MAGGIE LAKE: Hi, everyone. Welcome to the Daily Briefing. It's Tuesday, May 17th, 2022. I'm Maggie Lake, here with me today is Vincent Deluard, Director of Global Macro Strategy at StoneX. Hi, Vincent, it's great to see you again.
VINCENT DELUARD: Hi, Maggie. Thanks for having me. It's always a pleasure to interact with you and the Real Vision audience.
MAGGIE LAKE: Fantastic. And it's an interesting day, isn't it? Because we're seeing this big rally in equities today. We have the NASDAQ finishing it looks like up with 2. 76%, S&P up 2%, we're still settling here, but Russell up 3%. And at the same time, we have the Fed Chairman Jay Powell testifying before Congress doing his best to sound as hawkish as possible, saying, listen, we're not going to hesitate to keep raising rates till we get inflation under control. Even if that means moving past what's broadly understood to be neutral. And the VIX is down 4%, we did see bonds, the 10Y move back up toward 3%. But what do you make of this market action?
VINCENT DELUARD: It's really a reflection of how overblown this recession fears were. We basically have Charybdis and Scylla, like two parallels that we want to avoid. And depending on where we are in the cycle, sometimes we focus, so what is inflation and higher rates? The other one is this recession and the idea that the Fed is going to tighten into a mistake.
Then a couple of months back, clearly the biggest barrier was what is perceived to be inflation. And we had such a shift in sentiment, everybody's starting to price in a recession, yada, yada. You get a data like that, I think people focus more on-- I think you also had the retail sales that came out pretty strong. Okay, the economy is going to a recession, and until we have a typical risk-on movement like we'd have five years ago where you see small caps outperform, VIX going down, yields go up.
It does bring a sense of normalcy, which is nice. And I do think that on the economy, it's more correct. I think the moral panic around the recession of 2023 was not supported by the data. We still have an economy that's as far as I can tell, growing by 11%, 12% nominal, so to think that we can slow in six months into a recession seems excessive to me. That's [?].
MAGGIE LAKE: Yeah, that's interesting, because you really do get the sense that everyone is looking forward. And when you see things like retail sales, which were up 1%, not sure how much of that was actually higher prices that we were all paying or how much of it was actual demand, but still, they were holding up. We saw factory production holding up pretty strong as well.
What we've had is sentiment readings, like homebuilders today, down, Michigan last week, down at a 10-year low. I think people are wondering about timing. Do you think that we are not going to go into a recession and the economy is strong enough to withstand higher rates? Or do you just disagree on when that happens?
VINCENT DELUARD: Well, eventually, we will have a recession. Making a forecast without the time attached to it is [?]. Like all the strategies to [?] and you expect more volatility. The hard question is when. And yes, I think I disagree with that. What seems to be the consensus, one thing that I thought was interesting about where sentiment might be was the Bank of America, Merrill Lynch monthly survey, they survey actual serious money managers, 100 million of assets or more.
And it struck me that the biggest worry was obviously the Fed hiking cycle. And we all agree on that. The second one, by large margin was recession over inflation. I would fit this to-- I agree that for any asset manager, the biggest risk, obviously, is we had to be on a heightened rate. And because the risk-free rate is in every discount rate. For risk assets, this is the biggest one.
But then after that, I think the biggest concern remains that the economy is too hot, rather than too cold. Well, maybe we'll get there. My guess is that we will get there. At the end of the day, my views on inflation is very much structural. It's very much driven by supply side concern. Really, the only way to slow it down will be to destroy a tremendous amount of demand. And yeah, it probably means for the economy into a big recession, but I do not think we are anywhere close to this.
We still have-- real rates around minus 6%. Financial conditions are still incredibly easy. Yes, if you get junk spreads, it's up to about 4%, but it's still below inflation. I think investors are rushing to the end of the play and thinking that it's going to be over in 10 months, it may take 10 years. If you look at the experience of the 1970s, it took 10 years between one inflation story to go out of control, and the dollar went up, the gold standard to Volcker.
That's what it took for the nation to develop the courage and strength to do what it takes to solve inflation. I really don't think we're there yet. And I think people who worry about recession are focusing on their own risk.
MAGGIE LAKE: Okay, there's a lot to unpack there. I want to stay on the inflation for a moment. And we've got questions coming in, some of them super specific about how to navigate through this. John, Paul, Roger, Adam, welcome to the conversation. I'll get to those in a minute. But I think it's really important to understand your macro framework here. And I want to come back to growth and inflation.
Let's start with inflation, because you were early and right on the risk of high inflation. It took a lot of people, including the Federal Reserve, a long time to catch up and lock into that. Are you still expecting that inflation remains high for longer? What is your inflation forecast at this point right now?
VINCENT DELUARD: Thank you. Yeah, I've been very early in inflation, saying before COVID, I was worried about inflation. Obviously, I have not given up, but I have come up with a report acknowledging that inflation has probably peaked in March, all else equal, and that is a very important condition, one that is very difficult to maintain given the macro uncertainty that we have. All else equal, I would expect that 8. 5 was the high for this cycle.
And the reason is that inflation is really a tug of war at this point, between two parts of the CPI-- [?] start to call the date of two inflations from a [?] report, basically, you have COVID plus energy plus supply chain basket like the used car, gasoline, air tickets, all that stuff that really went crazy because of the reopening and all that stuff. And that is moderating, these cannot increase by 50% every month.
It's not getting much better I would argue, it's just stabilizing. But again, because of base effect, the contribution to inflation is lower. That's the disinflationary aspect of the CPI right now. And then on the other side, you have the inflationary aspect, which is the secure part of the CPI, services, wage and shelter. And for the near term, I would say the next six months, the disinflationary winds will be slightly stronger than the inflationary winds.
That should result in inflation slowing. Now, I believe it will not slow as fast as the Fed wants it, most big banks have forecast but 4. 5 at the end of the year, I think that's what the Fed has in the [?]. I don't think that will be the case. What I would expect, assuming nothing, no other macro shock, is inflation slows very, very slowly to finish the year at about 6%, which I don't think is enough to get where the Fed wants.
And one thing that is especially worrying to me, and I think, really for markets is that there'll be a pause in that slowdown in the summer. If you remember last year, oil prices were quite weakened, it has somehow went down to almost $60 a barrel, so these base effects are going to get harder. It will look for a couple of months that inflation is no longer slowing, and I worry that could be the next down leg for the market.
If by September, inflation exceeded 7%, there will be a brutal awakening. Right now, we are pricing this recession, dovish people thinking that this is going to play out like 2018, the Fed is going to overtighten, and then it'll walk it back. I think this is [?] and removing the delusion could get us to that second down leg in the bear market. We already had basically more of 20% down on the S&P 500. That's not the hard part.
Do you remember in 2008, the hard part was September, October 2008 when you give the next 20%, and that could be the trigger for that downfall because then we'll need to start pricing risk assets for the fact that all these nice stories that we hear on Bloomberg go, where is neutral? Are they going to go? You know what? No one knows where's neutral here. It's just like a purely academy concept. The Fed will just navigate as it sees it, but there is no anchor in the far future that they can follow.
MAGGIE LAKE: That is extremely concerning for risk assets. Do you think that we are definitely going to see that 20% leg down? Would you expect that to happen for US equities? Or does it all have to come together on that supply side of inflation, if I understand you're making a difference between that services, wages, and then the more commodity led supply side? Are you fully anticipating that next leg of the bear market for risk assets?
VINCENT DELUARD: On the commodity side, it's hard to tell. In my forecast, I was assuming that the COVID plus Ukraine plus supply chain basket, the indices stay where they are, so there is no longer inflation, there is no longer disinflation, it's just made base effect. There's disinflation because the base effects are getting easier, but these things are no longer rising in price.
For what it's worth, I think that's as good a forecast as one can make. I think with commodities in general, the spot is the best predictor of future prices. With think like used cars, if you're trying to buy one right now, it doesn't seem like it's going down. Maybe it's not as crazy as it was two months ago, but we still have the shortages. That's why I'm keeping it where it is.
Now, these things could change. Both ways, by the way. It could slow down. I hope it slows down more than the next-- but it can also go up higher. I can think of a number of inflationary shocks, macro shocks. China is going to reopen. We have $114 oil prices with a good chunk of China under lockdowns, and China consumes half of everything. Because consumers in China will also see something really bad happened in-- like Sri Lanka, you could see the same thing happened in Egypt, in Tunisia, in India, Pakistan.
When you have a balance of payment type crisis, dollar's strong, oil price is high, and weak prices are very high for countries where more than 50% of your consumption basket is made of food or energy. This is really a dire situation. You could have sharks either way. That's why I kept this where I [?] in the middle. As far as the stickier part, I don't see how that slows. If anything, it seems to be accelerating to me.
One part of the CPI that was somewhat deflationary was medical care, which is somewhat odd. In a pandemic, usually, healthcare costs, the US had always fastened inflation. And then this was the opposite. And in April, we saw accelerating medical care prices. Shelter also accelerating. Again, there's so much momentum. These things move slowly so I do not see how services, wages or shelter decelerate by the end of the year.
MAGGIE LAKE: In that case, it sounds like you're saying that-- we have a question from Raoul saying, what is the biggest risk? What's the right risk to focus on? It sounds like you think the right risk to focus on is inflation. Because it will mean higher rates for longer or a more severe tightening cycle than people believe?
VINCENT DELUARD: Yes, and especially the middle to long end of the curve. In the front, I think we priced a lot of tightening already. The 2Y went from 0% to 3% in a couple of months. Powell's been pretty clear about what he wants to do. He took out the 75, said, okay, I'm going to [?]. I think the market is right for the short end, because there's not much uncertainty there.
What worries me is that kink in the curve, so if you look at the Eurodollar, maybe you have the chart, maybe you can show the chart. Anyway, if you look at the Eurodollar curve, it falls there rapidly that the Fed is expected to raise rates until close to 3% and then in its May 2023, we priced two cuts. That's the part that worries me.
MAGGIE LAKE: Let me jump in, Vincent. Because if you're talking about persistently high inflation in prices, and you're talking about a Fed that is hiking rates at least through the end of this year, wouldn't that dampen economic growth? That's why people think there's going to be a recession, because high prices are the cure for high prices and that people will pull back, because wages aren't keeping up with inflation.
VINCENT DELUARD: Well, for now, wages aren't keeping up with inflation. My favorite economic indicator, real time indicator is the daily Treasury statement where the US Treasury shows how much taxes it's collecting from various sources. And there's really three that I'm focusing on. One is the withheld income tax. This is the stuff that I pay, and presumably, you pay. People with a normal paycheck, and we get our federal income taxes withheld. That's at 12. 5% year over year. Still is today.
I think inflation is maybe 8%, 9% something like that. That still leaves you like 3%, 4% real GDP growth. And then the part that's really booming is non-withheld stuff, individual non-withheld which is up 70% year over year, it's huge. Part of it, I think, is the effect of the crypto everything bubble last year, people have a lot of capital gains. And then part of it, I think, is also the rise of the economy. People driving Uber, creating content on Only Charms or YouTube or whatever.
And that's the part that I think the Fed does not really see or understand because its models are based on the BES survey and things that are tilted towards all the economy employers. To me, incomes are rising very, very fast. Yeah, sure, they will decelerate, but not yet. The third part that I look at is corporate income tax collection. And that's growing a lot less faster in 7%, 8%.
In other words, and I think we see that in earnings, where we see-- earnings are horrible, but given how rapidly the top earnings are growing, the fact that your bottom line is not growing as fast, and the margins are really getting eaten up. I think that's where it shows first. First, you need to see earnings slow down and then you'll see the economic slowdown. That's the proper sequence. That's why I'm worried about asset prices more than I worried about the economy also, because asset prices are forward looking.
MAGGIE LAKE: This is a really, really important point, I think, because you're separating out-- we tend to, and we've been told to conflate the two about the wealth effect, and the day we see the stock market right across the screen, that that somehow is reflective of the economy. But you're making a really stark distinction between what's happening in asset classes and to the wealth of those who hold assets, I suppose. And then what's happening in the real economy when it comes to jobs and workers and wages and that sort of stuff.
VINCENT DELUARD: And I think there is a bit of a selection bias from people who go on financial TV or who make forecasts and tend to be wealthy. We see crypto collapse, and then you see most tech stocks are down like 70%, 80% from the top and clearly, the discount, there will be a reason. The vast majority of people, the stock market does not exist, or if it exists, it's just a number that's out there.
I don't really see people slow their consumption because the stock market's down. In one of the reports, I had mentioned that we think of the economy like a drunk banker economy, which is where basically there's a banker, and the [?] is good. He goes out, parties quite a bit, [?] some tips. And then the recession is the hangover for that. And that's what we've lived for the past 12 years, we always had, there was always a demand problem, so when asset prices went up too much, you'd have more spending and then as the price goes down, that would resolve the problem.
I think it is different this time. I think this time, you don't focus on the drunk banker, you focus on the waiter. The power has come back to workers, because right now, yeah, there are shortages everywhere you look at. People, even if asset prices go down, I think the power of labor has increased. The power of workers has increased compared to that of consumer. The power of the young has increased compared that of the old.
I look at the Atlanta Fed Wage Trackers and I look at the income gaps between the educated and the uneducated, the poor and the rich, the young and the old, the white and the nonwhite, and every time, they stay weak for that group that's making more money. That tells me that we have this historical shift. And it is possible that for the first time in 15 years, the fact that the wealthy are slightly less wealthy is not going to force the economy into recession, because we have so much labor shortage and this historic expansion in [?] in 40 years is starting to work its way back.
MAGGIE LAKE: That's so fascinating. And that is what many had been hoping for. The US economy runs on the consumer, two thirds or was two thirds of the economy, and lower income consumers tend to spend their money. Presumably, that would bode well for the US economy. But I don't get the sense that you're bullish, Vincent.
VINCENT DELUARD: I'm bullish on the economy. I'm just bearish on asset prices. In a way, like if you want to take almost more view political about it, you can say this is what we needed. That is the reset, that is exactly that. We had four years of capital winning at the expense of labor, more spending and where it was mostly about owning assets instead of paying for labor. And it is changing.
And I think that that model died out in the COVID crisis. And now, we have the [?] on the historical cycle. I think it's going to be better for intergenerational inequalities, for economic growth or household formation. But the problem is asset prices are