Inflation and $ haven – July 28th 2023

Central banks took center stage this week with the FED delivering yet another 25bp hike to policy rates (now 5.25-5.5%), while the European Central Bank(ECB) called with a 25bps hike of their own (bringing ECB deposit rates to 3.75%). The hiking trifecta was upset by the Bank of Japan (BoJ) this morning, which held its short term rates at -0.1% but increased the range in which 10yr yields can move around the 0% target to 50bps. This further flexibility to Yield Curve Control (YCC) hints at inflation beginning to percolate through their system, yet ultra loose policy remains the BoJ’s priority as their inflation projections are well below 2% targets for 2024 and 2025.

J. Powell’s press conference summary: Deja -vous.

No changes to the script, nothing new, nothing learned. Basically, the Fed bought itself more time (8 weeks) and full optionality to raise further if consumers and markets allow it.

What to expect: well, yield curves will remain inverted for the foreseeable future, all meetings are live from here, term premia on the curve to remain absent and price action and positioning to continue moving out the 2- 5yr part of the curve. With that, 2y5y steepeners become attractive in the face of this prolonged data dependency by the FED, absent a larger crisis that would trigger an unwinding of recent restrictive policy.

Although the belly (10yr sector) is lagging and showing signs of richness at the top of its range, 10yr inflation break-evens have been slowly inching upward (now ~2.4%), suggesting that CPI could creep above a 2% level for longer than most are anticipating. Regardless, with this risk event totally priced in ahead of the announcement, risk assets reacted with relief and proceeded to celebrate the trending earnings surprises for the quarter against the subdued comps set by a majority of pessimistic analysts earlier this year.

Inflation isn’t all bad, is it? It’s important to highlight the side effects of keeping rates higher for an extended period of time by central banks: Protection for the USD.

Higher interest rates support the local currency of net importers relative to net exporters, favors export competitiveness in manufacturing and technology fields, and attract capital inflows which in turn provide market stability . The collaborative effort by DM Central Bankers is un-admittedly an attempt to disrupt the strength and growing unity of other EM’s (read BRICS). If the pressure is prolonged long enough and successful, the higher cost of imports and potential declines in domestic consumer spend and investment will certainly effect those economies in the long run. Another round of tariff wars later this year seems inevitable under this premise and at the doorstep of upcoming US elections.

** Commentary from RCG Portfolio Managers
————————————————————

** Dynamic Macro Strategy
————————————————————

This strategy relies on historical data and quantitative techniques to detect statistical disparities and make predictions in global markets through liquid ETF’s.

“Core positioning in the strategy remains unchanged as these overweight sector continue to lag broader indices on a relative value basis. On a tactical front, we reduced exposures to IWM pre-Fed meeting which had benefited from recent index re-balancing and positive Q2 earnings,. We’ll look for new entry points in small caps after month end as it currently failed and retraced from its 6m resistance level of 198. We remain sensitive to the overall level of interest rates, Central bank messaging and are tracking capital allocation and USD weakness closely as it could play as the next catalyst for both fiscal and monetary policy changes. ” – Nick Diaz

** Inflection Strategy
————————————————————

The strategy takes positions in highly out of favor US equities which we believe are inflecting due to changing fundamentals/events.

“Q2 earnings season is underway and thus far our companies have reported strongly. The Nasdaq is trading at 29x price to 2023 expected earnings while the Russell 2000 currently trades at 20x presenting an attractive rotation opportunity for this second half of the year. This portfolio is well structured with companies displaying earnings growth, cyclical and seasonal upside potential and running at an average price to earnings ratio of 9x”- Stefan Lingmerth

** Safe Haven Strategy
————————————————————

This strategy protects capital during inflationary environments and seeks to maximize yield using fixed income instruments and defensive assets.

“There and back again. Yields pushed higher after the Fed’s decision and are pursuing a re-test of recent highs [Current levels -> 2y: 4.99%, 5y: 4.25%, 10y: 4.00% and 30y: 4.05% ]. The front end of the curve remains our preferred engagement point to own US paper and we have continued to add exposure near this 5% level in 2y notes. As our T-bills roll off we will slowly be extending the books duration into the 2-5y part of the curve and buying up any sizeable dips in these instruments. ” – Nick Diaz