What macro regime are we in?

Over the last year, we have seen periods where data matters, then it doesn't then it matters again.

For us as macro focused traders, this can be a right ballache.

It can get frustrating when yield differentials matter, then the focus is on something else while you've got your head screwed onto another idea.

Like, take right now for example.

Where would you say that we are on the below diagram?

Now, my thinking is that we are at the risk on phase, but edging towards caution, and this is what I want to explain to you today.

Why do I think this?

Let's put the last three months into context.

We've seen a rampant rally in risk, most notably, however in commodities.

Here's the state of play there in agriculturals (corn, wheat, soybeans).

April has seen a sharp rally in said commodities, and lumber has also experienced a ridiculous price increase, again, specifically through April.

Why?

Well if we start with lumber, then there's a great podcast on this recently by Joe Weisenthal and Tracy Alloway.

Here's a Tweet from Joe explaining the main drivers mentioned in the podcast.

What is most interesting to me there is the word 'caution'.

See the title of the lower left quadrant in the image above.

Because, yeah, you can have high prices, but what are the driving factors of said high prices.

If one of those factors are to do with wanting to limit capacity because CEOs are afraid, then that leads me to think there is some unease, even if it hasn't necessarily displayed itself yet.

We can also look at some of the articles that have been written recently, which many are jizzing themselves over, without noticing one of the most important trends coming from them.

See, these articles state that firms making baby products and adult incontinence products are increasing prices due to the higher commodities costs...

But they are not factoring in the glaring issue, that even before the crisis, these firms were mentioning that the declining birth rate will have an effect on their bottom lines, and they will have to find new markets to retain market share, or increase the price of said goods.

Back in 2019, Reuters reported that more adult incontinence products were being sold than baby diapers.

In Jan 2020, Procter and Gamble missed forecasts due to a slowing birthrate.

In November, P&G, Nestle and Reckitt Benckiser have 'braced for lower sales as pandemic hits the birth rate'.

These producers have moved to making more premium items to ensure they keep revenue up, amidst this decline.

And as recently as February, Reckitt is reconsidering its choice to enter the infant formula milk market, after its $18bn acquisition of Mead Johnson.

Here's Bloomberg on the matter.

What I am saying is that, yes, there are issues in the market to do with higher commodity costs, but we are seeing a broader change in population composition where there are more old people and fewer young people, and the pandemic is accelerating this decline.

I point to the issues with declines in baby products and increases in adult incontinence products to paint the picture that I do not believe there will be a long term deviation in the inflation trend.

See the chart below.

We have never had such a long period of structurally stable and low inflation... yes, on the CPI measure... but who cares when it comes down to what the Fed base policy on?

And I don't mean to constantly allude to the prior articles that I have written on inflation, but I think it's good to refresh our memories.

Because now, we can also point to other issues that might not make the long term inflations expectations belief come true.

Below we have weekly wage growth in the US.

If people are earning fewer dollars, then how can we argue that wages can keep up with said price increases?

What will be interesting to note is whether we start to see a preference for lower cost goods going forward.

Right now, people are still being paid not to work.

This is a big problem for hiring managers.

But note in the article above there is no increase in pay mentioned to sweeten the deal, just added 'benefits' such as more holiday time, maternity leave and 'baby-bonding time'.

Yes, some firms have hiked wages, but I think this is more a continuance of a corporate governance push, started by Amazon, to release the pressure from unions, rather than a result of the pandemic.

This is perhaps more of a one off wage hike versus a sustained ability for labour bargaining power.

None of that particularly signals an increase in wages generally to make up for the increases in price, especially when there is a relatively competitive market.

To put it simply, I am still unconcerned about the prospects of breaking long term inflation trends, and in fact, I think people are starting to move towards being a little more cautious, as we tick closer to meeting the standard inflation metric of 2%.

And we are already starting to see online prices move a bit lower...

What can we deduce from the points above?

We are between the risk on quadrant and the cautious quadrant.

The biggest tell-tale sign for me that we are here is that data is mattering less and less right now.

We are starting to see YoY data being reported, which has very little meaning as base effects are in play (they're all going to be bloody positive).

And Colin Stewart over at Quant Insight agrees.

What might send us into a different macro regime is where we begin to see reality come back into focus.

'What is the true state of the economy when people realise normality is back?'

This is the question that has to be answered, but we can only do this when we begin to see fiscal support be removed.

One obvious beginning of this lies closer to home here in the UK, when, at the end of June, the stamp duty tax removal will be... removed.

This may highlight one part of the psychology of the economy as we edge closer to the full removal of fiscal support.

Remember, housing is a wealth effect, and slowing the demand for housing, especially in such a pent up economy could have real reflexive effects.

But that would just be something I take a peak at and say 'hmph' to if anything does happen.

The US is what matters.

Right now, I am still of the view that US markets are fragile and just a little bit weird.

Take a look at margin debt as a nominal measure and as a yearly percentage change.

This is quite frankly astonishing.

We're above the margin debt levels of 2007 and ticking up towards the levels of the DotCom boom.

Now I hate being bearish to be honest with you, because it makes little sense from an optionality perspective, but right now I do not favour broader upside moves.

Now if we take a peak back at Colin's LinkedIn post, he notes that he is expecting some volatility ahead.

I've mentioned a lot that I am massively intrigued by the June VIX Call Spread buyer ($200mm position) and I think this aligns pretty nicely with my thoughts if we conclude that there isn't really a macro regime right now and that we are simply being dictated by the forces of liquidity, which obviously makes sense, but I still feel that there needs to be something backing it.

Something else to note here is the extent to which 'memestocks' are still being traded amidst this lack of a macro regime.

In the 'cautious' quadrant, you may note that there is a mention of policy targets being met.

I think the market does still have the 2% inflation level affixed in its head - you can see this through the lack of belief from those online with regards to average inflation targeting.

I don't always think that corporations and investors simply take signals from the Fed.

I think most of the time they act according to their own thoughts.

I mean, take the example of me writing this to you today.

Even FinTwit is expecting some talk of light tapering coming into Jackson Hole in August...

So will the market try to front run this a bit before, perhaps?

Here's Tim Duy's expectations for the next few months of Fed Talk.

Perhaps even the mention of 'normality' will strike fear into the highly leveraged.

What I do know, is that between now and August/September, there is a vacuum of uncertainty. and this certainly makes life difficult.

But the crux of things is that I do believe we are going to gradually move to a a more cautious stance...