Risk Assets are Dependent on Real Interest RatesRisk assets such as, Bitcoin/Crypto, Tesla, QQQ, GDX, TIPS, EEM, etc.. all profit when real interest rates decline . Persistently high Inflation expectations will slow the rise in Real Rates potentially bringing price stability to risk assets. A bullish rally could be brewing when are you buying??
Real Interest Rates: Nominal Rates - Inflation Rate (Expectation)
Using the Ten Year Treasury Yield: US10Y as the Nominal Rate.
And the 10Y breakeven inflation rate: T10YIE this represents inflation expectations in 10 Years.
By taking US10Y - T10YIE, we can find the real rate of a 10 Year US Treasury Bond.
Chart: Real Rates will likely slow their decline offering eventual recourse to risk assets.
Featured Chart: It shows the TIPS BOND ETF which is just a proxy of Real Interest Rates (Inverted). When the TIPS etf goes up, real rates go down and risk assets go up. The embryo of a bond renaissance is developing with rates running out of room to move higher. When the economy is growing and consumers have large amounts of disposable income Gold usually appreciates in price along with inflation. ~50% of Gold is used in jewelry, 20% is used in coins and personal investment and the remaining ~30% is used in industrials and technology. Gold usually outperforms in the dawn of bull markets. QQQ showcases the Tech sector. Value in the tech sector is dependent on future earnings and in turn inflation expectations. The Tech sector is a highly speculatory sector and follows real rates closely. Not included on the chart but similar is EEM (Emerging Markets)...
This chart shows how the TIPS ETF is just Real Interest Rates....
We are no longer in an environment conducive for low inflation expectations. Contrary to market conditions following the 08 crash, we are now in a trader's market where potential success can be found in buying the rips and selling the dips. More volatility is on the horizon with persistently high fed funds rate and borrowing rates. Inflation expectations will remain elevated due to the sticky labor market and as a result, the fed will keep rates elevated. Hikes in Interest Rates take time to be felt in the economy and economic activity will contract... The fed's war against inflation is truly against the labor market. The fed must fight tactically to prevent a wage-price spiral or a deeper recession. The market is close to pricing in a 5% fedfundsrate level along with a recession. Bonds look more n more attractive day by day.... Real Interest Rates have sternly dictated the movement of Risk Assets since Covid and bulls should only be buying on the back of falling real yields.
Chart: The fed needs to slow down the job market as it is the cause of high inflation....
Bearish sentiment has taken over and investors are reluctant to enter. With good reason.... Every bull markets after 2008 was a product of easy monetary policy BUT NOW - with inflation running rampant, the fed cannot activate QE. All indicators point toward the bear market continuing. With only despair around and no apparent fuel for a bullish rally. Here I am saying maybe buy for the pop and sell for the drop. Why? Because I think inflation expectations will rise faster than interest rates in the short term, lowering real interest rates. Most risk assets receive fuel when real rates decline. Risk equities receive value from future earnings which are dependent on inflation expectations. There is a potential buying opportunity until, the next bearish catalyst appears....
My projection for FedFundRate Hikes at future Fed meetings:
Current: 325bp
Oct/Nov + 75bp
Dec + 50 bp
Jan/Feb + 50 bp
March + 25 bp
Terminal Rate: 525bp
Long Run Neutral Rate: 250bp
I expect US10Y to reach the general area of the terminal rate ~5.25%...and stay above the 2.50% neutral rate until QE starts again.....
The fed's two weapons are control of interest rates and the type of narrative they spread.
The fed’s narrative and forward guidance on policy dictates market expectations. Many financial instruments such as bonds rely on duration and must take into account inflation expectations. The fed's economic projection's expect PCE inflation to fall from 5.4% in 2022 to 2.8% in 2023. The longer run (after 2025) PCE inflation is projected to remain at 2% with the long run fed funds rate staying at 2.5%. As you may have the noticed the fed's inflation projections for the next three years have been very incorrect. The Fed has consistently been WRONG. The fed has consistently undermined inflation, saying it’s transitory or caused by supply shocks. Even though, there is truth to what the fed says. By spreading a transitory narrative, the fed is able to keep inflation expectations well anchored. Low inflation expectations puts downward pressure on medium/long term REAL interest rates. Negative/lower REAL interest rates incentivize borrowing over saving and are bullish for risk assets like stocks and economic growth. Lowering inflation expectations allow them to raise NOMINAL interest rates without raising REAL interest rates as much! If you look at the fed's economic projections from 2021 for Core/PCE inflation, Change in GDP and Unemployment. Core/PCE inflation is always projected to fall off of a cliff. In December 2021, the fed projected that inflation at the end of 2022 would be 2.6%!!! Here we are finishing the year with 5.4%. The fed also has consistently projected GDP growth to be higher than it is. In December 2021, the fed projected 2022 to be 4% growth!! Here were are ending the year (2022) at 0.2%. Unemployment projections were also projected to be lower. Unemployment will need to rise as the economy tightens. In December 2021, Unemployment for 2022 was projected at 3.5% for 2023. Now 2023 unemployment is projected at 4.4%. The fed will continue to blatantly "lie" to keep inflation expectations down - its their job. However, there is one thing the Fed won't lie about in projections. The only two projections that the Fed never changes is their long run projections because, the fed cannot let long run inflation expectations to become unhinged. Inflation expectations are important to keep anchored because price will reflect what people expect them to be. Runaway inflation will occur if Inflation expectations become unanchored. Long Run Inflation has always stayed at 2.0%, Unemployment at 4.0%, FedFundsRate at 2.5% and GDP at 1.8% (yoy). The fed's mandate is to keep these long term measures from changing.
Look for yourself here: www.federalreserve.gov
Look at the economic projections from 2021 till 2022 and observe how the numbers change....the fed's agenda becomes very clear.
Chart: Inflation is coming down along with economic growth.....very slowly tho....
Chart: The consumer is growing weaker due to inflation, high borrowing costs, less saving and more debt....
I have been long the dollar and short EEM; now I think that trade is fizzling out.....
