Topic 1: The Federal Reserve and interest rates
Two main scenarios for the Fed were dominant:
- The scenario has already been played out, with a 50-point increase in June and a 50-point increase in July, then a 25-point increase in September as the Fed slows its pace to assess its impact on the FCI and the real economy. The Fed’s pricing has evolved since January as a reminder of how far we’ve come and how little of a retreat from the extreme level we reached in early May.
This reassuring scenario depends on financial conditions remaining difficult, CPI and wages falling somewhat (it is important to focus on 3-month changes) and ongoing evidence of hiring weakness (higher initial claims, etc.)
From the price movement last week, we can see that the slightest recalibration of the Fed’s expectations leads to looser financial conditions and higher oil prices.
2. The second scenario is that every time the Fed speaks a little softer, the oil goes up and the FCI loosens and the dance continues when the Fed sounds hawkish again and things get tighter. One of the most startling (and worrying) aspects of price action in 2022 must be that risk aversion and the destruction of global demand have not affected the price of oil.
You can see in this graph that oil and interest rates usually move together, although the shock in Russia caused some noise in relations in March. This graph suggests that further increases in oil will hamper further declines in yields.
During the tumultuous technology rally of 2016-2021, a common acronym was TINA, which means “No alternative”. It was the idea that all the innovation and exciting things happening in technology and technology must take over the world. This accelerated in 2021, when Web3 bubbles turned on and YOLO (“you only live once”) purchases created even more prominence. Now TINA is dead.
This is best captured by the NASDAQ’s ratio to EAFE shares.
EAFE is an index of 900 stocks from 21 countries. Chinese stocks have many strange risks, such as regulation, Xi’s deviation from economic reform, real estate defaults, and so on. Below is the ratio from 2012.
US technology was on the verge of a manic state at the time the Fed collapsed temporarily and the ratio peaked that day.
This end to the exclusivity of US stocks is one of several reasons for a growing cohort of US dollars. The tightening of the global central bank is causing the direct sale of mega-technologies. GPIF (Japan’s pension giant) and Norges Bank are Apple’s two biggest sellers.
And GPIF was TSLA’s biggest seller.
Topic 3: Where to invest
If TINA is dead, it means there are alternatives. One of the main ones is the resurgence of interest in FX. The Carry / vol and EMFX ratios strongly support the idea of EM as a viable alternative for medium-term investors. The strong performance of EM in 2022, despite the significant tightening of financial conditions and the stronger dollar, is proof that EMFX is more resilient to shocks.
Two other ideas for areas of excellence:
• European shares. The loophole caused by negative interest rates can be reversed when the ECB rises, and this is rising for European banks. Negative rates suppressed profitability and sentiment and created distortions that would be less problematic if Lagarde and Co. managed to get out of ZLB.
• Pressure on Chinese authorities is growing and Li Keqiang’s comments raise many questions about what is happening in China. Is it possible that Xi allows more consensus on economic issues? If so, this could mean a more aggressive stimulus and less severe technological measures. If everyone says that you can’t invest in China, maybe that means it’s a great time to invest there.
Topic 4: What is happening in China?
Exceeding the CFETS in 2021 is the momentum that shows that the authorities are satisfied with the weakness of CNH. The preferred expression is a short CNH against other currencies, as no one is a bullish USD against the G10 anymore.
Li Keqiang’s statements about the economy surprised investors, as he seems to deviate slightly from the scenario.
In addition, Li Keqiang visited Yunnan University last week without a mask, and this meeting and the lack of a mask went unnoticed by Chinese state media. It seems a bit of a passive / aggressive power game, but it’s hard to say. Meanwhile, there are rumors of Xi Jinping’s illness. We cannot rule out the possibility of political instability in China in the future. The general mood of all the meetings was: “Something strange is happening in Chinese politics, but we don’t know what. Keep this story on the radar. ”
A framework that brings together many of the different discussions and topics is that the current environment is a mirror image of the period 2011-2021.
• QE has fueled risk parity trading for centuries. QT now triggers the release.
• World stagnation is now structural inflation.
• Globalization is now deglobalization.
• The fierce rally in technology is already overrated.
• Lower wages and higher profits have turned into higher wages and shrinking margins.
• Free money has disappeared and we have much higher interest rates on mortgages.
This is not something from four months. A secular 10-year-old party can deliver a rather nasty and long-lasting hangover.
The modest change in Fed prices has brought relief.
The Fed’s pricing may not affect much, as the price of oil refuses to help and cuts in technology will take some time.
If we are in a structural change in US stock prices, investors will continue to sell stock increases. Overcoming bear markets has always been a challenge.
Dealer Anatoliy Pavlov