“Lighten Up On Longs” – Dovish Fed Confirms “Late-Cycle Economy, Close To Recession”

Thursday, January 31, 2019
By Paul Martin

by Mark Orsley, Head of Macro Strategy at PrismFP,
Thu, 01/31/2019

Fed confirming all the economic and market signals that we are in late, late cycle close to “R”

Equities continue to shrug off poor earnings/guidance and breakout from the Trump Megaphone – equities tend not to rally at the end of the cycle

Trade War (TW) resolution can extend the cycle but there are signs that TW has gone on too long – now bleeding into domestic demand

Bias towards end of cycle trades like 5s30sn steepeners and Dollar shorts – use equity breakout to lighten up on longs

I am sure by now you have read enough “Fed was dovish” pieces so will spare you the recap.

For clients that I have had a chance to meet with since I started at Prism a little over a month ago, my thesis has been entirely about the end of the cycle. Readers may recall this list I provided back on Jan 10th as simple evidence:

Late cycle indicators:

Growth moderates (you could argue we are more than moderating, but check)

Credit tightens (for sure have seen that)

Earnings peak and start to decline (yes and being guided down now – see Apple, MSM, Samsung, LG, Delta, Skyworks, Macy’s, Kohl’s, American Airlines, Constellation Brands, Lindt, Goodyear, Ford, Stanley Black & Decker, Intel, and Nvidia for example )

Interest rates rise accelerates (had that in Sept– the decline in rates now is actually a recession indicator)

Confidence peaks (both business and consumer surveys have rolled over)

Inflation rises (also already had that – the recent easing of inflation expectations is another recession indicator)

As you can see from that Econ 101 list of late cycle indictors, every box is checked, and rates and inflation are basically pointing to the dreaded “R” word that nobody wants to talk about or use (so I will only use “R” to keep everyone calm). Yesterday the Fed essentially verified the late cycle possibly entering an “R” by confirming that rate hikes have been shelved and the balance sheet unwind could be slowed. Classic late cycle central bank behavior that typically leads to an “R.”

If you don’t believe that fundamental analysis (not sure how you can argue different and don’t bring up NFP because that is THE most lagging indicator), let’s see what the markets are telling us. After all, clearly the markets are driving Fed policy which drives the economic cycle. The two indicators I have been watching for further confirmation of this late cycle into “R” is (1) the 5s30s curve and (2) the US Dollar. It is therefore not surprising to me that 5s30s steepened a perky 5.5bps and the broad Dollar index depreciated 50bps (vs. EM like ZAR and BRL, the USD was 1% to 2% weaker) yesterday. Both charts speak to a continuation of those moves.

The Rest…HERE

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