and what factors will determine its longevity.

T-Bill Flooding and Market Support

The flooding out of the RRP with T-bills has been supportive of the market.

It makes sense to suck up some of those T-bills if there is a basis in terms of carry.

Sustainability Factors

The sustainability of this trend depends on how much more T-bills are going to flood the market with.

Whether or not it is sustainable will depend on future issuance both Bill and coupon, especially net coupon issuance.

Record Budget Deficit and Coupon Issuance

In this section, the speakers discuss record non-war non-pandemic budget deficit in the US economy which is minus eight percent GDP. They also talk about how it will lead to a ton of issuance both Bill and coupon.

Record Budget Deficit

The US economy is running a record non-war non-pandemic budget deficit that is minus eight percent GDP.

Coupon Issuance

There will be just a ton of issuance both Bill and coupon as a function of that record budget deficit.

It's important to note that it's the coupon that matters because quantitative tightening has not been draining Bank Reserves since January, but it will start to join Bank Reserves again this summer.

Summer Friday Drinks

In this section, the speakers discuss their favorite summer drinks and what they like to drink on Fridays during the summer.

Favorite Summer Drinks

Darius has long been sponsored by Whispering Angel.

Lena's trade that gave her some upside was Raul's Tesla suggestion two weeks ago.

Drink Recommendations

Raul has dragged Darius over to the Cava side, which is fabulous.

Fresca makes a mix that is good and low calorie with ABV.