Multiple signs economy shifting to “buyer’s market” vs seller’s = downside to inflation = justify stocks strengthening

Economy (parts) becoming a “buyer’s market” reversing “seller’s market” since 2020 = downside to inflation

I had a conversation earlier this week with the owner of one of the largest privately held food producers in the US (tens of millions of pounds sized, so huge). RM, the owner spent the pandemic in Maui but was able to run his business remotely, and during the pandemic, was able to raise prices nearly continuously since early 2020.

• but in the past 6 weeks, the environment changed
• switched from a seller’s market “I can raise prices 2% every month because Costco will buy this if you don’t pay”
• to a buyer’s market “give me a discount”
• RM attributed this to easing supply chains, which now makes access to protein easier
• and he sees outright “deflation” coming for fish, chicken and beef prices
• yup, deflation, not inflation

This is a big change. A commodity becoming a buyer’s market. And in fact, in his view, much of the rise of food/protein prices is not demand driven, but really due to supply chains causing scarcity. And as he sees delivery times falling fast, he thinks many prices of food items in the US could fall.

Market has taken out 1.5 Fed hikes (by YE) since March 2022 = incrementally dovish

This is so counter to consensus thinking. We hear time and again:

• Tom, inflation is so bad and there are so many sources
• thus, Fed is way behind and needs to destroy demand by creating a recession

This is pretty taken as doctrine. It is true the Fed is pursuing “tight” monetary policy as this is their main toolkit to battle the many fronts of inflation. But:

• in our view, markets primarily focused on risks inflation worsens (pressure for Fed to be tighter)
• there are at least 9 ways that inflationary pressures break to the downside (Fed moves dovish)

As our clients know, we have been leaning against this central narrative of rising inflation risks. We have pointed to multiple incoming data points that show inflation risks have been abating. And equally important, Fed has less “wood to chop” because markets have been doing Fed’s work for months already.

But until this week, our view has seemed so far from “reality” that many viewed our arguments as being stubborn. That is changing this week, as incoming data has showed a pronounced change in how markets see inflation risk.

And in our view, incoming data over the past week is reinforcing our view that downside — market-based pricing is already showing indeed that market’s perception on inflation risks have shifted towards the downside (fewer hikes, lower inflation).

• Fed funds futures has taken out 1.5 hikes in YE 2022 expectations from 3.0% FF to 2.60%, or 40bp > 1.5 hikes
• Inflation 12M forward still drifting lower after peaking at 6.3% in mid-March

Cumulative probability >50% that 9 factors could drive a downside break in inflation risks

Before delving into how inflation risks moved (in a pronounced way) to the downside this week, I think the more important story arc is to think about the developments that could lead to a downside break in inflation risks.

In our view, there are at least 9 reasons Fed will deviate from this “tight policy to destroy demand” path (not in any order):

• China economy comes back online, and impact normalizing supply chains = deflation on goods
• Russia war comes to a stasis/end = deflation pressure on food and oil
• US job market shows visibility, reducing upward pressure on wage inflation = disinflation
• Pandemic retirees “rebound” back into labor market = boost to labor supply
• Goods pricing in US turns into discount (buyer’s market) = deflation
• US housing market slows sharply, leading to negative wealth effect = disinflation
• Europe enters recession = deflation
• Oil and natural gas prices flatten = halt inflation
• Private credit markets seize up = crushing jobs loss = deflation

So a simple exercise is to do a conditional probability of these factors. That is, what are the odds one of these scenarios happens in the next 3-6 months.

• if the cumulative probability >50%
• then Fed will be more dovish, possibly far more dovish
• inflation risk has peaked
• thus, equity markets have bottomed
• our view is that the cumulative probability is indeed >50%

Inflation expectations (market-based) falling past 6-8 weeks…

Inflation and fears of surging inflation are top of mind. There are many causes behind this rise in inflation from supply chain woes, war-related disruptions, COVID-19 policies, China lockdowns, worker fear and of course, strong economic growth. And because there are so many factors, it is difficult for markets to assess where the Fed’s fight against inflation stands. And this uncertainty weighs heavily on markets. From the Fed’s standpoint, they are using tools to try to slow down aggregate demand, while many of the roots of the inflationary pressures are supply related.

But here is the interesting thing. Market-based measures of inflation, using 12-month T-bills less 12-month TIPS (USGGBE01 on Bloomberg) have been falling since mid-March. As shown below, this figure peaked at 6.3% and has since drifted towards 4.8%.

• While still not close to the “2%” goal of the Fed
• this inflation metric is 70% on its way back to 4%-ish, which is the level seen in most of 2021

Similarly, the market’s expected implied Fed Funds rate by YE 2022 has been pinned at 2.75%.

• 8 additional hikes into YE
• multiple Fed officials have reiterated 50bp for each of next 2 meetings and “assess”
• thus, Fed hike expectations are anchored by this somewhat “forward guidance”

In short, from a market’s perspective, incoming data in the past 6-8 weeks has not accelerated market’s fears of inflation. In fact, forward inflation expectations have actually been falling.

• there is some circularity to this, obviously
• after all, 12M forward inflation expectations could be tanking if the US is in recession next year
• but the fact this inflation rate is “pinned” and Fed Funds target rates are flat
• suggests that Fed communication strategy is tamping down market-based inflation
• that is a good thing

…But in that same 6 week period, equities are down 18%…overshoot?

But in this exact same timeframe, the S&P 500 has tanked 18%. Financial conditions have tightened, measured by credit spreads, market liquidity and depth and investor confidence.

• But given Fed funds YE has been pinned at 2.75% (8 more hikes), it means
• monetary policy in the past 6-8 weeks has been solely communications

• in essence, the Fed has been jawboning to tighten financial conditions
• in turn, to slow aggregate demand
• as one of my macro PM clients stated “this is the first ever use of communication channel to slow the economy”

While many might think the Fed is satisfied with this result, how does the Fed keep equilibrium? Will they keep jawboning whenever asset prices stabilize? And in the meantime, credit conditions are worsening. Moreover, this could trigger a larger scale selloff.

Curiously, the 10-year has been remarkably flat at this time as well. Mortgages and corporate credit (longer duration) is priced off the 10-year. So the fact this is pinned is also standing in contrast to the movement in equity prices.

• in other words, there are several scenarios where equities have overshot to the downside
• stocks have fallen far faster than other channels for tightening conditions
• and while some might argue this is a good channel because of the wealth destruction
• it is an unstable equilibrium, as stocks could fall far faster and trigger Fed reversal — overshoot
• incoming data could show labor market weakening, not due to higher rates, but due to COVID-19 ending
• and thus job market could be cooling (see below) at a pace faster than implied by tighter financial conditions

…lots of incoming data this week but we think indeed.com labs data shows job market rolling over

There is a ton of incoming data this week, as the US release calendar shows:

• tons of regional survey
• new home and pending home sales
• PCE deflator for April

All of these are important and the two areas markets seem most focused upon are inflation-related (PCE 5/27 plus regional surveys) and labor markets (no official data for a few weeks).

JOLTS vs Indeed.com: JOLTS is 6 weeks lagged, and indeed.com already showing significant weakening

Our data science team, led by tireless Ken, has compiled indeed.com labs data on job postings. This is a more real-time measure of the jobs market:

• indeed.com data is posted with daily information, updated weekly
• this coming Wed/Thu we will have job postings data through 5/19
• the BLS JOLTS report is only through 3/31 and with 6 week lag
• next JOLTS report is not for 2 more weeks (1st week of June) and only thru April
• See the picture?

JOLTS shows job posting rose by 3 million in the past year, while unemployed Americans fell 4 million

The JOLTS data (thru March 31, 2022) shows the tightness of the jobs market today. As the Fed has mentioned, there are 1.9 job postings for every 1 available worker. The math is shown below.

FED FOCUS: Of the ~2.8 million increase in job listings, 4 industries account for 60% of listings

We took a look at the JOLTS data more closely and 4 industries accounted for 60% of the rise in posting in the past year:

• Healthcare +657,000
• Leisure/Hospitality +524k
• Retail +328k
• Construction +169k
• These 4 total 1,678k job posting increase, or 60% of postings

In other words, if the Fed goal is to soften the labor market, these 4 industries should be the areas where postings should fall. There needs to be a large drop to bring labor markets back into equilibrium. But it should start here.

…Indeed.com data shows these 4 industries seeing a VISIBLE softening of postings

As the data compiled below shows, these 4 industries are indeed showing signs of weakening postings. This softness is for data through mid-May. And this should be appearing in upcoming JOLTS and other labor surveys:

• most surprising is the drop in Healthcare postings

…is fading COVID-19 behind healthcare postings falling for many categories?

The weakening of postings here surprises me the most as I have heard multiple stories of healthcare demand soaring as elective surgeries, etc are now being booked.

• visible drops in Medical technicians, nursing, therapy, pharmacy, personal/home care and medical information
• is this due to the collapse in severity of COVID-19 cases?
• this might make sense as hospitalizatons from COVID-19 continue to contract sharply

• we think this is counter to consensus views on the strength of healthcare labor
• Healthcare was the largest category for a surge in postings in the past year

Figure: Themes in 2022 – “BEEF”

Per FSInsight

Figure: FSInsight Portfolio Strategy Summary – Relative to S&P 500

** Performance is calculated since strategy introduction, 1/10/2019