Attack the Week (ATW)
Monday Thoughts
Francis Bacon, a luminary of the Renaissance era, encapsulated profound insights into the workings of nature and human behaviour with the following statement, which I included in last Friday’s chart book series:
“As in nature, things move violently to their place and calmly in their place …”.
This aphorism offers a powerful lens through which we can examine both our lives and the dynamics of financial markets, and I am sure you have all felt those very effects. I certainly have.
Bacon's observation reflects a fundamental principle of natural law: the transition from chaos to order. In nature, initial movements towards equilibrium can be tumultuous. However, once balance is achieved, there is a prevailing sense of calm. This duality of movement — violent and calm — is observable across various domains, from the physical sciences to human endeavours.
In our personal lives, we often experience periods of upheaval and uncertainty. These tumultuous phases can be likened to nature’s violent movements towards equilibrium. For instance, major life changes like personal crises often bring stress and disruption. However, these challenging periods are often precursors to stability and growth as they make us more resilient to the inevitable next disturbance. Bacon’s wisdom reminds us that enduring short-term discomfort can lead to long-term peace and fulfilment. I wrote a piece on comfort not too long ago.
Our beloved markets are a quintessential example of Bacon's principle in action. Markets are inherently volatile, characterized by sharp fluctuations and dramatic movements, as they respond to many factors, including economic indicators, geopolitical events, and investor sentiment. These periods of volatility can be seen as the market's violent movements towards finding a fair value or equilibrium price.
Investors often face significant stress during market downturns or corrections. However, those who understand and anticipate these cycles can navigate through the turbulence more effectively. Recognizing that volatility is a natural part of the market's journey towards stability can help investors maintain a long-term perspective and avoid reactionary decisions based on short-term market movements. We all know how stability fosters instability, its how financial markets, psychology and human behaviour works, over and over again.
The definition of this Minsky Moment highlights the fragile nature of financial systems. Periods of stability can lead to increased borrowing and risk-taking, which can inflate asset prices to unsustainable levels. Eventually, this leads to potentially sudden and severe market dislocations.
It is not difficult to analyse which regime we are currently passing. Carry trades are in vogue, risk assets are bought on any setback, and the vision of the future is what the consensus sees as pretty certain. Look around you; do you see similar signs? This phase can take time to be shaken, but change it certainly will. Preparing, anticipating and relaxing is my strategy for these times. Oh yes, and don’t do stupid things.
Let’s now read what Macro D has in store for us. We shall also have a quick run, as usual, for the week ahead and finish with the finest collection of charts to behold as we traverse through the coming week.
Let’s go!
Macro D’s Thoughts
"A lie has time to travel halfway around the world before the truth can put on its trousers."
- Sir Winston Churchill
I believe that contradictions are the salt of truth. For this reason, I am not scared by the fact that today, the market protagonists are divided between those who pull to the right and those who pull to the left, with the aim of convincing the audience to follow one direction rather than another. In my small way, I remain equidistant from any alleged Oracle of Delphi, but simultaneously, I must listen to everyone. Carefully. Let's start the dance.
There is a man who is not a central banker, but he is the head of a bank that is always in the front row when it comes to pulling the strings that hold up the world. It's a fact; when Jamie Dimon speaks (lately, he has been talking quite frequently), the markets stop and listen. Jamie is no oracle, but when he lines up his thoughts, listeners can't help but take his "personal sense of things" into consideration. Dimon does not exclude a priori a hard landing situation for the American economy and makes no secret that he is considering a hypothesis that the markets are not discounting: the assumption that interest rates could rise "a little" further.
Jamie's verbatim words;
“Inflation is more persistent than people think. I think the odds are higher than people think, especially given that the system still has considerable monetary and fiscal stimulus, which could support this liquidity."
And again,
"The worst possible outcome for the American economy right now is stagflation" (i.e. higher inflation and slowing growth).
There is something to resign ourselves to: inflation is a free spirit that chooses where, when, and how fast to go. You can't ask someone who loves Hemingway's writing style to sit down and read a Nicholas Sparks book.
We have heard all kinds of things: that inflation would remain at 2%, that it would skyrocket to 6%, that it would stop at 4%, and that we will have to consider inflation at 4%. There is no reason to believe one number over another, but there is every reason in the world to follow in its wake and sense the will of its compass.
Meanwhile, the latest minutes from the Fed refer to the state of affairs attributable to last April 11th. Still, since then, a lot of water has passed under the bridge, as well as changes in direction and sudden mood swings in the forecasts. The minutes show that US inflation has yet to make progress in its descent towards the desired target rate. The Federal Reserve kept its target range for the federal funds rate unchanged at 5.25%-5.50% at its May meeting, as inflationary pressures and a tight labour market signal stalled progress to pigeonhole inflation at the 2% target.
Already. We just named it the job market.
However, one fact deserves to be considered: the minutes of the Fed’s latest monetary policy meeting showed that the FOMC discussed raising interest rates in the face of increasingly stubborn inflation.
But you know, on Wall Street, it's quick to go from a downpour to a scorching sun. Like a bolt from the blue, the data on US inflation for April appeared, highlighting the much-desired price slowdown. This indicator finds that the core component of the CPI (consumer price index) has reported the lowest growth since April 2021, i.e., the last three years. This news immediately sparked enthusiasm on Wall Street.
What does all this mean? It means that after two months of slowing growth, the US economy has started to accelerate again, with flash PMI data for May indicating the fastest expansion in two years. However, this growth is accompanied by a rebound in input costs, and this information causes significant concern about the possibility of returning to the much-desired 2% inflation target.
What do I feel like saying? Reading this data, I am led to argue that there's been a notable shift in the main inflationary pressure. It now originates from the manufacturing sector, a change from the pre-COVID-19 period, when services were the main driver. As I delve deeper, I realize that the inflation rate, both in terms of costs and sales prices, is higher than in the pre-COVID-19 period in both sectors.
What does this information tell me? I seem to understand that the 2% inflation target cannot yet be seen, not even from the Lighthouse Tower [1].
How did that joker named Mercato respond? There was a decline in stocks and gold and a rise in Treasury yields. The 2-year Treasury note (very sensitive to interest rates) rose eight basis points to 4.96%.
In any case, Powell is a seasoned man; it certainly won't be a single macro data point that causes him pain in his back and makes him make rash choices. If anything, the pain in my back comes to me since I don't have the information Jay can count on. On the other hand, I have enough enthusiasm and passion to wear the clothes of the bloodhound and stick my nose in all the market pastures open to the public.
Let’s explore further.