US macro

Overnight, initial unemployment claims continued to tick higher. It’s a weekly series, so if you wonder why you see a lot of posts on the topic, that’s why.

In the “old days” we could probably look at lower frequency data (once a month) and feel we had a good enough handle on things. Even quarterly GDP was probably good enough.

Now we stare at higher frequency indicators, trying to get a sense of which way the data will break.

It would all appear consistent with a slowing economy, as desired. The Fed still seems likely to hike once more, having decided that the SVB banking crisis wasn’t morphing into something worse.

The Philly Fed business outlook (not shown here) was also below expectations. As such, yields were a touch softer, and commodity prices (oil, iron ore) were weaker. Note, commodities have had a good run pricing the China reopening story, and a pullback as that trade runs out of puff is warranted.

We’ve not thought the China reopening story had legs to begin with, given the problems in property and infrastructure. We are sticking to the idea that China will transition away from investment led growth, and rebalance towards domestic demand, increasing consumption.

One of these days, perhaps!

We continue to see a difficult outlook, one where muddling through is the best bet, but downside risks are real, and as such, we choose to sit somewhat moderately defensive against our SAA weights.

Within defensives, the choice (as always!) is whether you are long or short duration, or long or short credit, and how you combine those two premia.

We think a yield of 4% (and change) has proved “the upper limit” on Aussie and US 10 year government bonds. If they can’t be meaningfully above 4% with an overheated economy and lots of inflation, well, they just aren’t going to get there.

Equally, if we are in a world that has to price the chance of periodic inflation spikes, maybe 2% yields are too low. If we are in a world where the energy transition and working from home somehow (!) bids up the natural rate of interest, perhaps 10s at 2.50-3% is what we should think of as the lower bound.

That’s different to what I thought a year ago, which was 2.25-2.5% as the midpoint, with a bias to undershooting.

So the urge to buy a whole lot of duration at 3.5% is strong. But core inflation has proved sticky, and it could be that short term interest rates have to stay around 5% for much longer than priced to beat it out of the system. In that case 10s could well move to those upper bounds, at least in the short run. That would be unpleasant.

Suppose you didn’t buy the duration and were sitting instead in mostly floating rate investment grade credit. In that case, you might be tempted to sit it out, enjoying your higher yields and counting on spreads not to widen overmuch if the 5% fed funds rate [higher for longer, we mean] does happen. But you’d also be hoping that spreads also don’t widen a lot if the short run rate falls to 2% because a long period of rates at 5% cooked the economy. You’d be foregoing whatever capital gains duration would have given you, experiencing a lower ex-ante return from the lower carry and hoping spread blowouts didn’t eat all your previous gains.

Unclear, is the path forward. Diversify, as always.

Within our direct equity sleeves, we continue to sit fairly defensively, with much less materials, energy and discretionary exposure, than the benchmark (the pointy parts of the market).

We’ve much more health, telecoms, staples and financials (as in the insurance companies) than the benchmark.

If the world turns out fine, we’ll underperform a bit but do fine in absolute space, and if it is wobbly, well, we’ll be glad for the positioning.

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