1st class update Mr Blonde. Will let the others ask all the tough questions &, would simply add, I too, found myself once or twice too late at the bar with the wrong company but, was always thankfully rescued by the lights going back in before the closing 😂.
think depends on time horizon that you are using to evaluate. data in my chart is from 1950 to present...so multiple cycles and would evaluate performance over the full cycle. the table is focused on a single variable, but it would matter alot how inflation impacts economy and fed reaction function.
if fed hikes into rising inflation that causes a growth slowdown...you think banks do well? me either. the early stages of rising inflation swap is "good" as it suggests cyclical growth...but at some point that inflation rise is "bad" as it forces fed to react. react = tighten to slow growth to slow inflation. my 2c
I agree that change in growth expectations matters most for cyclicals, banks included. However upward moves in interest rates - which are correlated to inflation forwards -also benefit banks, especially when short-term rates are close to zero or negative. Due to much higher base levels, I believe that in the distant past rates steepness mattered much more than short-term rates for banks, whereas they probably matter about the same today - maybe that's why correlation to trailing inflation is negative (wild guess tbh). The superposition of these dynamics make banks hard to time in that stage of the cycle, where we may price slightly more hikes before we reach the neutral rate but growth momentum is negative. Not clear what factor is going to win. Is your view on lower growth expectations confined to the US or more global? It seems Europe has been surprising to the upside since the start of the year, and that they have much more slack. What do you think of going long European banks and short US banks at the moment ?
Love the content, always look forward to reading your thoughts. At what point will supply side inflation turn deflationary (unless we have more hard lockdowns), and will that be a positive for the market?
I.e, inflation eases into h1 next year if supply chains normalise and labour re-enters market pushing down wages and increasing unemployment. Given this backdrop can the Fed really afford to meaningfully hike rates?
i don't know the answer to that. the inflation indicator i use to guide my thoughts has yet to show signs of rolling over which suggests to me inflation momentum remains positive. obviously base effects get harder and its sensible to expect second derivative deceleration...which seems to be what central banks and fixed income markets are betting on.
i will say up front i don't envy position of central bank policy makers, but the challenge they face is largely of their own making so i don't feel bad for them either. in each cycle they stayed easier longer than was necessary. its hard to dig yourself out of a hole.
i don't think they need to "meaningfully" hike rates, but policy should be on a continuum rather than black and white. i think we would all agree we don't need emergency/crisis level accommodation today and the sooner they move on from it the better off we will all be. even if that comes with some market volatility.
IMO, if policy rates were ~1.5% it would not be an issue for the economy...its a bigger issue for markets. Fed's made up 2% precise inflation target is nonsense. i'm not even sure we measure inflation correctly...but 10yr average core PCE is ~1.6% (pre-covid) and the driver of the undershoot is goods prices which arguably is good for consumers. to suggest the lack of "inflation" is a huge issue that needs fixing doesn't make much sense to me.
i would happily trade some market volatility for less price control on the cost of capital that allowed markets to function with more rational two way risk. one can only hope.
Excellent. Well done
thanks Mike, really appreciate the feedback.
1st class update Mr Blonde. Will let the others ask all the tough questions &, would simply add, I too, found myself once or twice too late at the bar with the wrong company but, was always thankfully rescued by the lights going back in before the closing 😂.
How can we reconcile the negative correlation of banks to the 12m change in Y/Y CPI vs. positive correlation to inflation swaps ? thank you!
think depends on time horizon that you are using to evaluate. data in my chart is from 1950 to present...so multiple cycles and would evaluate performance over the full cycle. the table is focused on a single variable, but it would matter alot how inflation impacts economy and fed reaction function.
if fed hikes into rising inflation that causes a growth slowdown...you think banks do well? me either. the early stages of rising inflation swap is "good" as it suggests cyclical growth...but at some point that inflation rise is "bad" as it forces fed to react. react = tighten to slow growth to slow inflation. my 2c
I agree that change in growth expectations matters most for cyclicals, banks included. However upward moves in interest rates - which are correlated to inflation forwards -also benefit banks, especially when short-term rates are close to zero or negative. Due to much higher base levels, I believe that in the distant past rates steepness mattered much more than short-term rates for banks, whereas they probably matter about the same today - maybe that's why correlation to trailing inflation is negative (wild guess tbh). The superposition of these dynamics make banks hard to time in that stage of the cycle, where we may price slightly more hikes before we reach the neutral rate but growth momentum is negative. Not clear what factor is going to win. Is your view on lower growth expectations confined to the US or more global? It seems Europe has been surprising to the upside since the start of the year, and that they have much more slack. What do you think of going long European banks and short US banks at the moment ?
Wonderfull!
Love the content, always look forward to reading your thoughts. At what point will supply side inflation turn deflationary (unless we have more hard lockdowns), and will that be a positive for the market?
I.e, inflation eases into h1 next year if supply chains normalise and labour re-enters market pushing down wages and increasing unemployment. Given this backdrop can the Fed really afford to meaningfully hike rates?
i don't know the answer to that. the inflation indicator i use to guide my thoughts has yet to show signs of rolling over which suggests to me inflation momentum remains positive. obviously base effects get harder and its sensible to expect second derivative deceleration...which seems to be what central banks and fixed income markets are betting on.
i will say up front i don't envy position of central bank policy makers, but the challenge they face is largely of their own making so i don't feel bad for them either. in each cycle they stayed easier longer than was necessary. its hard to dig yourself out of a hole.
i don't think they need to "meaningfully" hike rates, but policy should be on a continuum rather than black and white. i think we would all agree we don't need emergency/crisis level accommodation today and the sooner they move on from it the better off we will all be. even if that comes with some market volatility.
IMO, if policy rates were ~1.5% it would not be an issue for the economy...its a bigger issue for markets. Fed's made up 2% precise inflation target is nonsense. i'm not even sure we measure inflation correctly...but 10yr average core PCE is ~1.6% (pre-covid) and the driver of the undershoot is goods prices which arguably is good for consumers. to suggest the lack of "inflation" is a huge issue that needs fixing doesn't make much sense to me.
i would happily trade some market volatility for less price control on the cost of capital that allowed markets to function with more rational two way risk. one can only hope.
thank you glitch…when i wrote this i intended it to have a long shelf life.