DECISION TIME

Double down or cut losses?

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There never really is any certainty in markets. There is always tail risk - some unknown unknown that could turn up and destroy your best laid plans. But sometimes, you get market set ups where you are offered a straight up choice between the world carrying on as it has (the future looks like the past) or a huge inflection, where we break with the past, and the future looks very different. To my mind inflation looks secular and likely to continue for the foreseeable future. However, most market indicators are signalling “Mission Accomplished” for the Federal Reserve in its fight against inflation. 5 year 5 year forwards have stalled out.

From the Federal Reserve perspective, they have seen the US yield curve invert. That is 2 year bond yields are higher than 10 year bond yields, which has usually been enough to slow activity. Yield curve inversions have happened typically before recessions, such as in 2000 and again in 2007.

Commodity indices are also showing signs of topping out, which makes the idea that deflation is returning seem even more likely. The problem with this view is that is conflates commodity demand with US or Western financial conditions. Using the BP statistical report, if we look at total energy consumption, the days that the rise and falls in western demand affected commodity demand are long gone.

The market knows this, of course, which is why Chinese interbank rates have tended to be much more highly correlated to commodity prices than US bond yields.

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