A Fall From Grace


Hiking into a recession

Macro thoughts. Not investment advice.

In recent posts I have written a lot about how the Fed is forced to hike the economy into a recession. That theme extends to most central banks as the splurge of money post pandemic is pulled back sharply to contain inflation.

There has been a big shift in the markets reaction function to higher US CPI. Previously the reaction has been:
Higher US CPI > Tighter US Monetary Policy > Higher US Yields

The reaction to yesterdays CPI print marks a sudden shift. The reaction function has changed to:
Higher US CPI > Sharply tighter US Monetary Policy > Lower US and Global Growth > Lower US Yields

The global growth picture has taken a sharp turn lower since this year. Not only is the Fed set on hiking until it breaks the back of the US consumer but the other world growth engine, China, is locking its consumers at home. This is an extremely negative growth backdrop which is suddenly dawning on a market that has been sheltered by the Powell Put for far too long.

This is the next development in the Stagflation scenario the world finds itself in. The high growth, high inflation environment is quickly turning into low growth, high inflation. Lower US yields are unlikely to give much respite to growth assets as growth expectations are revised lower. Although I do expect the usual havens like XAU, CHF and JPY that have been sold due to higher yields to start to accelerate higher as poor growth pulls yields lower. (Not investment advice, just my view of the world).

What I find particularly interesting is how the narrative has changed towards commodities and commodity linked currencies like AUD, NZD, CAD and ZAR. Commodities were on a strong march higher as the supply side of the equation was constrained. Although now the demand side of that equation is under a lot of pressure and Industrial Commodities (Copper and Iron Ore most notably) are sharply reversing their previous gains. This is removing that support for the current account of these commodity producers. At the same time the issue of large household indebtedness and inflated property markets is rearing its ugly head for Australia, New Zealand and Canada. It has been known for a long time that their respective house prices were unsustainable, the concern is that the bubble will pop rather than slowly deflate.

I titled this mail a Fall from Grace because that is what we are seeing across markets. The Hero’s of the easy monetary policy period, Cathie Wood’s Ark Innovation Fund, Coinbase and Cryptocurrencies in general, the meme stocks, Zoom, Peloton, Tiger Global and Vison Funds Masayoshi Son are all taking a spectacular fall from grace. These companies and investors were all on the right side of easy Monetary Policy. When money is cheap and growth is high it is those that take the most risk that run the fastest. Sadly it is those that run the fastest that also fall the hardest when the Fed suddenly slams on the brake. My observation here is more that it is a fault of monetary policy rather than anything irrational within these actors. Their business models are sound but excessive monetary easing ballooned their balance sheets to unsustainable levels. The excessive easing now requires excessive tightening and that is causing investors to rush for the exit and leaves some of these companies struggling to survive. I see a lot of similarities here to Emerging Market economies. Foreign investment tends to flood into fast growing Emerging Markets when growth is high. Investors become over enthusiastic and drive up the price of the countries assets and currency. When sentiment turns investors all suddenly rush for the exit causing the currency to collapse and often for the Emerging Market economy to collapse. This is a story that plays repeatedly, for example the Asian currency crisis of 1997. This is why many emerging markets enact capital controls to stem these speculative flows, public markets do not have these controls and rely on Central Banks to stem speculative investor behavior via monetary policy. Sadly it seems that central banks went too far with their Pandemic support measures and we may look back on this period as a significant monetary policy mistake.

Overall I see stagflation as the path that we are on so I am staying short crossJPY and long GOLD. XAUUSD based at the 200dayMA 1837.00 this week. Funding the cost of living crisis and funding support for Ukraine is only going to mean more money printing by central banks which should mean the trusted store of value is… as good as gold.