MAGGIE LAKE: Hello. Welcome to the Real Vision Daily Briefing. It is Wednesday, March 23rd, 2022. I'm Maggie Lake here with Darrius Dale, founder of 42Macro. Hi Darrius.
DARIUS DALE: Hey, Maggie. What's up? It's good to see you.
MAGGIE LAKE: Yeah, it's good to see you too. We were just talking right before we came on air. God, there's so much going on every day with these markets. We saw big moves again today, primarily in oil. We had a bigger than expected drop in US oil. Inventories talking more sanctions. Russia throttling a pipeline. All combining the news about pricing in rubles, all combining to send oil higher. WTI back to 114. Brent to 121. We had the bond route continuing.
Fed officials speaking today. Multiple ones signaling hey, we're comfortable with 50 basis points. Everything's on the table. That US 10 Year briefly went above 2.4. It's amazing how quickly this is moving for people don't always watch this market, but it did does. It's so quick it's coming down a little bit here backing off that level as we go into the close. Of course, US equity is getting wrapped up in all of this, down across the board here as we close this session. What are you watching? What's top of mind for you since everything's moving?
DARIUS DALE: Number one, it's this moving crude oil. I think we're up another round right around 5% day-over-day. We're up 20% week-over-week. That's a massive move. To me, I think the geopolitical tensions with respect to the Russia-Ukraine saga, are heating up a little bit at the margins. Today, from a longer term strategic perspective, I thought it was an enormous headline that really needs to be unpacked.
Putin effectively told Gazprom which surprise a considerable amount of Russia of gas to the continental Europe. I think there are roughly around, not maybe Gazprom, Russia, somewhere around 30% of Europe's gas or 40% of Europe's gas. He said don't accept payments in euros, labeled US, the EU, the UK and Hostile Territories. And say, look, we want to take payment in Russian rubles, which effectively would amount to a way for them to circumvent sanctions.
This obviously is a signal in our opinion that Putin is digging his heels in that we're going to be in this situation for a while. And that everything we thought about the impact of this conflict on global supply chains, particularly in the energy space, in the agriculture space, even in the metal space, all of that was actually true. It got priced into quickly, but those who bought the dip, like we did at 42macro, definitely our feeling good about that.
MAGGIE LAKE: Does that mean that you-- What does that do to your thought moving forward? I think a lot of people saw the speed that oil moved up, came back down, it's been consolidating a bit, as you said, back now, does it look like this is a new run to new highs? Or are we in some kind of range here? I think it's really important I'll just pause that question by saying everything we should talk about what your duration is here, really short term? What does that mean? Are you looking medium term? Most people don't want to do anything but do short term. So, tell me about your time horizons with any of these answers that you're giving today.
DARIUS DALE: Oh, yeah. I had a brilliant conversation with Jeff Farley over it at Forward Guidance yesterday, it'll be out that podcast to be out this weekend. But that was all about risk managing the different durations because the world we live in right now is a world at the bare minimum two durations probably three. From a short term perspective, there's really no reason to be short oil or short commodities. Very clearly, you're having some supply disruptions. You still have fairly robust demand across the broader world.
Historically, even if you saw some demand destruction, you typically can see energy in particular that the energy space continued to [?] appreciate in price into economic slowdown. Even into recession, we saw that in the recessions, all the recessions in the 1970s. We saw that in 2008, as well. We saw it in the 1990s as well. So, it's not like you have to sell oil on a demand destruction narrative. That means you can probably remain long have this type of exposure well into the summertime.
From that, when you think about the summertime, and we talked about this last week, I tweeted that out this afternoon. When you get into the summertime, one really core tenet to the bull case and not just your commodities, and really the bull case for broader risk assets, is that growth is fine. We've had a geopolitical incident, it's a really spooked markets thus far throughout the years data and it's obviously not going anywhere anytime soon.
The reality is you look at growth statistics on a trailing basis, whether you look at leading indicators like Composite leading indicators still north of 100 for most economies. You look at obviously GDP in Europe and the US, well multiple deviations above trend in the most recent quarters, and PMIs are comfortably above 55 for most economies. Everyone who's in the levels oriented camp, and what I mean by levels, things are good, things are bad, those people are still very bullish because the data on the ground, the lagging incident indicators are confirming that.
The problem with that is that when you look at a forward and leading indicator basis in terms of what we're projecting in our models, then we certainly believe that by the time we get into the summer, that data will start to slow at a much more material pace, and at a pace that really starts to open up a pocket of downside to the market. So, you could see new lows and things like the stock market and crypto as you progress throughout the summer. For now, I want to say it the most maybe one or two months, you could have a pocket of reprieve because we just don't have the growth dynamics to support a big crash yet.
MAGGIE LAKE: Yeah, that makes a lot of sense, Darius. When you're looking at that, so we have this pocket of reprieve, does it mean that you-- we're down today. I'm looking over at some screens I have, we're down today. In that window, buy the dip opportunistically, or rather do you look for uptrends to get out to start to lighten positions you haven't been able to so far, because you know it's coming, you know that more sizable slowdown that's going to mean troubles coming in the summer? How do you play that?
DARIUS DALE: Well, I think you can play both. We talked about this in the program all together, or all the time, which is portfolio construction is the name of the game, particularly in an environment like this. We have so much volatility. It's easy to take advantage of that on the trading side. But you also have a core medium term, the longer term fundamental view that's either bullish or bearish, we're obviously bearish.
As you know, you definitely want to start to think about organizing your portfolio around different durations. We definitely have things we in our portfolio that were long in terms of risk assets that we fully intend to be selling at some point over the next month or two. What we're trying to do is capture, take advantage of what could be a window of opportunity here on the long side, because we did come into this downside with elevated cash position. We did sell equities and other risk assets that are fairly well going.
Starting back to November of last year, December, we sold crypto. November, we sold a lot of equities. Early February, we sold a lot of equities. So, it wasn't like we needed to use the first bounce to sell cash. Well, there are some investors that might have to do that. We definitely saw a little bit of that today, but the reality is, until you get a real big growth slowdown, it's going to be very difficult for the market to make new lows.
MAGGIE LAKE: And you're seeing this idea that people are thinking that the economy is strong enough to hold out. I know you look at crowding, is this where you're seeing that show up that you feel like that there is not an overly bearish sentiment when it comes to equities? And I think we're talking about equities now, right?
DARIUS DALE: Yeah. Brian, if you don't mind putting up that crowding versus dispersion analysis. This is one of the clues that we got to say, hey, look, the Coast might be clear for now. What we're looking at in the chart on the left of that crowding analysis is the relationship between the deviation and skew that's on the x-axis and the volatility risk premia in terms of how we calculate that on the y-axis.
Typically, what you find is that markets that have elevated skew, i.e., the consensus is either overly hedged or they're actually outright bearish on this particular exposure. Whenever you get into a situation where the volatility risk premia becomes negative as you are in that lower right quadrant, that tends to be a sign that a lot of the near term negativity is already priced in. You typically need to cover shorts in that environment.
That's exactly the environment where US equities are, risk assets are in terms of the median of all the different exposures we track. US equities are there. Global equities are there. Risk assets are there. Even fixed income is there. And so, we've seen a lot of damage and destruction to 60/40 style portfolios. Obviously, risk parity is having one of the worst years on record. And a lot of that damage and destruction as calm as a function of the market having to go from December.
This Fed might hike a couple times in 2022. Feds going to hike pretty much every meeting, maybe even get a couple 50 basis point hikes. By the way, we might get a trillion dollars a QT in the first year, and that's a big Delta. That's a big Delta from a policy rate tightening standpoint that had to get priced into the markets. Now it's priced into the markets. Now the next shoe to drop is okay, what is all that tightening mean? What is this big rise in crude and energy prices and food prices mean? We have to actually get to that point in the process when we start to see that show up in the data.
MAGGIE LAKE: I think that's really important because there is a lag, isn't there? To a certain extent, some of the pain from commodities and food because it started before the Russian invasion of Ukraine. We've been talking about this, and you've been pointing it out, well from the fall. We've seen that and we can see what it's happening to prices at the pump as a result. The Fed situation is a newer regime, we have to get our head around. Is that the lag that we're looking at before we start to see it hit the real economy sometime in the summer? Is that what you would be expecting?
DARIUS DALE: Yeah. This is a getting phenomenal question, Maggie. One of my favorite jokes is making fun of the Fed when they go, well, monetary policy works on long and variable lags. It takes me back to my days in the Prospect Street in New Haven, going to these econ classes, what a wonky comment. Long and variable, like this smoke coming out of the chimney, what does that even mean? That you think they know by now. Very clearly, they do not know by now.
The Fed is typically in these tightening cycles, and they always break something. There's only been one tightening cycle in the history of tightening cycles that they didn't break anything, and that was 1994. Obviously, we had a lot more organic growth potential in the US economy back then. You have the labor force is growing gangbusters. We have this thing called the internet we were developing. There was a lot of really positive stuff going on back then that we don't necessarily have going on now, not to the same degree.
With respect to the lag and when all this stuff shows up in the data, I happen to think and our models, again, based on our forecasting our econometric tools, the models are saying it's about to show up in the data sometime in the next three to four months. At the beginning, it'll get worse and worse as regards to the back half of the year. But sometime around late Q2 is where you would actually start to see a lot of the tightening that's been talked into the market is.
By the way, Forward Guidance works in both directions, in face. There were Forward Guidance, you are going back to the March of 2020, on the corporate bond purchases, was really one of the catalysts that bottom the market in that interval. Where now, there were Forward Guidance every day since basically, or December has been too tight monetary policy.
We've seen that price into the Treasury curve. We've seen that price in overnight index forwards. We've seen that price into the Euro dollar curve. We've obviously seen that priced into a curve compression as well. And so, we definitely seen that in high yield, bond prices and yields. We see it in mortgage rates as well. The economy suffered a decent amount of financial tightening already.
MAGGIE LAKE: Yeah, and we had housing data that you started to see a little bit of that, although the supply demand balances so off that it may take more time, as you're suggesting, for all of this to really start to put together a meaningful trend. Since you're talking about where this is showing up, it's a perfect time, I think, we have a clip for Roger Hirst.
He breaks down sometimes these conversations that Raoul and Julian have in the Macro Insider when they're tossing back data back and forth, slowing it down a little bit just to dive a little deeper into some of what they're talking about. And one of the things he tackled in this latest post was talking about is the yield curve behind the curve. Let's have a listen to what he said.
ROGER HIRST: Now, we talked about that yield curve. I think last time I showed a yield curve, which was the 5Y 30Y 1Y forward. Well, actually now part of the plain vanilla curve has just inverted just briefly. Remember I said that, on the Fed, we got the 5Y part and the 2Y part moving the most aggressively. The 5Y to 10Y part, this is 10 Year yields in the US minus 5 Year yields, government bonds, has just nudged into negative territory only just by minus 1.2 basis points. But it is nonetheless a slight inversion of that curve.
If we're going closer on that with this, you can see that you always had this steep decline in the curve. And I think it's on the intraday basis, it got to minus 1.2. As we record this on Friday, it's got back up to about positive two, positive three, but it has inverted on an intraday basis. Now, I've said before, you can find any curve that will fit almost any narrative because there's so many different parts of the curve out there.
But when we map the 5Y 10Y on the more traditional used 2Y 10Y, they're pretty much going into inversions at the same time. This one's inverted, even though the 2Y 10Y, that more traditional part has still not quite got there. Is that fine the starting gun, or both of these actually, behind the curve?
MAGGIE LAKE: Darius, I know a lot of people have been looking at these, the flattening or inversion. They haven't been sticking there long enough, I think for people to really put down the hammer. But there's concern, as you're pointing out that although the Feds being really aggressive, they're going to break something. And that something that they're going to break is most likely the economy and push us into recession. That's the idea that maybe that's what the yield curve is telling us. Are you looking at slowing growth? A moderation of growth? Or is the risk of recession real?
DARIUS DALE: The risk of recession is definitely real. We talked about this at the beginning of the year before any of the energy price spike happened, or before we saw anything out of Russia-Ukraine that might have exacerbated confidence and supply chains globally. We were already-- Let's take a step back.
The Bloomberg consensus, and I keep saying this ad nauseam, because they won't take down the numbers, but there's an expectation out there that the economy, both of US, both domestically and globally, is going to grow comfortably above trend in 2022. Obviously, I think anybody can look around at the yield curve, look around at sector and self-factor dispersion within the equity credit markets and you could say that's probably wrong.
Right now, as of today, Bloomberg consensus is expecting 3.5% US GDP growth in 2022. That number is above the Feds 2.8 target. That number is 150 basis points above our potential. It's even worse for the global economy. The economists could expect to right around 4% growth for the global economy. That's about 300 basis points north of where a potential GDP has been for the world over the last five years prior to COVID.
There's a lot of lofty expectation out there in terms of growth expectations. Obviously, corporate fundamentals are a derivative of that certainly in and around Wall Street. The disappointment associated with that is likely, again, to commit sometime in late Q2 and persist throughout the summer and until the fall. That's how you get that retrenchment. That surprise is how you speed up the process of moving to a recession.
A couple things I'll call out on the recession risk. If you look at the last couple of quarters on GDP, specifically, this is a longer leading indicator, inventories accounted for 90% of our growth in Q3, and 70% of our growth in Q4, the headline figure. We're now starting to overbuild inventories. Usually, in terms of the most obvious easy recessions to call are, they're always the inventory cycle, the manufacturing cycle. Those are the ones where you have to have a correction in terms of the supply and demand for goods. We can see that building already.
We can also see, again, that financial condition starting to tighten. If you look at the average note yield unlike the Bloomberg high yield credit index, we're up about 260 basis points since July. Mortgage rates are up right around 170 basis points year-over-year. Now, these are big moves. We're not at places where you would expect a recession over the near term. But we're moving at a speed and a pace that would suggest that recession risk should be pretty elevated like a year from now.
MAGGIE LAKE: Good question from Bo, and this comes up a lot. And we've got a couple variations of it, but let's start with the broader one. With all the talk of 25, 50 basis point rate hikes, how many are they going to do when-- wouldn't balance sheet reduction make a bigger difference at this point?
DARIUS DALE: Balance sheet reduction definitely makes a bigger difference from the perspective