Top Things to Watch this Week

Commodity Cycle and Recession Equation
“The iron rule of nature is: You get what you reward for. If you want ants to come, you put sugar on the floor.” – Charlie Munger Commodity Cycle Over the course of the last month or so, the world has started to turn to commodities and their impact on the real economy. Wheat at multi-year highs, crude oil at levels not seen since the last high in 2008 and Nickel in a world of its own. As people have shifted more of their attention from bits to atoms, it is becoming increasingly more likely that single-commodity shortages are turning into a much broader phenomenon. When commodities rally over the course of years, we call that a commodities supercycle. Investing behind such a cycle can earn substantial alpha over sustained periods of time as a commodity equilibrium evolves over the course of years with new capital coming to the table eventually. However, for the time being, we are not seeing the capital; in fact, quite the contrary is the case with open interest in oil at multi-year lows, continued outflows in energy related equities, and financing restrictions on hydrocarbons from reinsurers to banks. The pessimism in commodities and around oil & gas, in particular, doesn’t come from nowhere. Over the last 12 years, the industry has seen 3 bankruptcy waves, a fight for volume share against OPEC and Russia, and a loss of jobs in each of these phases. As such, consensus is now waiting for a sustained period of time where the industry can “prove” that it operates profitably and in the interest of those that allocate capital. It is precisely because of the lag between initial performance and investor capital flowing into the space that the process of finding a new equilibrium is prolonged (accompanied by ESG, bank lending, etc.) Another factor that may extend the time it takes to catch on to this new trend in commodities is the recency bias that Mr. Market has instilled in investors. In software and tech at large, it wasn’t a question of capital anymore but rather how fast that capital could be put to work. As a result, risk assets rallied relentlessly on the back of Covid, banking on zero-rates and an infinite allowance for cash burn. When the facts change, so does my mind a wise man named Winston Churchill once said. And facts have changed. With these thoughts on commodities, let’s turn to the current economic backdrop. |
Macro Corner The main discussion in this editorial has revolved around where the focus of the Fed is going to be and whether their continued emphasis on combating inflation is ultimately going to lead to an increase in the recession probability. In order to assess the likelihood of it, we turn to the Eurodollar yield curve, the 10s-2s yield curve and the 10yr – 3m recession indicator. Interestingly so, though, the divergence between 2yr and 3m yields has been substantial. Usually, when we see treasury curves close or at inversion, it takes time to get reflected in risk assets at varying degrees. To what extent is this the case this time around? Treasury Curves and Risk Assets |
![]() In order to make a more informed assessment of what the divergence between the two yield curve spreads could mean, we turn to a historic spread analysis and whether there have been similar lags before. (10yr – 3m) – (10yr – 2yr) Treasury Curve Spread | Who’s Leading? |
![]() For one, we note the currently extreme level of divergence between the two spreads. Secondly, though, the 3m-10yr spread has shown a tendency to be late for the downturn in past years and may just be acting on a lag this time around. Ultimately, as the New York Fed’s primary recession indicator (the 3m-10yr spread that is), higher for longer may force the Fed’s hand with rate hikes while underlying economic conditions continue to deteriorate. It will be a question of the Fed’s priorities and whether the institution is taking on voters’ primary issue: inflation. Number of 25bps Rate Hike Projections |
![]() While bond market participants are pricing in an additional 8 rates hikes by the end of the year, a BofA asset manager survey shows that the majority of managers expect 4 rate hikes in total this year. In other words, the Fed doesn’t have anywhere near the credibility the bond market indicates. More likely than not, the Fed causing a de-risking in financial assets may lead them to move with much fewer hikes. However, it is important to account for the belief that some may still have around transitory inflation — despite the term being “officially” retired. A strong commodity cycle as noted in the introduction of this writing may dampen economic conditions for a prolonged period of time while keeping inflation relatively higher for longer. That would indicate a regime shift entirely — one where quality cash flow generating businesses are favored over lottery tickets; an environment where we could see negative real yields for much longer and witness a market in which investors look for safety in assets that can put a floor under purchasing power erosion. Coupled with a multipolar world of multiple sources of political and economic power, a return to a Fed that’s not entirely orientated towards the rise in risk assets is possible but not probable at this point. Please reach out to info@Bluelinefutures.com or call (312) 278-0500 with any questions. Our trade desk is here to help! Adding Fed Funds Into The “Recession Equation” |
![]() China Activity Throughout Covid, western markets have turned to China as a frontrunner. Now, it is not as obvious that we will follow China’s trajectory as they face a variety of unique country characteristics: * Covid zeroism forcing major cities into lockdowns and therefore reducing economic activity * 20th National Congress held in the second half of 2022 at which Xi Jinping will want to present stability * China’s focus is on a strong Eurasian economic and political alliance that coupled with Russia is going to put the U.S. in a corner * Resiliency over efficiency may mean increased focus on becoming self-sustainable while putting less emphasis on absolute economic growth figures China Leading Index |
![]() Index of Economic Activity includes: Hang Seng China Mainland circulation index, investment in newly started projects, ratio of industrial production, real estate development leading index, money supply M2, national debt interest rate spread, consumer expectations index, logistics index. China Credit Impulse 12 Month Net Change |
![]() China’s credit impulse at low levels has been a reliable leading indicator for the recent weakness in the country’s economy broadly; more importantly, though, commodities have performed in spite of China’s weakness. China Credit Impulse | Hang Seng Index | Bloomberg Commodities Index |
![]() There are two paths the Fed and central banks broadly can take: 1. Combat inflation and address the median voter’s concerns 2. Leave interest rates relatively lower for longer, try to mitigate recession risk, and move along with negative real yields for a sustained period of time. With those thoughts in mind, let’s turn to the upcoming week’s economic agenda. |
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![]() Economic Calendar U.S. |
![]() China |
![]() Eurozone (decreasing importance of events from top – bottom) |
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![]() Food for Thought China Dependence |
![]() Fertilizer Prices |
![]() U.S. 5yr 5yr Forward Breakeven | Markets Still Believe in Transitory |
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Earnings Micron Technology (MU) reporting after the close on Tuesday: * Consensus: EPS est. $1.97; Revenue est. $7.51bn Commentary on the following will be monitored: * The semi inventory cycle and whether double-ordering from customers in the past is set to impact future orders * IoT, datacenters and future chip demand |
![]() BioNTech (BNTX) reporting before the open on Wednesday: * Consensus: EPS est. $8.02; Revenue est. $4.57bn Commentary on the following will be monitored: * Future vaccine demand and how coordination on a country/continent basis is set to look * Waning vaccine efficacy and what an epidemic may look like * China commentary |
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