Andy West, PhD Profile picture
Oct 17 15 tweets 8 min read
What the updated US Inflation Model shows will happen from here:

The Fed's primary input into rate decisions continues to be CPI & as we know CPI is a lagging indicator. So what does data show will happen to CPI from here & the implications for rates?

#macro $SPY $QQQ #SPX #CPI
We've updated out HedgQuarters.com US #Inflation model with recent data and the forecasts are critical for the rates outlook and timing.

Chart shows Actual CPI (light blue) vs model (dark blue). Image
As can be seen, the peak is clearly past but #CPI will likely stay high to year end. The model suggests in the vicinity of 7.5% still by end December.

What happens in 2023? Image
In '23, assuming no large oil spike, #CPI already looks like it will fall quickly based on what has happened with rates, oil, food & other econ variables.

Model #inflation falls quickly to ~3% by May '23 & continues below the #Fed's 2% target by Jun/Jul!

Implications for rates?
With CPI high now, theres high probability of two more 75bp hikes. The #Fed could justify continuing with another 25bps if they choose at Feb '23 meeting to a term rate of 4.6-4.8% given the CPI reading in Jan is still likely to be in 6's.

But by the March meet, CPI nowcasts
will likely be showing a read below 5% (based on this model), so theres good reason to suggest that may be it for rates. MoM% readings will likely be flat to -ve at this point.

More importantly, is there a pivot in this chart? Image
If, as the model suggests that #CPI falls to 2% or below by mid '23, and if as is likely its been accompanied by increased unemployment, this starts to point to a Fed cut cycle commencing in Q3 '23 (the June meet is likely too soon).

So why so much "no cut" noise from #Fed?
They have these models too probably showing the same thing after all. But they are running a record number of speeches all saying "5% rates" and no cut through 2023.

This is all aimed at avoiding a repeat of 2021 where they stuffed up and #inflation got out of control...
Here's our model fitted to data only up to Dec '19 (pre COVID - the old world). We've then forecast it forward as if we are standing in April 2021 which was the time CPI really surged (light blue line = actuals). How was this risk missed by #Fed? Image
The dark blue line is the answer to that. By April '21 you could already forecast an #inflation surge to ~5% based on simple assumptions. But they chose to let it run "hot" given past low-flation.

HOWEVER, they underestimated the impacts of COVID supply chain snarls (red arrows) Image
and then got hit by the Russia/Ukraine war impact on energy prices to top it off.

The #Fed made the critical error of assuming the supply chain impacts (proxied by the initial deviation from the model, which cant forecast that dynamic) would pass quickly (see used cars below).. Image
But this seems incredible folly given (1) they had no precedent to determine that & (2) their own model wouldn't have been able to forecast its impact

So the #Fed was already running hot & now blind!

So the decision to wait till Mar '23 to raise will be studied & questioned
for a long time.

The current speech frenzy is designed to front load in markets the rate hikes (before they're even made) and push back pivot bets to ensure CPI falls as their models probably show - not gets overtaken again by re-rising inflation expectations.

No 2nd chance...
So dont take Fed speak at face value. As always its all about expectations management, NOT a real forecast by them.

The HQ Model shows how quickly CPI may fall in 2023 with rate hike expectations alongside it & a rising pivot probability by Q3.

If you found this useful...
I'd appreciate it if you retweet the first tweet of the thread & consider pre-reg for the launch of HedgQuarters.com - the new investment research platform that's being designed to provide you with the resources of an institutional hedge fund thru Process, Team & Tools.

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More from @andycwest

Oct 19
PART 2 of 2 - Bond crash implications for stocks:

Why does the #bonds crash signal further pressure for #stocks?
(& why do rate hikes take so long to show in earnings?)

Here I deal with general corporates, consumer & the banks:
$SPY $QQQ #macro
CORPORATES:

As cost of capital rises, the direct impact on corporate earnings starts small then builds. The direct impact of higher rates on corporate borrowings can be estimated to be only approx -2-3% on EPS extra each year due to termed out debt at past low rates. But
about 20% of debt gets refi’d each yr so this builds to a more material headwind over 12-24 mths.

WORKING CAPITAL EFFECTS

Working capital terms start to get tightened by companies as rates rise. Due to WC debt costs (mainly floating rates), companies are forced to offer
Read 21 tweets
Oct 19
Why does the #bonds crash signal further pressure for #stocks?
(& why do rate hikes take so long to show in earnings?)

High inflation & rate hikes transmit through the economy with a range of 1st to 3rd order effects with varying lags. Lets map those out:

PART 1 of 2 threads: Image
This is complicated to map given various dynamics, sectors & lags, particularly with 280 char limits! But lets give it a go anyway. This is descriptive to help you think through aspects & trades you may not have yet considered

Theres 2 PARTS to this thread due to length
Direct impacts:

When rates are hiked in response to #CPI, theres 2 1st order effects that are fairly contemporaneous. First #bond prices fall as they are the direct inverse of their rate. Higher Fed Funds, higher rates across the curve, lower bond prices
h/t @leadlagreport chart Image
Read 18 tweets
Aug 8
The hidden importance of jobs data for tech stocks & the Fed Put - a 🧵: Many recent investors think that tech (growth) is a safe haven in slow times as tech performs when 10yr yields decline. This is a recent trend & directly related to the Fed Put. See chart & thread. $QQQ 1/7
The chart shows the Nasdaq 100 (white) overlayed with job cut announcements (green) and 10yr yields (orange). Critically, employment is the largest driver of tech spend. When job cuts rise as macro deteriorates, tech spend growth stagnates or falls. 10 yr yields fall as well. 2/7
Pre 2011 (QE ramp), there was a strong relationship between rising job cuts & tech stocks crashing even with lower yields. This changed as the market got drunk on the Fed rushing to rescue with larger & larger QE programs post 2011. See changing direction of white arrows ...3/7
Read 7 tweets
Aug 4
Beware Fed cuts, not hikes & the dreaded ISM Services 52/53 band. An equities timing 🧵: The equities market has front-run the economy driven by a reset in stimulus fueled P/Es but not yet by earnings. What to expect from here? See 2 charts & discussion. 1/5
$QQQ $SPY #SPX #macro Image
Cycle timing: In the '01 and '08 cycles, the real #recession (rising #unemployment) did not start till after the Fed had broken something and stopped hiking. Its at this time we see the ISM services really deteriorate. But in past thats been 19-36 mths after hikes started. 2/5
Do we need to see outright services contraction to be worried? No & Yes. The time to get really worried is when ISM Services hits the 52-53 band. Thats when firings accel - before it gets to 50. But yes, when it hits that level, it often collapses. And thats when the Fed cuts 3/5
Read 6 tweets

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