Oil > Inflation > Rates > Risk Assets - an update on the catalysts in the market

 We have looked at the Fundamental and Behavioral parts of the market in the last couple of weeks. In both cases, the story leans more negatively. However, investments need catalysts. What can happen to change people's minds? This is what I try to look at in this last segment. 

The chart of the day today is one I want to highlight again here. This chart does identify a catalyst but on a longer term time frame. It is important to understand the demographics of the aging society. In addition, with Basel III and Insolvency 2 regulatory changes to banks and insurance after the Great Financial crisis, financial institutions were forced into sovereign assets which had the lowest risk-based capital weighting. This was the financial repression that Rogoff and Reinhart said would happen in their book "This Time is Different". When central banks began aggressive QE into 2020 (recall the economy was weakening) and throughout, there was a powerful squeeze higher in all duration assets. We saw this first in bonds as the amount of negative yielding bonds spiked massively. High growth/low cash equities followed and then cryptocurrencies did too. Since early 2021, this trade is being unwound as central banks remove liquidity:

 

It is important then to understand how this might be affecting the economy near term. Does the removal of liquidity start to have an effect? Consensus expectations are for a global economy that will gradually move back toward trend (but not into recession) this year. So far, the economic surprises are coming in line with those expectations: 

 

Central banks will only change their tune if we see a material shift lower in the data relative to expectations. We are not seeing that right now and so should not expect any meaningful changes. 

How do I know where consensus is? I refer to the BAML Global Fund Manager Survey which is the gold standard of surveys of all investors across the world and asset classes. Here is a look at only a few of those charts. 

Investors see us as late cycle:

 

and are rotating assets accordingly:

 

However, this may be getting to an extreme:

 

 

and interest rates hold the key:

 

and are watching CPI very closely for clues as to Fed policy:

 

and we may be at peak hawkishness as we hit almost 7 rate hikes in the next 12 months a week ago but have started to back off since:

 

 Oil has been a major driver (though not the only driver) of inflation and many wonder how much of a geopolitical risk premium is in the price. Until very recently, the entire move higher in oil could be explained by the lack of supply globally, as ESG factors limit investment in the space, OPEC doesn't have the spare capacity it says anymore, and Russia might just have an incentive to not bring as much online, especially with sanctions a risk:

 

Since December, Brent crude has been moving with Ukrainian news as we can see when comparing to the Euro vs. Ruble cross:

 This is why markets respond so positively when it appears that Russia will engage in negotiations. Oil might hold the key to CPI, which in turn holds the key to central bank policy, the biggest tail risk concern for investors and the most important driver of risk assets and the economic cycle this year. 

At this time, it is difficult to see this category of Catalyst as anything more than a negative. The positive development would be getting past some of these negatives with a non-event. Is the Ukrainian issue is resolved in any way, this can get better. If we get through the Fed meeting in March with only 25 bp and a message that it will be gradual, markets will respond favorably. If the economic data around the world surprises modestly to the upside (not strong enough to bring central banks more aggressively into play, but good enough that recession is taken off the table), markets will respond favorably. 

We are all dependent on headlines now which is why many professional investors are choosing to sit on the sideline and watch. Liquidity is poor as real money managers are positioned and choose to not get caught up in the noise. This means more volatility so be patient when putting on your longer term positions. 

And Stay Vigilant