I hereby present the Maradona theory of interest rates from Mervyn King (credit to my friend Mario Baronci):
Last week, the Fed announced various nominees for the task forces Warsh has set up. Former BoE chief Mervyn King was chosen to lead the new ‘’communications task force’’.
Back when he was at the helm of the BoE, King proposed the Maradona approach to Central Bank communication: pretend to go right (be hawkish), pretend to go left (be dovish), and in the end get to your final objective without really moving much.
And given the output of the macro models I use to look at US growth, labor market, and inflation, the Maradona approach to interest rates could be the best fit.
What if Warsh says something hawkish now, something dovish later, and in the end, Fed Funds just stay where they are for a while longer?
Consider the two charts below:
The top chart shows how US real consumer spending (blue) is running below its 10-year average, and US companies are not hiring workers in cyclical industries at a rapid pace (orange). The hiring plans for the foreseeable future are also pretty weak (black).
The bottom chart is a valuable, real-time proxy for nominal income growth coming from labor – US withheld income taxes are growing just in line with the last 10 years.
The two engines of core US growth – the labor market and consumer spending – are far from being hot.
And when that’s the case, the odds of sticky inflationary pressures are also much lower:
The left chart shows how US core goods inflationary pressures have risen in line with our PCA-based prediction model – no major inflationary impulse left in the tank there, especially as the has stopped depreciating against major trade partners and hence imported core goods prices are set to slow down a bit.
The right chart shows how Zillow and the Cleveland NTRR tend to anticipate changes in Shelter CPI.
I didn’t even bother to fit a lead/lag timeline there as it’s quite obvious that official housing CPI in the US lags real-time rent measures due to the statistical methodology used to calculate shelter CPI.
And if anything, there should be some mild disinflationary pressures in the US housing market.
This leaves us with the following:
– The core engines of US real growth running at trend levels (~2% real annualized);
– A far from hot US labor market
– Real-time indicators of wage growth and nominal labor income growth being disinflationary;
– No major inflationary pressures in the pipeline;
– Pretty much Goldilocks!
In the meantime, the option-implied distribution for Fed Funds in 12 months from now looks like this:
The median expectation remains for 2-3 , but the biggest mispricing against the macro environment I just described sits in the hawkish tail of this distribution.
The market is pricing in a ~35% probability for 4+ hikes over the next 12 months. I think that’s wrong.
So, how to position for a world in which macro data justifies the Maradona theory of interest rates?
The most aggressive and convex approach would be to buy precious metals here.
The chart on shows my Euphoria/Greed index for Silver – it’s the average percentile for the call/put skew, RSI and the distance from the 50-day moving average.
If one systematically buys or sells the underlying asset when the index is above 90 or below 10, the 6-month forward returns are pretty solid and have a high win rate.
Buying or silver here seems to be a positive expected value idea if your time horizons are long enough.
But it also requires the Fed Fund distribution at page 4 to materially change – not only the very hawkish 4+ hikes tail doesn’t need to materialize, but to unlock convexity in this trade, the Fed should remain on hold.
If you instead want to solely focus on fading the 4+ hikes hawkish tail, the best trades to do that remain EM FX and equity longs:
1) If the Fed ends up hiking once or twice over the next 12 months, there won’t be any macro surprises, and interest rate differentials would still largely favor BRL, COP, ZAR, MXN, etc;
2) 1-2 hikes in the face of US nominal growth at 5%+ are irrelevant for equities as they don’t materially affect financial conditions – no macro surprises unfold, so long as equities are in a world of steady growth.
The Maradona theory of interest rates is likely to materialize.
Perhaps in its full format (Fed on hold), or maybe Maradona-Warsh will actually move a tiny bit to the right (hike once or twice).
But in the grand scheme of things, the market seems to be pricing fat macro tails that are unlikely to occur.
This was it for today. As always, remain hungry for macro and humble in markets.
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