Eric Townsend and Patrick Ceresna, the people behind the weekly Macro Voices podcast, have released an extended, hour-long interview with Julian Brigden founder of Macro Intelligence 2 Partners, in which among the various topics discussed (see the attached slidepack for supporting materials and charts) were:
- U.S. Dollar impact on the U.S. shale bubble
- Peak acceleration in ISM manufacturing
- Headline inflation peaking
- Fed tightening going to start to impact data
- Bond shorting opportunity is over
- Risks to the reflationary trades
- Wage trends in the U.S.
- Perspective on European growth and inflation
- Relative pricing between U.S. and European bunds
Brigden, who until recently was aggressively bearish Treasuries since June, is now confident that the "time to be out of US fixed income shorts for now." The reason for that is that he anticipates the recent surge higher in economic indicators (all of them of the survey, or "soft" kind), is now rolling over, and it "doesn't get any better."
Furthermore, adding to the downward pressure will be the upcoming inflation peak, as the energy base effect will in several months start to exert a downward influence, the same way it boosted inflation in the late part of 2016 and early 2017.
Furthermore, the ongoing tightening of financial conditions via higher interest rates across everything from Libor to mortgages, will start to impact the data.
Making matters worse, all of this will take place as expectations are near their highs, and all this puts the recent reflationary trades at risk.
And while Brigden says that he is not changing his overall secular outlook on the US economy - the upcoming deflationary wave is merely a temporary blip until wage growth catches up - he is shifting his investing decisions and attention to Europe, where he believes growth is set to accelerate as there has been no tightening of financial conditions yet as the ECB's QE train continues to chug along, and where after a lag, European inflation is expected to more higher (we are not so confident, especially now that the base effect just lead to a big disappointment in the latest European CPI print just yesterday).
In any case, if Brigden is right and the next inflationary wave hits Europe as the US is deflating, however briefly, it would have major implications for both relative bond pricing (10Y TSYs vs 10Y Bunds and US vs Eurozone output), as well as FX: USD vs EUR.
Some notable quotes from Brigden:
- Obviously, we've all seen it in energy prices and how oil prices are percolating through into inflation. But I think what's also not quite as well understood is how that also manifest itself via that same sort of essentially base effect into the economic data, the growth data.
- When we typically look at growth data we very rarely look at the level of growth. What we typically discuss is the speed or the acceleration of growth and by that, I mean, month on month, quarter on quarter, year on year
- So, to a large extent what we've seen is that in terms of some of these PMI data and that's what we were playing all of last year and what we said in December, we will come to a point where this thing will just naturally run its course. It just doesn't get any faster.
- The model suggesting that maybe we can punch out one further higher number which I think comes out next week in May, we can clip at 60 on ISM manufacturing
- you're already starting to get some signs of disappointment in some of these PMI. So, if you look at say the Dallas Fed survey which came out I think last week the previous number had been 24.5. It was supposed to come in at 22 and it came in at 16.9 and all of this makes us believe that we are approaching not only this sort of cyclical high in terms of the inflation story which we'll talk about in a second but also the cyclical high in terms of the speed of the growth story.
- That has important ramifications I think for markets. it's not super bearish. We're not trying to say that we think the U.S. is going back into recession. We just think that the data is going to start to essentially disappoint.
- we're going to settle on I think into a much more normal level of inflation. Essentially the same sort of level of inflation that we saw prior to oil's drop and now for central banks that's going to create bigger problems but that comes. Initially we’re going to get peak, initially we’re definitively going to get that peak.
However the most interesting part of the entire interview is Brigden's take on the so-called "Armageddon scenario", or rather what he calls the "endgame for markets", which as he correctly points out is not in the context of a deflationary episode - after all central banks can always paradrop money, political considerations notwithstanding, but when inflation is running hot. Below is the key excerpt:
Erik: Let me just ask a question there because we've had quite a few guests express a view that Europe is in really serious trouble of course the Brexit article 50 trigger occurred this week a lot of guests have said that they think it's the beginning of the end. That soon several other countries will exit Europe. The economy will fall apart. They're in big trouble. Obviously, you're expecting European growth to accelerate. So, does that imply a different view about European exit risk contagion or how do you see this?
Julian: Structurally no. One of the things that I often disagree with friends and peers of mine is whenever you get weak data, you have a lot of people that sort of run around and say oh my goodness look ISM is going to drop below 46. The whole experiment has failed. The world is going to blow up. The equity market is going to implode. My base case is always been that you don't get to the Armageddon scenario with weak data. You actually get to the Armageddon scenario when you actually get strong data. Because in weak data – the ISM dropping to 46, European growth failing to materialize, inflation sitting on the lows of 2014, 2015 – you can get vast swathes of accommodative central bank policy.
They can print, they can do all the other distortive measurements and steps that they've taken and they can essentially inflate the market. They can do what the Japanese are doing they can buy equities they can do whatever they want to Erik that's never the end game. You can get a wobble in that scenario but it's not the end game. The end game for markets, the most dangerous toxic scenario for markets, comes when you've got vastly inflated prices and central banks actually need to hike.
So, imagine a scenario later this year where they say look, obviously the French election could be a heart attack, but let's say we have continued deterioration in Italian economy which is our base case but everywhere else in Europe is booming and inflation pressures are coming through and the ECB whether Draghi likes it or not, he's facing a full revolt with everyone in Northern Europe including the French because the French economy looks to us like it's absolutely barring as I said Marie Le Pen about to explode in terms of growth and Europe’s second largest economy growing will have a material, material impact.
But let's say for instance that that's what happens Draghi's actually forced to hike. In a bizarre way because he's created such a bubble in the bond market as that thing blows he's actually going to be responsible for sinking Italy because if the equity markets go south as that bond market blows, he can’t come in with more QE because he has ingrained inflation and they have a singular mandate. So, the end game doesn't occur by weakness it actually occurs by strength.
All this and much more in the full, free, hour-long interview below.
And the associated slide deck below: