Macro and Flows Update: June 2023 - e18

Summary

The video discusses the current economic climate, focusing on the Federal Reserve's actions in response to core inflation stabilization at around 5%. Despite headline CPI decline, the Fed increases interest rates by 50 basis points, indicating a misunderstanding of the situation. The market's rally, driven by short squeezes and options trading, is contrasted with the anticipated liquidity draw and potential market liquidation by year-end. The video suggests a shift from NASDAQ outperformance to a more negative outlook, recommending strategic hedging and a focus on downside opportunities.

Takeaways

• 📈 The core inflation has stabilized at around 5%, indicating a secular sticky inflation trend.
• 📉 Despite headline CPI decline due to cyclical pressures, the Federal Reserve is actively using interest rates to combat inflation.
• 🚀 The FED increased their dot plots by 50 basis points, surprising the market.
• 💹 The market largely ignored the FED's actions, with yields declining on the day of the FED meeting.
• 🌐 Central banks globally are tightening liquidity, affecting markets outside of China.
• 🏦 The US interest rate market has experienced a 5% lag, impacting liquidity in the economy.
• 💰 The Treasury General Account needs to refill approximately 1.4 to 1.6 trillion in liquidity, impacting the system by year-end.
• 📊 Market rallies have been driven by Vana and charm and volatility compression, leading to short squeezes.
• 📈 The market has seen significant upside, particularly in the back end after two to three months.
• 🔄 Positioning incentives have made a U-turn, with sentiment indicators showing more bullishness and less bearishness.
• 🔽 The NASDAQ is expected to underperform as volatility declines in the short end of the curve, leading to a market downturn.

Q & A

What was the recent CPI report's impact on the market?

The recent CPI report showed a slightly weak headline but core inflation remained sticky, around 5%, indicating a stabilization of core inflation which is a critical secular aspect of the economy.

What does the term 'secularity' refer to in the context of the script?

In this context, 'secularity' refers to long-term trends or conditions in the economy, specifically relating to inflation and interest rates.

How has the Federal Reserve responded to the current economic conditions?

The Federal Reserve has increased its dot plots by 50 basis points and is using interest rates to influence the economy, despite the headline CPI showing a decline due to cyclical pressures.

What does the term 'dot plot' refer to in the context of the Federal Reserve?

A dot plot is a chart used by the Federal Reserve to show the interest rate projections of Fed officials over the upcoming years.

What is the significance of the market ignoring the Fed's actions?

The market's disregard for the Fed's actions indicates a potential misinterpretation of the current economic situation and could lead to a misunderstanding of future monetary policy impacts.

What major event in March caused a significant impact on the banking sector?

A bank run occurred in March, which, along with the debt ceiling debate, influenced the Federal Reserve's decision to pause its actions to ensure no liquidity tail occurred.

How is the Treasury General Account affecting the market?

The Treasury General Account needs to be refilled, which will require pulling approximately 1.4 to 1.6 trillion of liquidity from the system, impacting the market significantly.

What is the expected outcome of the liquidity draw mentioned in the script?

The liquidity draw is expected to lead to a decline in asset demand and potentially a market liquidation, particularly in the second half of the year.

What recent market trend was discussed in the script?

There was a sizable rally in the market, with an almost 7% increase over two to two and a half weeks, driven by factors such as Vana and charm, volatility compression, and market positioning.

What is the expected change in the NASDAQ's performance?

The NASDAQ is expected to underperform as volatility declines, particularly in the short end of the curve, leading to a NASDAQ downtrend.

What is the recommended strategy for investors based on the script?

The recommended strategy includes short stock focus, short put in the portfolio, and considering NASDAQ underweight relative to previous overweight positions.