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Treasuries? Not Yet
Welcome to The Observatory. The Observatory is how we at Prometheus monitor the evolution of both the economy and financial markets in real-time. Here are the top developments that stand out to us:
i. Markets are pricing tightening liquidity conditions, showing more risk-off characteristics. Our market regime monitors tell us that markets are pricing tightening liquidity conditions more dominantly than stagflationary nominal growth. Therefore Treasuries are receiving some support here. We show the recent performance of major asset classes below:
Treasuries are caught between opposing forces, with the flight to quality during a growth scare and the repricing of unexpectedly high inflation weighing on fixed income cash flows. We show our market monitors, which show the dominance of tightening liquidity conditions in market pricing:
However, our fundamental systems point to stagflation in the real economy; therefore, our bias remains towards the dollar relative to treasuries for the time being. Our systematic analog finder, which uses information on growth, inflation, liquidity, and market dynamics to find analogous periods in time, supports this bias. Equities typically do very poorly during periods like today, while the dollar outperforms:
ii. Industrial production continues to stay elevated, but fuel for expansion is running out. Capacity utilization rates have run up extremely quickly, thereby creating less room for industrial production to rise further. From a secular perspective, there may be significant room for increased capacity utilization. However, we think the speed of the current ramp-up in capacity utilization will likely be a limiting factor to sustained industrial production growth. When we look under the hood of the extremely high levels of production we are seeing today; these moves are mostly coming from areas tied to energy:
Industrial production is trying to meet the nominal demand for energy, business transport, and energy drilling & manufacturing, but there remain limits to how much output can be increased. This elevated pace of capacity utilization uptake has not been enough to offset inflationary pressures and is unlikely to be over the remainder of the year. The most likely channel of taming inflation will be curtailed demand, which bodes ill for pro-cyclical assets like stocks. We will touch on these mechanics in our Week Ahead note.
iii. The dollar continues to show trend strength and is well-supported by tightening liquidity conditions. We show our return/risk gauge monitors, which take into account momentum, regime dynamics, volatility, and correlation:
As we can see above, the dollar shows the most robust characteristics on the long and short sides. We take this as a strong sign of the times. Eventually, we expect tightening liquidity dynamics to find their way into the yield curve, i.e., the long-end will eventually rally; however, we remain a ways off from this point.
Our systems are biased towards regime identification and exploiting the current regime opportunities. Said differently, we’d rather miss the start of a new regime than bet against an existing one. Our systems remain positioned for stagflation and tightening liquidity; we show our Alpha Strategy positioning at the asset class level below: