The Most Important Chart for 2024

What the Fed's dovish decision has to do with it, and why I favor commodities now as a result

In my last post “The Playbook” I stated that with an election year coming up and the societal fear of unemployment still greater than that of inflation, both the Fed and the Treasury would likely be supportive of asset markets in 2024. I further stated my expectation that the Fed would use last night’s FOMC to be hawkish one last time, as with high stock prices and near-record low unemployment there was little to lose in doing so, while being dovish too early would create unwarranted inflation risks, however high one deems them to be

The Fed clearly saw things differently and did nothing to push against the markets’ recent easing of financial conditions, which has been the most significant in years. Now, if you give the market a hand it will take a whole arm, and subsequently bond yields melted down, and will likely continue to do so for some time as trillions of dollars parked in T-Bills and Money Market Funds look for a new home to get ahead of a Fed that is now clearly perceived as dovish and in cutting mode

While I had spelled out the economic growth risks in last week’s post, and my sense that they were contained for now as the industrial cycle turns up and the all important US residential housing sector improves. The Fed’s stance likely poured rocket fuel on these dynamics, which brings me to the most important chart for 2024

So what is it? 2024’s most important chart plots the US headline CPI against the NY Fed Supply Chain index, which historically anticipated rising inflation with a 5-months lag

The NY Fed index measures the state of the global supply using with a broad host of inputs, from shipping rates to delivery times or certain PMI measures. Plotted against the CPI with said lag, it portrays an obvious relationship: as the supply chain for goods clogs up on high demand (or insufficient supply), higher prices follow. This eventually includes higher prices for everything including services, most of which require some form of related input, such as energy or staff costs

As we can see, the NY Fed index has already tightened from previously very loose levels. This is no surprise - across the global supply chain orders have been cut and capacity taken out in response to collapsed goods demand following the Covid-19 sugar-rush high

Yet, the FOMC’s policy pivot is highly likely to stimulate demand across the goods economy, right at a time when inventories have been destocked to once again lean levels. A key role falls to the US housing sector. New single family home supply is historically tight after a decade of underinvestment, and house prices increased this year in spite of an 8% mortgage rate (!). The demand is there. This sector will be on fire in 2024 as long-term bond yields fall, and mortgage spreads compress. And every new home needs a new fridge, washing machine or garden hose - in other words “stuff” produced by the global supply chain

More so, as Joseph Wang articulates well in his latest piece, lending conditions (charge-offs, defaults etc) remain benign, so lower rates should quickly lead to higher credit demand. This creates more new money creation, and production as well as services are unlikely to expand quickly enough to match it

With all that in mind, it seems highly likely to me that the Fed’s missed chance to hold the market back one last time will see the NY Fed Supply Chain index rise substantially further in the coming months, with inflation likely to follow

Is this certain? Absolutely not. The economy is an agglomeration of countless reflexive feedback loops, and many things can happen. These are the three main pushbacks to my view

• First, the pandemic messed up a lot of historic relationships. The current NY index rebound may simply be a normalisation into the pre-2020 period with the whiplash to the up- and downside now complete. Historic precedent of inflationary supply chain whiplashes makes me doubt that, but I can’t rule it out

• Second, a recession is around the corner due to the long and variable lags of monetary policy that are now starting to bite. This is possible, but anyone favoring this view would need to explain where it would originate from? With housing likely improving significantly next year, that crucial “swing sector” is unlikely to be the culprit, and the spending of the top 60% Americans who account for 80% consumption is highly correlated to asset prices which are at record highs

• Third, the primary driver of inflation is the cost of energy, which is behind every economic activity, from driving a car to keeping the lights on in a barber shop. The best proxy for this is the cost of gasoline, which tracks the CPI very closely

• Gasoline in turn is a proxy of the oil price, and there are some arguments that it will remain low going forward. US shale production has expanded, and the three supply cuts OPEC performed could be unwound should the oil price rise

Source: Axios

• But we need to keep in mind that oil is a financial asset after all, with its price derived from the view of millions of market participants in a reflexive way. Right now, the market is currently incredibly bearish on it as speculator positioning shows, while the industrial cycle is climbing out of its lows and 40% of oil demand comes from the goods economy. The market’s perception of oil can change quickly as demand improves with higher industrial production, and shorts would be forced to cover aggressively

With regards to the industrial cycle, we clearly see the upturn in the ISM New Orders/Inventory ratio (or you can just look at a share price chart of the DAX…)

Into this context, I find it likely that the wall of money now rolling over global financial markets finds its way also in this sector - global commodities, which have sold off heavily on recession fears

This is how the circle closes, and where the next round of inflation could come from, which I believe may not be so far off

Conclusion:

• The Fed opened the liquidity flood gates

• This is fuel on the flames of a reviving industrial cycles, and it will set the crucial US housing sector properly on fire

• A resurgence of inflation a few quarters out seems likely, even though some risks remain to this view, in particular the evolution of the gasoline price

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What does this mean for markets?

The following section is for professional investors only. It reflects my own views in a strictly personal capacity and is shared with other likeminded investors for the exchange of views and informational purposes only. Please see the disclaimer at the bottom for more details and always note, I may be entirely wrong and/or may change my mind at any time. This is not investment advice, please do your own due diligence

Following the FOMC, I amended the positions laid out in my last post as follows:

• I closed the gold short with a small gain. Positioning is still very heavy in this one as many buyers used it to protect against an escalating Middle East war or a looming recession, so I still don’t love it as a risk-on expression. The competition from TIPS is still significant and I encourage anyone with a flavor for gold to explore that alternative

• I bought mining equities as well as copper futures (see commodity logic above)

• I kept my oil exposure that I switched to from oil majors earlier in the day. Oil had sold off on heavy volume just before in what appeared stop-runs from wrong sided investors, so it looks like a good risk/reward entry point

In total, a fair share of my book is now in commodities, with little else. I see them as key beneficiary at the nexus of early cycle and inflation protection. They should win in several scenarios bar the hard landing, for which there is just no sign in any of the market internals (see last post) or for that matter anywhere else but in economic theory (or the UK…). Should it come, I think there should still be some time to adjust these positions

Higher commodity prices are the key risk for equities more broadly. This is why I feel they offer possibly the best risk/reward to play the risk-on nature of the Fed’s decision, instead of just buying the S&P 500. Keep in mind, Large Cap Technology ETF inflows were the highest in 5 years earlier this week, the opposite of when no one wanted them 40% lower at the beginning of the year. I will wait with exposure to other equity sectors until the dust has settled

Thank you for reading my work, it makes my day. It is free, so if you find it useful, please share it!

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