Oil/Expected Inflation Divergence: Canary In The Coal Mine?

The rise in oil above $80/barrel adds to pressure on the Fed to withdraw pandemic stimulus as soon as possible. Nevertheless, the oil surge may also be a “canary in the coal mine”, warning that too many interest rate hikes already are discounted for 2022. Long-term inflation expectations embedded in the bond market have not followed oil higher, in contrast with the tight correlation of the past decade (see Chart). This fits with Alpine’s view that inflation expectations are well-grounded and that inflation surprises will be to the downside later this year.

Is A Dollar Transition Underway?

The U.S. dollar has failed to benefit from the Fed’s increased hawkish rhetoric and has been losing ground. To some degree, the pullback in the greenback should not be too surprising from a technical perspective. Our intermediate-term oscillator showed overbought conditions. Additionally, speculators had built sizeable long positions in the dollar. These are bearish signals from a contrarian perspective. But is there more at play than just technicals? Are the macro conditions falling into place for the dollar to transition from strength to weakness?

Financial Mania In Growth Stocks?

This Alpine Macro chart is reminiscent of the late 1990s when tech stocks were in a massive financial mania. Back then, the mania was led by the “four horse men” — Intel, Cisco, Dell and Microsoft. Today, the market leader is FAANGMS.

Are we heading for a similar end as the last tech bubble? Which side of the trade do you want to be, being long Dow while shorting NASDAQ or the other way around? The answer may not be as obvious and straightforward as you think.

A Look At The Dollar’s Reserve Status

The IMF just released its data on global FX reserves for 2021 Q3. The dollar’s share of world reserves has been trending down and currently stands at 59%. This is the lowest allocation to the greenback in over two decades. Is this a sign that the dollar is losing its hegemonic status and heading towards a collapse?

The DAX Versus The S&P 500

The S&P 500 outperformed European equities in 2021, but an excessively hawkish Fed could spoil the party. Historically, a flattening yield curve has often warned of equity market tops. The U.S. Treasury curve has flattened significantly in contrast to the German Bund curve.

Eurozone liquidity conditions remain very accommodative given the ECB’s continued dovish stance. Liquidity is one of several reasons why the GTAAI model prefers German equities over the S&P 500.

Will 2021 Stealth Bear Market Give Way to Stealth Bull in 2022?

Many stocks have been left out of the 2021 bull market. In fact, it could be argued that there has been a stealth bear market over the past few months, apart from large cap companies offering “quality growth”. The Table looks at the proportion of stocks for a given benchmark index that are currently down 10, 20 or 25% from their 2021 highs. For example, only 11% of S&P500 stocks and 61% of NASDAQ Composite stocks are at least 25% below their 2021 highs. Yet none of the overall indexes is even 10% below their high for the year. In general, the smaller capitalization or more cyclically sensitive the stock, the more likely it is to be far below its high for the year. This is not necessarily bearish going forward. A “coiled spring” has been created in which laggards will become leaders when policy pivots as inflation and growth surprise to the downside.

Is the US Past “Peak Bottlenecks”?

At a time when supply shortages are “on the front page”, and Omicron threatens to exacerbate infrastructure bottlenecks, the ISM manufacturing survey is sending a message in the other direction. The latest reading for new orders is at the low end of its 17-month range, while the reading for inventories is close to its 37-year high. Firms have been desperate to accumulate inventories, but this could shift to unintended inventory accumulation if new orders dry up. It is also possible that the rising Prices Paid component (shown inverted) will undermine overall manufacturing activity readings. This supports our view that surprises will be on the side of lower inflation and economic growth 2022, increasing the odds that 10-year Treasury yields will test 1% and the Fed will pivot back to dovish sometime next year.

Big Tech Vulnerable to Fed Mistake

The composition of the Treasury rally is consistent with a Fed policy mistake that puts Big Tech stocks at risk. While long-dated bond yields have fallen since last week’s hawkish FOMC statement, the rally has been driven by declining long-term inflation expectations. In contrast, 10-year TIPS yields are up 25 basis points from last month’s low. The Chart shows that real bond yields and FAANGM relative performance move inversely. Having said that, these world-beating companies with robust cash flows remain candidates for an eventual mania-like overshoot. Any vicious correction would ultimately ingrain a “buy the dips” mentality once the pullback runs its course.

Is A Liquidity Shortage Developing?

Conventional wisdom says that there is too much liquidity around, which will keep pushing up asset value.

This Alpine Macro chart tells a different story: it says that much of liquidity has already been absorbed by exploding asset value and there could be a liquidity shortage developing.

Is the Fed about to make a similar policy mistake as it did in 2018? Why is the yield curve flattening? Should we trust Jay Powell?

Will The Fed Make A Policy Mistake?

The latest projections from the Fed have three rate hikes penciled in for 2022 and 2023, followed by another two in 2024. If the Fed raises rates in line with its forecasts, it could invert the yield curve. As seen in this chart, a recession typically follows when Fed tightening leads to an inverted curve.

Is the Fed heading towards a policy mistake? Will the Fed be forced to dial down the hawkishness? And what will it mean for Treasuries and the dollar?