Macro Monitor
From Tighter Lending To Margin Pressure
Intuitively, what happens in the credit market is usually echoed by lending activities. This was a key concern when the credit market joined the stock-market rout in May. Another big leg up in real interest costs, through higher rates and/or lower growth, will surely create more headwinds for profit margins.
Recession Dashboard Update—More Warning Signs
Overall, there are now more warning signs, but it still doesn’t suggest a recession is imminent.
Risk Aversion Index: Stayed On “Higher-Risk” Signal
While inflation might have peaked, a material slowdown looks more certain as the Fed stays on an aggressive tightening path. Caution is warranted.
U.S. Dollar—Drivers & Impacts
Most U.S. dollar drivers point to a stronger dollar: attractiveness of U.S. assets; policy differentials; real interest-rate differentials; terms of trade; weaker Yuan; and capital flows/hedging activity. Speculative positioning, however, is a negative and suggests the dollar rally might at least take a pause in the near term.
Risk Aversion Index: A New “Higher-Risk” Signal
As long as the Fed stays on the current aggressive tightening path, caution is highly recommended.
Yield Curve—Focus On More Reliable Themes
Predicting a recession is a very tall task, let alone using a single yield-curve indicator with long and highly variable lead time. Instead, we would rather focus on some of the more reliable themes: The macro-policy setting; U.S. dollar; and Bank stocks.
Recession Dashboard Update—Recession Not Imminent
Currently, the dashboard shows 6 green, 3 yellow, and 2 red lights. The overall message is that, while there are areas of concern, a recession is unlikely to be imminent (within the next twelve months).
Risk Aversion Index: Stayed On “Lower-Risk” Signal
With the Fed still on a tightening path, caution is still recommended. Among fixed income, we remain neutral on TIPS but have turned favorable toward EM bonds.
Yield Curve Crossing The 50-Bps Rubicon—No Imminent Trouble
The U.S. 10/2-year curve just fell below the key threshold of 50 bps. Over the last 25 years, the yield curve proceeded to invert after this “Rubicon” was crossed. That doesn’t mean imminent trouble. The lead time of a yield-curve signal is lengthy, but it—and real yields—definitely warrant close monitoring.
Risk Aversion Index: A New “Lower-Risk” Signal
Despite continued weakness in equities and a higher reading in our Risk Aversion Index (RAI), it generated a “Lower-Risk” signal.
Not All “First Hikes” Are Equal
The market has started to price in a much faster pace of the Fed’s tightening this year. We have found more similarities than differences between recent market action and the historical patterns around the first rate hike.
Risk Aversion Index: Stayed On “Higher Risk” Signal
Lofty valuations amid shrinking liquidity conditions make all risky assets vulnerable.
2021 Surprises & 2022 Time Cycles
Market revelations were certainly not in short supply in 2021. We believe some of those surprises will continue to have a huge impact on markets in 2022. We have updated our time-cycle composites to provide an idea of what a “typical” 2022 could look like.
Risk Aversion Index: Stayed On “Higher Risk” Signal
The impact of Omicron is already fading and the global-tightening cycle is far more important going forward. Elevated valuations amid a broadening global-tightening cycle is our key concern.
China—See The Policy Forest Through The Tree (Diagram)
There has been a torrent of new policies coming out of China recently. The goal of this report is to disentangle these seemingly random or even nonsensical policy moves and present a clearer roadmap of what China is thinking and doing.
Risk Aversion Index: New “Higher Risk” Signal
With the market getting less sensitive to each iteration of new variant, we believe the impact of Omicron is unlikely to be as significant as the global-tightening cycle.
Fed Taper—Not A Policy Error
We believe concerns about central-bank policy error are mostly a foreign issue, because they have moved much more aggressively than the Fed. The market has shown no indication of a Fed-policy mistake and we are still on board with the reflation trade.
Risk Aversion Index: New “Lower Risk” Signal
With seasonality once again turning positive and inflation breakeven rates bumping above the recent range, we continue to favor the reflation trade.
“Stagflation” Gap = Limited Impact
The Citi Economic Surprise Index fell to a negative extreme, while the Citi Inflation Surprise Index made all-time highs—a “stagflation” gap. Overall, if history repeats itself, the extreme ESI-ISI gap is apt to resolve itself, and the effect on asset markets will likely be limited. The global tightening trend will be a far more persuasive driver.
Risk Aversion Index: Stayed On “Higher Risk” Signal
Elevated valuations and a global tightening cycle are usually not a favorable context for risky assets. Within fixed income, we remain positive toward TIPS and cautious on credit.