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Price Distortions and Signal, Credit Cycle, Consumer, Job Market | Top Things to Watch this Week

Posted: May 22, 2022, 1:29 p.m.

Price Distortions and Signal, Credit Cycle, Consumer, Job Market

"Being right too early is indistinguishable from being wrong." - Howard Marks

Price Distortions and Signal

Markets move in cycles and mean-revert around long-term secular trends. People and machines alike extrapolate macro and micro trends, leading to sharp inflections at turning points. It is that extrapolation of current conditions that led to a 2.5% energy weighting in the S&P 500 while tech stocks were weighted closer to 30%. In a world in which passive flows exacerbate the extrapolative nature of financial assets, the turning points become ever more vicious.

In order to understand where markets are headed, we need to 1.) assess underlying conditions and 2.) evaluate how they are either countered or catalyzed by the reaction function of monetary and fiscal policy makers. In other words: how are economic variables shifting and in what ways are they affected by policy makers and governments at large.

Last week's The Capital Allocation Question Amid Regime Shifts was all about structural supply shifts, not supply chain issues; meaning that economies globally have more likely than not entered a time period in which production becomes more decentralized, labor arbitrage increasingly difficult and redistributive measures to the bottom 50% progressively inflationary. It is not a secret that this mix of conditions requires us to rethink our assumptions as it pertains to how we think about the aforementioned economic, fiscal and monetary variables.

Despite the perception that things are shifting from a monetary driven cycle to one dominated by the themes such as the ones covered in last week's writing, central banks will play a crucial role adjusting policy.

The Credit Cycle

The credit cycle sits at the core of the business cycle, which determines the way people transact and engage in commerce. For the most part, the creation of credit depends on central bank policy and the willingness of banks to extend credit to customers. Up until March 2020, it was atypical for a central bank to establish highly targeted lending facilities where winners and losers get picked by our institutions. While by itself, it may have been a necessary step at the time, more targeted governmental involvement is turning into a trend. Irrespective of targeted intervention, however, we return to credit markets and how they are finally catching up to economic realities. 

For the better part of this drawdown in risk assets, credit markets have remained extremely contained. The assumption that the Fed may pivot early and keep the belief of an imminent Fed Put alive had most investors hesitant to bet against credit. As a result, Chair Powell and his colleagues perceived to have a lot of leeway to tighten financial conditions without disrupting the business cycle to too great of an extent.

However, if past underlying economic conditions made it so that risk assets were mainly driven by the confidence in the very institutions distorting the price of risk assets, price signals are close to non-existent. Thus, the same price signals used to guide monetary policy lack the necessary accuracy to make well-informed decisions. It is at that point at which policy errors occur and ultimately ripple through the economy.

To simplify the complex:
Central Banks globally have distorted the price of risk assets to the point where their own price signals provide wrong confidence in their ability to tighten financial conditions. Years of conditioning market participants to stimulus has led to a one-way trade in risk assets and ultimately led to MMT as yet another theory that's going to pass as wishful thinking. It is at the inflection of the confidence game that the price of assets has to adjust.

Credit Market Barometers
Let's turn to the actual behavior of credit markets and credit spreads in particular. 

Credit spreads have been extremely subdued despite the sell-off in risk assets, sending an initially false signal as to how aggressive the Fed can get before things "break". Again, it is all about confidence.

As the Fed has become incrementally more hawkish, however, credit spreads on the lower end of the spectrum are starting to show signs of stress. While Investment Grade (CDX IG) and Medium Grade Spreads (BAA) are at levels seen during the taper tantrum of 2018, high yield credit is trading near 2015-2016 levels (the economy was on the brink of recession then.) How far will the Fed push the envelope until a pivot is warranted? 

Medium Grade, High Yield and Investment Grade Credit Spreads

Source: Bloomberg

Another indicator to look at in the credit environment is the lack of short interest in high yield products such as HYG (High Yield ETF). While open interest on put options has increased drastically since the peak in 2021, the short interest ratio has only seen an uptick recently. Is it possible to see a permanent bottom in credit when so many continue to rely on a Fed Pivot?

High Yield (HYG) Short Interest Ratio & Total Put Open Interest

Source: Bloomberg

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The Consumer

As the largest contributor to U.S. GDP, the Fed as well as fiscal policy makers will watch the health of the consumer.

Coming off of March 2020, consumers had record savings and enjoyed the positive wealth effect from rallying risk assets. Unlike then, today's dynamics are diametrically opposed: inflation, negative wealth effect and credit getting more expensive.

From the Fed's perspective:

  1. This is desirable to the extent that people are forced back into the labor market, which in turn is going to decrease the job openings/# of people unemployed ratio and put downward pressure on wage inflation; thus, circumventing a worsening of the wage-price spiral.
  2. After having trended below the 2019 trend up until now, services spending is expected to increase while durable goods spending is likely going to settle in. In order to counter similar degrees of inflation in services, the Fed will have to encourage an increase in labor participation and potentially weaken the average household temporarily.
    1. The shift from durable goods to services spending, and the associated shift in price inflation, is going to be a key tool for the Fed mitigating the economic landscape.
  3. A weakening consumer trying to maintain recent living standards is going to lead to an increase in the amount of consumer credit (potentially increasing currently low but increasing delinquency rates, which in turn are going to drive the (un)willingness of banks to extend credit.) 

Consumer Credit and Real Wages | Durable vs. Services Spending | Delinquency Rates

Source: Bloomberg


Job Market

In Job Market, Credit Spreads and Inflation Expectations from May 7, I wrote about the job market as a lagging indicator to underlying economic conditions. Businesses don't lay off until a blip turns into something more serious while employees discouraged to enter the labor market as a result of transfer payments won't return until their own economic reality hits. 

As a result, we've seen extremely low unemployment, subdued jobless claims numbers and wage inflation threatening the Fed with a potential wage-price spiral. If the Fed wants to temporarily avert that increasingly real potential of higher and higher wages on the services side, willingly slowing spending and therefore the business cycle is a feasible option.

Labor Market

Source: Bloomberg

As stated in the introduction of this writing, while there are much larger trends that will impact the lives of everyone in and outside markets, monetary policy will continue to be an important factor in the capital allocation question. Changes rarely occur in absolute terms, but rather on the margin. 

Be sure to check out prior writings of Top Things to Watch:


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Economic Calendar


Data Release Times (E.T.)



Data Release Times (E.T.)



Data Release Times (E.T.)


Food for Thought

Eurozone and UK Data

Source: Bloomberg

Central Europe's economy relies on the assumption of cheap energy and high productivity. Along with a rapidly slowing domestic consumer base, the ECB is facing an utterly challenging task of acting under its price stability mandate.


Manheim Used Vehicle Index (% YoY)

Source: Bloomberg


Drilled But Uncompleted Wells | Rig Count

Source: Bloomberg



Zoom Video (ZM) reporting after the close on Monday:

  • Consensus: EPS est. $0.87; Revenue est. $1.07bn

Commentary on the following will be monitored:

  • Further deceleration in work-from-home as workers return to the office.
  • Indications about post-Covid stickiness of customers ("new normal")


Intuit (INTU) reporting after the close on Tuesday:

  • Consensus: EPS est. $6.70; Revenue est. $5.51bn

 Commentary on the following will be monitored:

  • Small business slowdown as wages increase


NVIDIA (NVDA) reporting after the close on Wednesday:

  • Consensus: EPS est. $1.20; Revenue est. $8.12bn

 Commentary on the following will be monitored:

  • Semiconductor inventory cycle (over vs. under-ordering)
  • Economic slowdown in the western hemisphere while China prepares for reopening

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Futures trading involves a substantial risk of loss and may not be suitable for all investors. Trading advice is based on information taken from trade and statistical services and other sources Blue Line Futures, LLC believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder. Past performance is not necessarily indicative of future results.

Crude Oil Stocks Credit Cycle Labor Market High Yield Eurozone Consumer Sentiment

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