Published in


Macro update 27.6.22

Source: Warner Brothers

Bye bye “soft landing”

Policymakers like Fed Chair Powell last week are starting to admit that a “soft landing” may not be possible as it seeks to tame inflation. Moreover, signals of a hard landing are coming from the falls in oil and copper prices as well as the NY Fed’s models here pointing to an 80% chance of a hard landing. Interest rate futures are already pricing in easing in H1 2023 (see chart below).

Source: Goldman Sachs, The Market Ear

‘Bad news is good news’ returns

These factors are supportive of a stronger bear-market rally than what we have seen to date. Indeed, the notion of ‘bad news is good news’ — i.e. weak economic data raises the likelihood of the next Fed pivot spoke about last week — may become dominant and also lead to “FOMO” bids, particularly in the context of weak markets and hedge fund performance ytd. At the same time, the chart below suggests: ’tis the season for a rally!

Source: Goldman Sachs, The Market Ear

This week, there are numerous data to push the ‘inflation peak, recession fears’ narrative, including May durable goods (today), PCE (Thursday) and June ISM manufacturing (Friday) as well as many Fed speakers.

Fundamental flaws

Despite this, we believe economic and market fundamentals are not fully reflecting recessionary conditions at present as the burden of proof is with the recession-istas! Hard data ranging from the labour market to inflation will need to rollover to justify concerns.

As the table below illustrates, numerous sectors in the S&P500 have not yet experienced drawdowns comparable with prior recessions. We thus expect hard-data confirmation of recessionary conditions to lead to further pain for risk assets.

This is illustrated more broadly in the chart below, which suggest a further 15–20% downside for the S&P500 to be in line with historic bear-market norms.

If demand-driven inflation (blue bars below) abates due to economic weakness down, this should move inflation down significantly. However, inflation would still be elevated minus demand-driven inflation, at some 4% yoy (PCE based on April’s numbers, far right bar below), albeit a more reasonable level. Supply-driven inflation is less likely to be fixed in the near term. This implies less downside for rates than in recent cycles.

Source: Federal Reserve Bank of San Francisco

Vicious policy cycle

There is also a vicious policy cycle for the Fed that looks like this:

This is why our base case is that the Fed continues on its hawkish path until something changes to justify breaking this. Specifically, inflation moderates and/or growth is unexpectedly weak.

Digital assets — ride on risk on

We can see a bear market rally with more legs from here, but ultimately there are constraints to the underlying ‘bad news is good news’ narrative including:

1) Downside compared to previous bear markets suggest another significant leg down;

2) Asset rallies run counter to the Fed’s goal of tightening financial conditions and

3) For digital assets, a background concern remains how many skeletons there are in the closet and what could be the next shoe to fall. To be clear, we would expect Bitcoin and alts to participate in a risk-asset rally as long as contagion fears do not arise.

Kind regards

Lyndon Barreto, CFA

Chief Economist and Project Specialist

Disclaimer: The content above does not constitute investment or financial advice. All statements are opinion and not statements of fact.



Get the Medium app

A button that says 'Download on the App Store', and if clicked it will lead you to the iOS App store
A button that says 'Get it on, Google Play', and if clicked it will lead you to the Google Play store