Makes sense but looking past that doesn't it raise the risk of a credit/liquidity event down the road (say H2 23 or 2024)? My read is that last Fall stuff (esp. financial markets - Stocks yes but mostly long bonds and USD) seemed fairly close to break and the Fed and the Treasury (not sure what's the level of coordination here) decided to raise their foot off the brake a little bit to achieve a disinflationary soft landing... Was probably too early and with that and China reopening markets looked forward and FCI re-eased too fast too quick... So now yes it's likely that at least the higher for longer scenario will get repriced (if not even a higher terminal rate), but then it will bring some markets close to breaking point again (housing, leveraged credit,...), maybe quite quickly.
I think this cycle is really difficult because the economy is really out of sync... Some sectors seem still strong but others seem vulnerable... And monetary tightening is quite a blunt tool. So it's hard to play, especially if the repricing of higher for longer probability is slow and gradual... But if it's brutal and rates very quickly go back to last autumn's highs and stay there or break them, I'd be inclined to fade it. And then expect more fiscal stimulus and monetary reversal... But might not be immediate with debt ceiling negotiations... So air pocket then back to structural inflation in maybe 6 to 12 months after that.
I don't want to be too cute so I'm trying to structure my portfolio as a barbell. Commodities look cheap in the inflation re-acceleration scenario but still want to have a decent cash position, some 2Y exposure + rate hedges look close to become attractive again in my view. Pondering 5Y or 10Y TIPS too, look like decent performers in both scenarios ( at least as buy and hold).
I think growth will be good - especially in nominal terms, but I think the risk is that there are many businesses that have prospered on low interest rates, and low cost of labour. And these business need to face a reckoning - just as unions faced a reckoning in 1980s and 1990s. My best guess is we have very whipsaw action in the markets as financial conditions tighten and loosen - but in the end dont really go anywhere
The hold to maturity is important - as the inflation is added to end principal, so in a period of rising rates and inflation you could get frontloaded with capital losses. The TIP ETF has been pretty poor - I need to sit down and work out if it attractive here or not
Ya agreed - the main thing I've been reading about (not in mainstream media obviously) is that a massive amount of dioxins were released when the vinyl chloride was burned up. Dioxins take a very long time to break down and go away, so something to keep an eye on for longer term impacts
Hi russel a question on bank stock performance in rising inflation environment.for me yes there’s a positive impact from NIM expansion early in the rate cycle but later you have risk of low credit demand and high cost of risk.what do you think ?
I think we have moved to a government led investment cycle - which is why sovereign bonds and equities have become so correlated. The real risk is that governments and central banks destroy asset values in the pursuit of REAL wage growth. That is wages grow, so you have inflation, so central banks try and control that inflation by destroying asset value - or the opposite of what we have seen the last ten year. So banks with the least risk would be one where asset values are lowest - which is why I like Japanese banks.
not sure i got what you mean by asset value? you mean the valuation for these banks will be lower from higher discount rate? or you mean rising rates will impact the investment book of the banks.
Russell - how does subsidy factor into your thinking given that the fact that Big Mac & McNuggets pricing is heavily dependent on subsidy of animal feed inputs?
Meat consumption is also in decline and will continue to, if not speed up...
This thesis must fit your earlier presentation on short sell opportunities there too.
I guess some assumptions I am making is that Chinese meat consumption wont fall in the short term yet. I am also implicitly saying that bread prices are more important than meat prices in the US, but that I think US meat prices are too low, given Chinese corn prices.
Using the short selling methodology, I would be wondering why meat and bread prices are going their separate ways... and as the presentation says, I think meat goes higher, and hence inflation is stickier than expected...
If Chinese pork prices start rising (amongst other commodity prices) I expect to see the PBoC allow the yuan to appreciate to offset inflationary pressures. Very good for Chinese bonds.
Biggest contra indicator so far is the Mo is gone. Thanks for this piece. Very clear. So many data points floating around at the moment to justify one position or another. I like your corn price method, I don’t think people have factored in another wave of food/grocery price increases coming this year which will drive wage inflation.
Makes sense but looking past that doesn't it raise the risk of a credit/liquidity event down the road (say H2 23 or 2024)? My read is that last Fall stuff (esp. financial markets - Stocks yes but mostly long bonds and USD) seemed fairly close to break and the Fed and the Treasury (not sure what's the level of coordination here) decided to raise their foot off the brake a little bit to achieve a disinflationary soft landing... Was probably too early and with that and China reopening markets looked forward and FCI re-eased too fast too quick... So now yes it's likely that at least the higher for longer scenario will get repriced (if not even a higher terminal rate), but then it will bring some markets close to breaking point again (housing, leveraged credit,...), maybe quite quickly.
I think this cycle is really difficult because the economy is really out of sync... Some sectors seem still strong but others seem vulnerable... And monetary tightening is quite a blunt tool. So it's hard to play, especially if the repricing of higher for longer probability is slow and gradual... But if it's brutal and rates very quickly go back to last autumn's highs and stay there or break them, I'd be inclined to fade it. And then expect more fiscal stimulus and monetary reversal... But might not be immediate with debt ceiling negotiations... So air pocket then back to structural inflation in maybe 6 to 12 months after that.
I don't want to be too cute so I'm trying to structure my portfolio as a barbell. Commodities look cheap in the inflation re-acceleration scenario but still want to have a decent cash position, some 2Y exposure + rate hedges look close to become attractive again in my view. Pondering 5Y or 10Y TIPS too, look like decent performers in both scenarios ( at least as buy and hold).
I think growth will be good - especially in nominal terms, but I think the risk is that there are many businesses that have prospered on low interest rates, and low cost of labour. And these business need to face a reckoning - just as unions faced a reckoning in 1980s and 1990s. My best guess is we have very whipsaw action in the markets as financial conditions tighten and loosen - but in the end dont really go anywhere
To be honest, aren't longer term TIPS the best trade here?
Conspiracies about CPI being manipulated to reduce payouts aside:
1) inflation accelerates, no recession - your indexed coupon rises, if real yields rise there might be a capital loss but not if you hold to maturity
2) recession occurs - coupon falls but yields collapse and you get a capital gain, sell the fact and cash out
The hold to maturity is important - as the inflation is added to end principal, so in a period of rising rates and inflation you could get frontloaded with capital losses. The TIP ETF has been pretty poor - I need to sit down and work out if it attractive here or not
Look at LTPZ that's probably my idea
Have you looked into the Ohio disaster at all? And possible future impacts on gas production / agriculture if no one can live there / nothing grows?
Not yet - but Exxon Valdez didn't really slow down the oil and gas industry - just made all tankers double hulled...
Ya agreed - the main thing I've been reading about (not in mainstream media obviously) is that a massive amount of dioxins were released when the vinyl chloride was burned up. Dioxins take a very long time to break down and go away, so something to keep an eye on for longer term impacts
Hi russel a question on bank stock performance in rising inflation environment.for me yes there’s a positive impact from NIM expansion early in the rate cycle but later you have risk of low credit demand and high cost of risk.what do you think ?
I think we have moved to a government led investment cycle - which is why sovereign bonds and equities have become so correlated. The real risk is that governments and central banks destroy asset values in the pursuit of REAL wage growth. That is wages grow, so you have inflation, so central banks try and control that inflation by destroying asset value - or the opposite of what we have seen the last ten year. So banks with the least risk would be one where asset values are lowest - which is why I like Japanese banks.
not sure i got what you mean by asset value? you mean the valuation for these banks will be lower from higher discount rate? or you mean rising rates will impact the investment book of the banks.
So real estate and other assets will be impacted by rising cap rates.
Thanks Russell. This food price theme is super interesting and under-covered.
I have put all the post on food inflation under one tab
Russell - how does subsidy factor into your thinking given that the fact that Big Mac & McNuggets pricing is heavily dependent on subsidy of animal feed inputs?
Meat consumption is also in decline and will continue to, if not speed up...
This thesis must fit your earlier presentation on short sell opportunities there too.
I guess some assumptions I am making is that Chinese meat consumption wont fall in the short term yet. I am also implicitly saying that bread prices are more important than meat prices in the US, but that I think US meat prices are too low, given Chinese corn prices.
Using the short selling methodology, I would be wondering why meat and bread prices are going their separate ways... and as the presentation says, I think meat goes higher, and hence inflation is stickier than expected...
This inflationary upcycle still has legs to run, I agree there.
Chinese pork prices (the real driver of grain prices worldwide) are now back at longer term averages
https://en.macromicro.me/collections/24/cn-price-relative/12773/cn-pork-price-vs-cpi
If Chinese pork prices start rising (amongst other commodity prices) I expect to see the PBoC allow the yuan to appreciate to offset inflationary pressures. Very good for Chinese bonds.
Thats the funny thing about China - working to protect real wages could end up being very good for Chinese bonds indeed - just not great for stocks!
Biggest contra indicator so far is the Mo is gone. Thanks for this piece. Very clear. So many data points floating around at the moment to justify one position or another. I like your corn price method, I don’t think people have factored in another wave of food/grocery price increases coming this year which will drive wage inflation.