The Observatory
Inflation Momentum Persists
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The Observatory is how we systematically track the evolution of financial markets and the US economy in real-time. Without further ado, let’s dive into what our systems are telling us:
Markets: The past 24 hours were beneficial to our alpha generation strategies, with all our positions up. From a beta rotation standpoint, markets continued to favor Commodity exposures. However, Equities Treasuries and Gold all caught a bid, suggesting the move was driven by financial markets discounting increased private sector liquidity. These moves coincided with the release of the FOMC minutes, which contained little-to-no information on the timing and composition of Quantitative Tightening. Over the last week, we have seen equity sector dispersion reduce considerably in the US, reducing the opportunity set to exploit. However, Communications remains a short position that our systems think can be value accretive.
To summarize our systems' current assessment: Our Market Regime Monitors shows a dominance of (+) G (+) I, with a high and rising chance of (-) L, dragging on risk assets. This distribution of probabilities poses a significant drag on pure (+) G (+) I allocations and dampens their expected return prospects. Our Momentum Monitors show that momentum in Gold is now at levels we haven't seen since 2020, suggesting robust trend support. This dynamic adds to markets pricing of (-) G (+) I, which has been a strong trend this month. Consequently, our systems tell us that the best opportunities are Long: Bonds, Cotton, Lean Hogs, Cattle, Sugar, and Short: Communications. However, our Risk Management Monitors indicate that we can ADD to LONG: Bonds, Cotton & Sugar, and REDUCE our LONG: Lean Hogs & Live Cattle and SHORT: Communications. Our Expected Return Strategy is LONG: Bonds, Cotton & Live Cattle.
Macro: Yesterday's FOMC minutes offered little-to-no information on the timing and pace of Quantitative Tightening and decreased the probability of a 0.5% hike. However, we should note that the FOMC penned their minutes before the most recent CPI and Jobs prints; therefore, we expected relative dovishness. Considering the current data, we estimate the potential paths for central bank liquidity. Our estimates tell us the most crucial marginal driver of the degree of liquidity drain will be whether money market fund assets leave the Fed RRP facility for Treasury Bills. Therefore, the Treasury is likely to have a huge role in determining the success of QT.
To summarize our systems' current assessment: Yesterday's upside surprises to Industrial Production and Retail sales caused a spike in Economic Momentum to 54.2%. However, these data points were not substantial enough to increase our GDP Nowcast, which remains at 2.6%. Our CPI Nowcast remains elevated and relatively unchanged, mainly due to the surging strength in commodity prices. The longer this gauge remains elevated, the higher the pressure on real growth and real return in the economy and markets, respectively.
The future is dynamic, and our systems adjust as new information is available. Our bias is to allocate for the existing regime while trying to peek around the corner to what the future may hold. Finally, we optimize these views to minimize portfolio risk, resulting in our trading signals. We show all this in the document below.
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