Macro and Flows Update: September 2022 - e09

Summary

The video discusses ongoing macroeconomic trends, emphasizing the challenge faced by the Federal Reserve due to accelerating core inflation. It suggests that the Fed may need to increase rates significantly, potentially nearing 7%, leading to bearish market conditions. The script also highlights the impact of reduced asset demand due to higher costs of money, margin compression, and the shift of funds to bonds. It advises viewers to continue selling rallies and to be cautious of market positioning and macro flows, while also noting potential opportunities in the medium to long term, especially as the market navigates through a period of fiscal and political changes.

Takeaways

• 📈 The CPI print indicates ongoing strong and accelerating core inflation, complicating the Federal Reserve's policy decisions.
• 💹 As interest rates rise, expect multiple contractions, reduced demand for assets, and margin compression due to the reverse Tina effect.
• 💲 The shift of funds to bonds, increased volatility, and risk premiums are signs of a changing economic landscape without a Fed put option.
• 📊 Conservative estimates suggest that long-term rates may reach 4.3-4%, but the actual Fed target could be closer to 7%, indicating a more aggressive stance.
• 🔻 The advice is to continue selling rallies as the structural negative effects and macro flows persist, despite short-term countertrend rallies.
• 🌐 Strength in the US dollar is expected to continue, with margin compression from international earnings filtering through the upcoming earnings season.
• 📅 The Fed's tapering has reduced demand for assets by billions daily, which is a significant figure to consider for market dynamics.
• 🚫 The buyback blackout period and the five-week expiration cycle could lead to reduced market support and increased fragility in the short term.
• 📉 The Fed meeting approaching is unlikely to show a pivot towards ease; a hawkish stance is anticipated, emphasizing the importance of not fighting against the central bank's direction.
• 🎯 The bull case lies in short interest and record high V (volatility) supplies, which could lead to short-term pressure but also opportunities for market corrections.

Q & A

What is the current situation regarding core inflation as mentioned in the script?

The script indicates that core inflation is not only strong but continues to accelerate, making the Federal Reserve's job more challenging.

What does the script imply about the Federal Reserve's position and actions?

The script suggests that the Federal Reserve is in a difficult situation, often referred to as 'in a box'. As the cost of money goes up, it leads to multiple contractions, less demand for assets, and margin compression. The Fed is expected to raise rates significantly, potentially close to 7%, to combat the negative real rates currently in place.

How does the script describe the impact of rising interest rates on various financial aspects?

Rising interest rates are expected to lead to reduced demand for assets, margin compression, elevated volatility and risk premia due to the absence of a 'put' at the Fed, and an increase in the discount rate which results in a decline in business investment.

What is the significance of the term 'reverse Tina effect' in the context of the script?

The 'reverse Tina effect' refers to a situation where the cost of money goes up, leading to money flowing into bonds as an alternative investment. This term is used to describe one of the consequences of the rising interest rates.

What does the script suggest about the future of the 10-year yields?

The script suggests that the 10-year yields are expected to go higher due to the Federal Reserve's likely aggressive stance and the ongoing issue with CPI core inflation.

How does the script advise investors to position themselves in the current market conditions?

The script advises investors to continue selling the rallies, as the long-term trend is bearish. It also warns against waiting for a market pivot and a return to all-time highs, suggesting that this is a secular move that is just beginning.

What is the expected impact of the FED's change in tapering on the market?

The FED has reduced its tapering from 47.5 billion to 95 billion, which means there is now about 4 and a half billion less demand for assets per day. This significant number is something investors should be mindful of as it could impact the market dynamics.

What does the script indicate about the upcoming earnings season?

The script indicates that the upcoming earnings season will be more relevant and important than previous ones. It suggests that the margin compression from international earnings should begin to filter through, making this earnings season more impactful on the market.

What is the potential effect of international dollar-denominated debt on the market?

The script suggests that there might be a lag in the effect of international dollar-denominated debt on the market. However, as this impact starts to be felt, it could potentially lead to increased volatility and risk in the market.

What does the script imply about the short-term market dynamics?

The script implies that the short-term market dynamics are influenced by factors such as the FED meeting, the entering of a blackout period for buybacks, and the beginning of a five-week expiration cycle. These factors could lead to a fragile moment in the market, especially in the next two weeks.

What is the script's stance on the potential for a market downturn?

The script maintains a bearish stance, suggesting that a market downturn is likely and recommending strategies such as selling rallies and looking for counter-trend opportunities. It advises against waiting for a market pivot and emphasizes the importance of being cautious in the current macro environment.

What does the script indicate about the potential for long-term investments?

The script suggests that long-term investments, particularly in the context of options and structured products, may face challenges due to reduced demand and increased supply. It advises investors to be cautious and to consider the potential for a market downturn when making long-term investment decisions.

Outlines

00:00

📈 Economic Trends and Monetary Policy Challenges

This paragraph discusses the persistent long-term trends, particularly focusing on the recent CPI print indicating sticky core inflation that continues to strengthen. It emphasizes the challenges faced by the Federal Reserve in managing the economy as money costs rise, leading to asset demand contraction, margin compression, and a shift towards bonds due to the reverse Tina effect. The speaker suggests that the Fed is likely to increase rates significantly, possibly close to 7%, and advises selling rallies due to the public's awareness of the situation. The tug-of-war between macroeconomic flows and market positioning is highlighted as a recurring theme throughout the year.

05:02

📊 Market Dynamics and Upcoming Fiscal Events

The second paragraph delves into the market dynamics, especially the impact of the expiration cycle on buyback and charm flows, signaling a potentially fragile period for the market. It mentions the upcoming Fed meeting and the likelihood of a hawkish stance due to political considerations. The paragraph also discusses the Fed's actions in selling calls to achieve lower volatility and asset prices, and advises against waiting for a market pivot. It further explores the potential for short interest and the supply of V (presumably a financial instrument or index), predicting continued market pressure and a difficult environment for long positions. The speaker also notes the potential for long-all to perform well in the coming months, especially as election season approaches.

10:04

🌐 Global Economic Outlook and Investment Strategies

The final paragraph provides an overview of the global economic outlook, emphasizing the likelihood of continued inflation despite potential recessionary signals. It suggests that any reduction in inflation will be minimal and based on the short end of the curve. The speaker advises to continue selling rallies and looking for counter-trend opportunities, without the need for significant tail hedging at this point. The paragraph concludes by acknowledging the challenging market conditions but encourages viewers to seek opportunities in the current environment. It also includes a disclaimer that the content does not constitute investment advice and that viewers should consult with their advisors for personalized guidance.

Keywords

💡CPI

CPI stands for Consumer Price Index, which is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. In the video, it is mentioned that the CPI print this month indicates that core inflation continues to be strong and accelerating, making the Federal Reserve's task of managing inflation more challenging.

💡Fed

The term 'Fed' is short for the Federal Reserve, which is the central banking system of the United States. The Fed's responsibilities include influencing the availability and cost of money and credit, safeguarding the stability of the U.S. financial system, and fostering maximum employment and stable prices for goods and services.

💡Sticky Inflation

Sticky inflation refers to a situation where inflation rates remain high and do not easily decrease in response to economic policies or changes in market conditions. It implies that once prices have increased, they tend to stay high, making it difficult for central banks to control inflation.

💡Margin Compression

Margin compression occurs when the difference between the interest income earned on assets and the interest expense paid on liabilities narrows. This can happen when interest rates rise, causing the cost of borrowing to increase while the returns on assets may not increase at the same rate, leading to a squeeze on profitability for financial institutions.

💡Risk Premia

Risk premia refer to the additional expected return an investor demands for taking on riskier investments instead of safer ones. When risk premia are elevated, it indicates that investors require higher returns to compensate for the increased risk they are taking on.

💡Discount Rate

The discount rate is the interest rate charged by the Federal Reserve to commercial banks and other depository institutions for borrowing from the Fed's discount window. An increase in the discount rate typically leads to higher borrowing costs for businesses and consumers, which can affect economic activity.

💡Real Rates

Real rates are interest rates that have been adjusted for inflation, providing a more accurate reflection of the true cost of borrowing and the real return on investments. When real rates are negative, it means that inflation is outpacing the interest earned on investments.

💡Tapering

Tapering refers to the gradual reduction of a central bank's bond-buying program, which is often used as a monetary policy tool to stimulate economic growth. When the Fed tapers, it reduces the amount of new money being injected into the economy, which can lead to changes in asset prices and interest rates.

💡Buybacks

Buybacks, or share buybacks, are a corporate action where a company repurchases its own shares from the open market. This can support the company's stock price and is often used as a way to return value to shareholders. However, buybacks can also affect market dynamics by reducing the supply of shares available for trading.

💡Structured Products

Structured products are financial instruments that are created by combining various types of assets, such as stocks, bonds, and derivatives, to form new investment products with specific risk-return profiles. These products are designed to meet the needs of specific investors and can be complex, with their value often tied to the performance of the underlying assets.

💡Seasonality

Seasonality in finance refers to the pattern of price changes or market behavior that tends to repeat at regular intervals over the course of a year, often related to the time of year or economic cycles. Seasonal factors can influence investor sentiment and trading volumes, leading to predictable market trends.

Highlights

Long-term trends continue with CPI print showing sticky core inflation accelerating, complicating the Federal Reserve's task.

The Fed is facing a challenging situation as the cost of money increases, leading to multiple contractions and less demand for assets.

Margin compression is a significant topic of discussion due to its impact on the reverse Tina effect and money flowing to bonds.

Volatility and risk premia remain elevated as there's no longer a 'put' at the Fed, and the strike has gone down.

The discount rate is rising, leading to a decline in business investment, which is bearish for the market.

Long-term rates are conservative, and the Fed is expected to go much higher, possibly close to 7%.

The current situation calls for selling the rallies due to the public knowledge of the macroeconomic situation and short positioning.

The tug-of-war between structural negative effects and positioning is expected to continue in the medium term.

Dollar strength is anticipated to continue, with margin compression from international earnings becoming more relevant.

The upcoming earnings season is expected to be more impactful than previous ones, with attention on international earnings.

Issues related to international dollar-denominated debt and potential tail risk are expected to build up in the market.

The Fed has reduced tapering, leading to less demand for assets, which is a significant number to be mindful of.

The market is entering a fragile period with a buyout blackout period for buybacks and a five-week expiration cycle.

The upcoming Fed meeting is anticipated to result in a hawkish stance due to political considerations.

The Fed is selling calls, aiming for low volatility and lower asset prices, which is a key point to remember when trading.

Short interest is at record highs, and supply and demand dynamics are expected to continue putting pressure on the market.

Long-all may become a better trade in the coming months as the election season and Q1 period present potential opportunities.

Seasonality is weak at the moment but is expected to improve slightly in about a month, providing more support and a positive turn.

Transcripts

hello and welcome back to our September

macro and flows

update the long-term trends that we've

spoken about throughout these updates

continue to be in place as witnessed by

the CPI print this month sticky core

inflation continues to not only be

strong but continues to

accelerate uh making the fed's job

harder uh we talked about this in our

quarterly uh update um about uh the fed

and the sticky situation that they're in

the fed is in a box we've been talking

about this for some time as the cost of

money goes up uh you get multiple

contraction less demand for assets um

margin compression which we talked quite

a bit about the reverse Tina effect so

money starts flowing to bonds there's

now there is an alternative now um

volatility uh and risk Premia uh stays

elevated because there's no longer a put

um at the Fed

or at least the strike has gone down um

and of course the discount rate goes up

so business investment declines as well

all of these things obviously are

bearish we've talked uh about this quite

a bit the important part to understand

is that four three and a half 4% uh

long-term

rates um are actually conservative um

now uh again we talked about this in the

quarterly uh newsletter if you haven't

listen to it please or read it please go

read it uh but what we talk about is is

that burns raise rates 10 a half per. um

William mcchesney Martin raised them 7 a

half per. um and both of them uh barely

made real rates positive or or kept them

slightly negative but we are now at

incredibly negative real rates um the

FED has a ton of work to do it's our

view that fed will actually go much

higher probably close to 7% at the end

so expect these 10year uh yields to go

higher um expect uh a significant uh

aggressive fed and CPI core to continue

to clim all of that means longterm you

need to keep selling the rallies that

said we shouldn't continue to get these

counter trained rallies why because this

is public knowledge at this point

position positioning is very short right

um it is too easy to continue to sell uh

this uh you know down to to lows at this

point so there's a bit of a tug-of-war

between these structural negative

effects the macro flows that we're

seeing and then the positioning and this

tug-of war is what we've seen all year

that should

continue in the medium term the dollar

strength

continues um you know margin compression

from International earnings should be

beginning to filter through uh you know

the earning season will be coming up

here soon when it does we expect this to

be a more relevant uh you know uh an

important earnings season than we've

seen in a while so expect there to be

more attention on it this time around um

and it for to actually have an effect um

on on the underlying

Market um we would also expect more

medium to longterm starting to see issu

isues which you know there's a bit of a

lag here to uh International uh dollar

denominated debt um and potentially tail

starting to build in that uh

venue um importantly September 1 uh

September 1st uh we the FED has gone

from 47.5 billion of tapering to 95

that's about now 4 and5 billion Less in

demand for assets a day so you know that

is a signif ific number now up from half

of that um in the months prior so um you

know that's something to be very mindful

of um in the short term here you have

that effect as well as the fact that

we're entering a buyout uh a blackout

period for BuyBacks that is um that is

also huge right by BuyBacks have been at

record highs that uh you know that flow

has been something that has been

consistently supporting the market when

we get into these blackout periods um

that reduces is demand add to all of

that uh we are now entering a five week

expiration cycle I've talked about this

before when these happen they once every

three months or so when they happen uh

especially at the beginning of that that

five we cycle significantly reduce vaa

and charm flows there's going to be

significant less buyback of decay of the

options which sit at the October monthly

expiration and the Structured Products

that primarily sit at that expiration

so less demand from vonach charm more

Supply uh from QT coming off the table

or I guess less

demand um uh less buyback um so a really

kind of a fragile moment here uh the

next two weeks in particular represent

uh you know potentially dangerous period

the FED meeting is also incoming here

that is uh this coming Wednesday um you

know unlikely to see a a Fed that is um

especially going into this election

season given the politics involved uh

very likely to see a dobish Fed likely

to see a hawkish Fed very um very

strongly kind of ratcheting up uh what

they need to do the FED is selling calls

we've said this before they're not

buying plates they're selling calls they

want low volatility but they want asset

prices lower they want deleveraging in

the market and again don't fight the FED

there will be counter trun rallies but

do not sit here waiting for a pivot and

a return to alltime highs this is a

secular move that is really just

beginning so CBI is hot F fed's

credibility is probably the most

important thing especially going a

political cycle so the macro is uh you

know there's a macro overhang um you

know these are all things that you need

to be cautious of so what what's a bull

case you know what should we be careful

of again positioning short interest

record highs also V is dramatically

overs supplied we just left a quarterly

expiration where there was lots of short

interest from

dealers and behind that they've been

able to buy and own B um at a discount

so there is VA well supplied on top of

that we have an incoming JP Morgan

hedged Equity VA put Sprint collar being

sold that'll be sold at the end of the

quarter here D quarterly um V really

coming into the picture that's important

because D quartly at end of the year V

generally is very highly demanded when

you get a lot of V Supply in that area

you're actually begin to see uh people

who are short getting back the Vall that

they've been short and that has an over

exaggerated effect on V so v We Believe

will continue to be well supplied um but

there we we believe there will be short

um you know pressure on the market

throughout this period so more as we've

called for Market down VA down more of

what we've seen this should continue We

Believe until the end of the year to

really make longv a um a you know short

the market a good trade but longall

broadly a difficult trade the more that

this happens the more we're going to

begin to see liquidation out of all

trade out of all Investments puts will

be less demanded we believe we are

already in the eighth or ninth inning

now of um and we called about we called

this in late June actually um of of the

um uh you know the longall

underperforming trade so we we believe

there's a a window that is opening now

for longall to perform probably starting

in about a month or two so as we get

past you know into November December

election season it get starts to get

interesting

uh and very much so even the q1 period

January through uh March we believe is

is really a window um of a potential

tail opening um so we're getting there

we believe we're we're in the last

Innings maybe another quarter here but

we called in late June 3 to nine months

out uh about and we're almost to that

three-month Mark which I think is

important um to note so those are those

are the kind of the bullish supportive

things that are happening so we don't

expect big fireworks yet but something

out there on the horizon and something

to be thinking about and planning for

with your your

trades um last of all um you know it's

important to note that that seasonality

here is still quite weak as well people

talk a lot about that but that's

probably for about another month um and

then and then we'll we'll probably see a

little bit more support and some

positive um turn there um but again

longterm the trend is clear the macro

reasons for it have been reinforced of

anything throughout our period it's what

we've been calling for we begin to we

continue to see in the data even if we

do get a recession like we saw from

FedEx uh calling for for that we believe

the amount of inflation reduction that

we'll see will be based on the short end

the curve and if anything they response

to that which is likely to be more

fiscal in this political season will

only make that 10-year longer term um

inflation Outlook even worse so continue

to sell the rallies look for counter

Trend opportunities no need to sell it

here no need to try and Hedge for a big

tail yet but that that is on the

horizon as always thank you for tuning

in uh and and be water there's lots of

opportunities out there even in this

difficult Market thanks for tuning

in

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