What’s Driving Global Liquidity?
Darius sat down with Maggie Lake last week on Real Vision’s Daily Briefing to discuss all things Global Liquidity.
If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio:
1. The Recent Surge In The Dollar Has Negatively Impacted Global Liquidity
Our 42 Macro Global Liquidity proxy, a sum of global central bank balance sheets, global broad money supply, and global FX reserves minus gold, is a key driver of risk assets like equities and bitcoin.
Since mid-July, the US Dollar has rallied aggressively. This rally weighed on global liquidity because the Dollar and FX volatility are negatively correlated to global liquidity.
If we see a breakout in currency volatility, which is in the process of occurring according to our Volatility-Adjusted Momentum Signal, the negative global liquidity impulse could continue to decline, negatively impacting risk assets.
2. Currency And Interest Rate Volatility Have Hampered Private Sector Liquidity
Most retail investors think of liquidity solely in terms of whether or not central banks are supplying liquidity to the global financial system.
Private sector agents like commercial banks and non-bank lenders – primarily from net international investment surplus economies like Europe and Japan – also supply liquidity, referred to as “private sector liquidity.”
Recent currency and interest rate volatility have made it difficult for these private sector agents to supply liquidity to the system, impeding the overall global liquidity supply.
3. The Dollar Could Reach Its Highs From Last October If It Slows Its Trajectory
If the dollar continues its aggressive trend over the next few months, the Fed may have to step in and intervene because it will likely coincide with something “breaking” in the Treasury market.
But, if the dollar slows its trajectory and grinds its way higher, we believe it may reach its highs of $113 from October of last year in DXY terms.
That’s a wrap!
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The Current State of China
Darius sat down with Anthony Pompliano last week to discuss China’s economic landscape.
If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio:
1. The Evergrande Debt Default May Have Spillover Effects on The Broader Chinese Economy
One of Evergrande’s subsidiaries recently defaulted on nearly 600 million dollars worth of principal and interest payments.
The implications are significant for two reasons:
- Evergrande has 328 billion of debt outstanding, the largest of any property developer in the world.
- Evergrande will be in court next month to discuss a potential liquidation.
A bankruptcy of Evergrande’s size could lead to knock-on effects for the Chinese economy.
2. If China Does Not Issue Large-Scale Fiscal Stimulus, They Will Likely Remain In Their Liquidity Trap.
China and Japan supplied trillions of dollars in global liquidity from Q4 2022 to Q1 2023, a primary factor in the BTC and stock market recovery we have seen so far this year.
But if China does not issue large-scale fiscal stimulus, they will likely fall back into their “liquidity trap”:
- For the last decade, Chinese growth has been below trend, with the exception of early 2021.
- China has also struggled to generate inflation.
Today, China’s economy looks very similar to Japan’s from the early 1990s.
3. Just Because The Chinese Economy Has Downshifted From A Growth Perspective Does Not Mean It Will Stop Demanding Energy Products
The volume of Crude Oil imports is near all-time high levels established in 2020.
Conversely, the volume of Copper imports is down 38% from the 2020 highs.
This is significant because Crude Oil creates inflation across the global economy, while Copper more closely signifies underlying demand for materials and goods and is correlated to growth.
That’s a wrap!
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What is the Outlook for Commercial Real Estate?
Darius recently sat down with Nick Halaris to explore the current state of US commercial real estate.
If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio:
1. A Commercial Real Estate Disaster May Be On The Horizon
Over the past couple of years, there has been a confluence of factors that have negatively impacted the real estate sector:
- The rise of interest rates
- The blow-up in Crypto
- The increase in layoffs at tech companies
- Office space occupancies leveling off at 50%
- The regional banking crisis
As a result, US commercial property prices are back down to pre-covid levels. Although they have declined substantially since the COVID-19 blow-off top, they will likely decline even further.
2. Commercial Real Estate Distress Levels Are On The Rise… Albeit Slowly
Distress levels in US commercial real estate have been accelerating since mid-2020 but are not yet at levels seen in the Great Financial Crisis because:
- Banks learned from the Great Financial Crisis that the rapid withdrawal of liquidity from real estate would hurt them, so they are more patient with borrowers and more lenient with covenants.
- The “Goldilocks” economy continues to be resilient, supporting the real estate sector.
3. Commercial Real Estate Investment Volume Is Drying Up
Investment volume is down significantly YoY across commercial real estate:
- Multifamily: -70%
- Industrial: -48%
- Office: -63%
- Retail: -65%
Sellers are hesitant to sell because they expect inflation will increase again, increasing the value of their properties back to 2022 levels.
Buyers are hesitant to buy because their existing exposure is declining in value and interest rates are pricing them out of further investment.
Transactions are sparse as a result. The waiting game continues….
That’s a wrap!
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US-Global Growth Divergence
Last week, Composite PMIs came in below expectations across continental Europe and in China. Stagflation is the fear in Europe, while deflation is the fear in China. Neither public sector appears ready to supply the liquidity required to ignite animal spirits within their respective economies and financial markets. Regarding the Composite PMI data specifically, only four (Japan, Russia, Brazil, and US) of the 13 economies that have reported thus far posted MoM accelerations in August. Only Japan, China, India, Russia, Brazil, and the US reported figures greater than 50, indicating expansion. Europe was a noteworthy laggard with Spain, Italy, France, Germany, Eurozone, and UK all slowing sequentially to sub-50 readings, indicating contraction.
It is now fashionable to make the short-USA/long-RoW (rest of world) call, citing valuation differentials, but we disagree with that view. Valuation is not a catalyst for market developments, Rather, valuation merely acts as an accelerant when flows reverse. FWIW, we do not believe valuations matter all the time; in fact, most of the time valuation is irrelevant because the overwhelming majority of investors cannot take risk in accordance the time horizons (3, 5, 10 years) that valuation metrics are most instructive on. Retail investors generally operate on short to medium-term time horizons because of FEAR and FOMO; institutional investors generally operate on short to medium-term time horizons because of career risk.
“No Landing” = No Liquidity, Says The US Dollar
The US Dollar Index is poised for its ninth consecutive weekly advance — the longest winning streak since 2005 as the global currency market rerates economic resiliency in the US and derates the economic outlooks in Europe and China. The reason why FX and interest rate volatility are drags on global liquidity is because when net international investment surplus economies like Japan and the Eurozone see their currencies weaken, it makes it harder for their financial intermediaries to create the dollars required to capitalize investments around the world. FX and interest rate volatility complicate that process and slow down the creation of new dollar supply at the margins.
Growth of the world’s demand for dollars is more stable due to the refinancing requirements of the existing stock of cross-border financing that is denominated in USD — roughly 50% of the total, with ~65% of cross-border loans and ~80% of international debt securities issued by entities that have no organic access to dollars. Thus, fluctuations in the supply of new dollars have an outsized influence in driving FX trends because of the relatively inelastic demand for dollars versus a more elastic dollar supply curve. More FX and interest rate volatility = marginal dollar supply falls faster than marginal dollar demand = stronger dollar. Less FX and interest rate volatility = marginal dollar supply rises faster than marginal dollar demand = weaker USD. This process is reflexive and feeds on itself until exogenous factors like central bank pivots inflect the trend. This is why price momentum in the currency market tends to trend.
The US Economy Remains As Resilient As Ever
Last week’s +1.8pt MoM advance in the ISM Services PMI (54.5 = 6mo high) was adequately presaged by the New York Fed’s Services Survey a couple of weeks ago. The New Orders PMI hit a 6mo high as well alongside the highest reading in the Employment PMI since Nov-21.
The probability of a near-term recession continues to dwindle because the services sector accounts for 86% of Total Nonfarm Payrolls.
Offsetting the positivity was the 4mo high in the Prices PMI, which is now trending higher again. If the inflation narrative devolves sooner than our qualitative research views anticipate, we could be in the early innings of a market crash.
China’s Crude Oil Imports accelerated to 30.9% YoY in August, fanning the flames of an ill-timed, hazardous breakout in energy prices.
All eyes on Wednesday’s August CPI report to confirm or disconfirm the prevailing “immaculate disinflation” theme, which itself is one-half of the “transitory GOLDILOCKS” theme we co-authored in mid-January (with the other being “resilient US economy”).
Will Bitcoin Crash Before The Halving?
Darius recently sat down with Anthony Pompliano to discuss global liquidity, bitcoin, the Fed, and more.
If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio:
1. The Years Leading Up to Bitcoin Halvings Are Extremely Volatile.
When we analyzed the past Bitcoin halvings from November 2012, July 2016, and May 2020, we found that in the years leading up to the halving, Bitcoin tends to have three drawdowns of more than -20% on a median basis.
All drawdowns in the year leading up to halvings have a median decline of -27%.
We believe Bitcoin will be much higher in a few years, but it will likely require a rough path to reach its destination.
2. Over The Next Year, Liquidity Will Determine Bitcoin’s Path.
On a median basis, Bitcoin increases 144% in the year leading up to halvings.
These increases have closely followed global liquidity cycles; the liquidity cycle bottomed in 2012 and 2015, years leading into the halvings where Bitcoin increased 384% and 144%, respectively.
However, in 2019, when liquidity conditions were less favorable than in 2011 and 2015, Bitcoin failed to see a similar price increase.
The increase that year was only 20%, and the drawdowns were more significant than in the previous pre-halving years.
The amount of liquidity in asset markets will decide Bitcoin’s path over the next year.
3. We Believe The Fed Will Be Forced to Increase Their Inflation Target From 2% to 3%
The change will likely come in two phases:
- First, the market will become comfortable with inflation settling above 2%. This is likely a 2024-25 phenomenon.
- Then, when the unemployment rate is high enough, and with enough political pressure, the Fed will officially increase its target to 3%, ultimately paving the way for it to resume QE and lower interest rates. This is likely a 2025-26 phenomenon.
That’s a wrap!
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All Things Macro
Darius recently sat down with Nick Halaris to discuss proper risk management, the labor market, inflation, asset markets, and much more.
If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio:
1. Investors Are Doing A Great Disservice To Themselves By Not Being Bayesian
At 42 Macro, we use three core tenants to form our systematic macro risk management process:
- Regime Segmentation: We identify which investable regime the economy is in, the probability of that regime persisting, and how long it is likely to persist.
- Bayesian Inference: We systematically update the probability of relevant economic scenarios as new information becomes available to the market.
- Risk Management Tools: We use sophisticated quantitative tools like our Volatility Adjusted Momentum Signal (VAMS) and Global Macro Risk Matrix to predict when the price momentum of a particular security or overall market regime (risk on vs. risk off) is likely to change.
We urge our readers to infuse proper risk management in their investment strategies. We welcome you to use our tools if you want to gain a systematic edge in the market: https://42macro.com/sampleresearch.
2. Labor Hoarding Has Contributed To The Resilience Of The US Economy
The most recent US Total Labor Force SA reading was 167 million people – a value below its trendline since 2009.
Conversely, Gross Domestic Income recovered its trendline approximately 18 months ago and remains above it.
The discrepancy in strength between the two indicators suggests there is a large amount of cash in the economy that can be used to demand goods and services but insufficient labor to supply those goods and services.
3. History Tells Us The Fed Must Break The Economy to Achieve Its Price Stability Mandate
We analyzed every recession since 1969 and found that, on a median basis, core PCE inflation is almost always flat-to-up in the year leading up to a recession.
Historically, inflation does not break down without a recession.
Both this study and our HOPE+I framework confirm that inflation is a lagging indicator, and we believe it will again fail to fall below the Fed’s 2% target without a recession.
That’s a wrap!
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What is Making the U.S. Economy so Resilient?
This week, Darius sat down with Maggie Lake from Real Vision to discuss the resiliency of the US economy, the housing market, and much more.
If you missed the interview, we have you covered. Here are three takeaways from the conversation that have significant implications for your portfolio:
1. The Resiliency of the US Economy Will Likely Continue
Our research shows the US economy has nowcast itself into “GOLDILOCKS” for the past five months. GOLDILOCKS is a regime marked by growth trending higher and inflation trending lower.
The strength of the economy will likely continue because:
- Goods demand is increasing — real goods PCE increased 5.4% on a three-month annualized basis in the most recent month.
- Corporations have been reducing inventories for the past five quarters, reducing 72 basis points off of GDP per quarter, on average. This, paired with increasing demand, could lead to inventory restocking the next few quarters.
2. New Home Sales Are Surging Because The Existing Home Sales Market Has Been Starved of Supply
Today, homeowners are unwilling to sell their homes and trade their ~3.5% mortgage (the effective mortgage rate nationally) for the current market rate of ~7%.
This supply shortage is causing a spike in new home builds:
- Building Permits are growing at 7% on a three-month annualized basis.
- Housing Starts are growing 31% on a three-month annualized rate of change basis.
- New Home Sales are growing at 21% on a three-month annualized basis.
3. “Bidenomics” Is Also Contributing to Our “Resilient US Economy” Theme
The US economy is experiencing a record non-war, non-recession budget deficit under the current administration.
Last year, the deficit was -3.7% of GDP.
Today, it is -8.4%.
That 470 basis point difference equates to approximately $1.3 trillion of incremental fiscal stimulus supplied to the US economy, further contributing to its resiliency.
That’s a wrap!
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Even Higher For Much Longer
Global bond yields hit their highest level since 2008 as investors were forced by the data we have been highlighting to reprice economic resiliency in places like the US and Japan, as well as sticky inflation in places like the Eurozone and UK.
Last week’s Industrial Production (+210bps to a 2mo high 3mo SAAR of -0.9% in July), Capacity Utilization (+70bps to a 2mo high of 79.3% in July), Building Permits (+590bps to a 3mo high 3mo SAAR of 7.1% in July), Housing Starts (+2,560bps to a 2mo high 3mo SAAR of 30.9% in July), and NY Fed Services Activity Survey (+0.6pts to 0.6 in August; highest since Sep-22) were each marginally confirming of our “resilient US economy” theme.
Market participants are increasingly accepting the “higher for longer” guidance we have seen from a handful major central banks — most notably the Federal Reserve.
Floor policy rate expectations (min value on OIS curve out 2yrs) for the ECB, Fed, and BOE have climbed +3bps, +39bps, and +37bps MoM, respectively.
That’s dragged 10yr Nominal German Bund, US Treasury, and UK Gilt Yields up +18bps, +48bps, +37bps, respectively, over that same duration.
The 10yr Nominal JGB Yield — which is effectively managed by the BOJ — is even up +22bps MoM.