A COMING GLOBAL SHIFT ACROSS INFLATION SENSITIVE ASSETS

Gordon T Long

Global Macro Research | Macro-Technical Analysis

TIPPING POINTS

RISING INFLATION

A COMING GLOBAL SHIFT ACROSS INFLATION SENSITIVE ASSETS

LONGWave - 04-07-21 - APRIL - Covid-19 Triggered Inflation

We have been arguing that though Inflation pressures are clearly with us, many of the underlying drivers are associated with bottlenecks in the ‘just-in-time’ (no inventory) global supply chains restarting from Covid-19 lock-downs. Though these transitory factors will begin to moderate in late Q2 and Q3 2021, Y-o-Y comparisons from the extreme lows during the initial Covid lock-downs will dramatically distort increases in actual ongoing rates of inflation. The shock of Inflation is not over but will nevertheless moderate in Q4 at around ~2.2-2.4% as concerns with Disinflation takeover. We want to explain this shift will mean across assets so you can prepare your investment thesis early.

We were able to warn of Inflation and the potential for exploding commodity prices last year (see our video archives) because of our focus on the drivers of Real Rates. One of the most important macro analytic drivers of Real Rates since the 2008 Financial Crisis has been the Chinese Credit Impulse. It is now signaling an important shift is coming in Q4 2021.

THE CHINESE CREDIT IMPULSE CORRELATION

Not to repeat what we have outlined many times previously, need we need to briefly revisit what the Chinese Credit Impulse has been telling us for a year now.

The 10Y UST Treasury Real Rate (for both the 10Y Note and 30Y Bond) track the Chinese Credit Impulse with a 12 month lag. As the charts to the right illustrate the Chinese Credit Impulse aggressively turned up in late Q1 of 2020 when Covid-19 took control of the global economy. At that time China aggressively flooded its domestic economy with liquidity via available bank credit as the world went into Covid-19 lock-downs and global demand quite literally seized up.

Based on the 12 month lag it was expected that this liquidity would filter through the global markets into increased Real Rates in Q1 of this year. This is exactly what we warned of and what subsequently occurred.

However, since last fall China has been significantly tightening its’ domestic credit!

2021 VERSUS 2022 CORRELATION

To the right we see the rollover in the Chinese Credit Impulse continuing as we entered into Q2 of 2021.

This suggests we will soon see significant reductions in Real Rates with Disinflation occurring in Q4 of this year with US Treasury Yields potentially falling precipitously. This is premised of course on the decade long correlation continuing to hold.

MATASII DISINFLATION ARGUMENTS

This correlation shift in fact supports our separate analysis which indicates significant disinflation potential is presently being baked into the pipeline:

Tax Increases Are Disinflationary
A “Popped Equity Bubble” is Disinflationary
Weak Economic Growth (via Debt Overhang & Demographics) is Disinflationary
Covid related business failures is Disinflationary,
Accelerated Technology Advancement (i: Machines for People, ii: Communications Without Travel, iii: Work Without Offices) is Disinflationary,
Supply Chain Restoration (after the shortage surge) will be Disinflationary,
Rising Productivity will hold down labor costs and be Disinflationary,
Low Inflation follows Recessions by ~ 15 months (End of Q3 2021) which is Disinflationary.

THE CHINESE CREDIT IMPULSE AND INFLATION SENSITIVE ASSETS

As Tyler Durden recently outlined:

“the credit impulse first reaches assets that are driven primarily by the Chinese economy (Chinese bond yields and industrial metals). Next to be impacted are inflation break-evens and sovereign yields in Western economies. The peak correlation for other growth-sensitive assets such as euro-zone banks and AUD/JPY arrives with bigger lag of around 4-5 quarters. This result, while logical, is quite significant, as it gives us a playbook for the ebb and flow in Chinese credit impulse.

The table above shows the correlation between different assets and Chinese credit impulse for varying lag times. The extent of the differences between lags in correlations is exemplified in the left-hand chart below. While peak correlation for Chinese interest rate swaps arrives with an eight-month lag, the peak correlation for euro-zone banks manifests itself with a lag of 14 months (read more here “In Historic Reversal, China’s Credit Impulse Just Peaked: What This Means For Global Markets“).

Looking ahead, with high correlations and short lag times, Chinese interest rate swaps and industrial metals should be the first assets to be adversely impacted by the topping of the Chinese credit impulse. Australian house prices and US 5Y forward 5Y inflation will likely also be hit in this first group.

The mining and industrial sectors also have short lag times, but their correlation is slightly lower. The other highly correlated group of assets, including euro-zone banks, also gets strongly affected by credit impulse, but the rather large lag time opens the door for other factors to influence the price action of these assets as well.

Low correlation with certain assets suggests that Chinese credit, while being one of the drivers, may not be the main driver of price performance for these assets (e.g. semis/software ratio, sovereign yields in the West and value/quality ratio).

In the chart below, SocGen provides a critical estimated timeline of the peak Y/Y performance for each of the assets it sees as impacted by China’s credit impulse slowdown. While these assets are influenced by multiple factors and therefore could easily diverge from expectations, the chart below does present a neat output from a lagged regression analysis and is a useful guideline for the balance of this year and next.”

CONCLUSIONS

Current MATASII expectations are:

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