Global Macro/Markets Notes: Week #33 (Aug 14-20, 2022)


Insights, Perspectives & Trends

Skeptical; the devil is in the details…

Macro/Markets Overview

FX | Rates | Credit

Equities | Alternatives

Skeptical; the devil is in the details…

Week #33 is here and with it, another edition of the Global Macro/Markets Notes. As you know, here we try to make sense of short-term financial markets movements in the context of hard data, facts, and reason to help us Navigate Global Macro/Markets.

Last week, US investors welcomed better than expected inflation data, as it took the first steps in the right direction; July CPI headline decelerated to 8.5% on a year vs. an expected 8.7% and 9.1% year over year change in June. I dislike with a passion having to say that we (with an immense help from our research partners), have been suggesting inflation deceleration for a while now. Thankfully, we timestamp our comments and opinions to avoid the typical #hindsightbias that permeates the financial industry. Said that, we remain SKEPTICAL of the current market behavior and still believe this to be a #bearmarketrally and a #bulltrap.

In this week Insights, Perspectives and Trends, we dig a little deeper on what we would like to see to have a change of heart. Read on and please let us know if you think differently or have any questions, comments, opinions… those are always welcomed, as I truly believe that investing is a "team sport".

Best Regards, LeoC.


Insights, Perspectives & Trends

Last week, even if you wanted you could not have missed the noise about inflation turning into deflation. Media outlets and financial market tourists were shouting the word deflation with vengeance, not only here in the US, but also in Brazil and China, but not in Europe.

As we have been mentioning since early summer, inflationary pressures have started to move in the right direction, but let's not confuse disinflation, which relates to a deceleration in inflation with deflation, which is a GENERAL decrease in price levels mostly caused by a shift in supply and demand.

But why am I being so technical? Why am I being, potentially defined by some people, "a pain in the butt"?

Simple answer. Because of a key word - GENERAL. As the saying goes, "the devil is in the details…". So, let's look under the hood.

#clickbait of the week = DEFLATION

Figure 1: US CPI for July 2022

To recap: consumer inflation through June showed energy prices raising close to 42% in one year, of which 7.5% was in that month alone, pushing the headline CPI index to a 9.1% increase year over year (YoY). For the sake of full information, we also identified that energy was not the only problem; the price for food and all other items, which include the price for services, have also been increasing significantly. Fast forward a month and last week the Bureau of Labor Statistics reported that US consumer inflation in July was down to 8.5% for the YoY period vs. an expected 8.7% year over year change (figure 1).

Needless to say, the USD basked (BBDXY) fell 1.1% during the week, on the expectations that the Fed will not have to continue raising rates aggressively (figure 2). The broad US equity markets welcomed the news and soared on the week; the S&P500 Index (SPX) jumped 3.8%, the NASDAQ Composite Index (CCMP) increased 4.4% and the Russel 2000 Index (RTY) leaped 5.4%, since the report was released on the morning of Wednesday, August 10th.

Figure 2: Number of 0.25% hikes expect for 09/22 FOMC

On the surface, it seems that everything is all sunshine and rainbows. Not only in the US, but also in certain countries like Brazil where consumer inflation also decelerated in July. The social media channels, and to some extent the traditional media as well, were quick to use DEFLATION as #clickbait. For the record, core European countries have yet to experience deceleration in inflationary pressures.

Figure 3: DM Govt weekly bps change

Victims of click bait, usually the occasional headline reader or a market tourist, would not have noticed that in fact, interest rates continued to raise over the week; albeit, less so in the US and Japan, but more so among core European countries. The 2yrUST increased 1.65bps to 3.24% and the 10yUST inched 0.44bps higher to 2.83%. Core-European countries France and Germany ended the week with 2yr sovereign yield up more than 10bps and 10yr yields up around 5bps (figure 3). More importantly, not only core DM yields increased, but the #10_2USTspread, despite bouncing from -0.50% mid-week, continued to decline on a weekly basis to end Friday at -0.4213%, levels not seeing since the early 2000s.

What do I make out of this?

For me, global economic deceleration still on the horizon. Maybe, we won ONE battle, but we are far from wining the [inflation] war.

Now, let me tell you why we have not won the war yet…

It was mostly energy

Figure 4: Oil futures $/barrel (WTI and Brent)

Don't be fooled by clickbait DEFLATION. Please remember that US midterm elections are around the corner and touting a 0% inflation over one month is a pill much easier to swallow than 8.5% inflation over one year.

Furthermore, with oil prices falling close to 30% since early June (figure 4), an energy driven decline in consumer inflation was pretty much inevitable since energy items represent close to 8% of the weight in the index. As such, the deceleration of CPI headline index for July is mainly explained by the collapse in oil prices (figure 5).

Figure 5: Contributors to change in US CPI headline index

Yes, core inflation, which removes the volatile food and energy items, was "better than expected", but still unchanged from June at 5.90% YoY. With services prices ex-energy, which represents about 58.2% of the CPI index increasing and shelter not budging (a sub-category of it with a 32.8% weight of the CPI index), there is no reason to think that Fed officials will do a #fedpivot