Darius Dale is the founder and CEO of 42 Macro, an investment research firm that aims to disrupt the financial services industry by democratizing institutional-level macro risk management processes.
Key points to remember
The distribution of likely economic outcomes – and by extension, financial market outcomes – is as flat and wide as it has been in recent years. 42 Macro’s deflation base case predicts an expected return of -10% annualized for bitcoin. Our bullish scenario of deflation plus lower key rates forecasts an expected return of +29% annualized for bitcoin. Our bearish deflation and quantitative easing case calls for an expected return of -37% annualized for bitcoin. Importantly, all three scenarios are equally likely over the next three to six months. If we seemed very confident to issue sell warnings at every bitcoin price low from early December through July, we should seem equally unconvinced today.
The base case
US and global growth continues to slow, although at a more modest pace than in recent quarters. The Fed and other central banks continue to tighten their monetary policy in a procyclical way until the end of the year: a soft landing.
Bayesian Spotlight: The slowdown in the ISM manufacturing index to the lowest level since June 2020 was an afterthought to the decline in the “new orders minus inventories” gap falling to -9. This is the lowest level since December 2008. There have only been eight instances where the spread has reached its current level or worse. The median trough of the ISM manufacturing in such cases is 38.6, which is usually reached a month later on a median basis. The median trough of the ISM manufacturing when the gap reaches +/- 1 point from its current level of -9 is 42.5, which is usually reached three months later on a median basis (n = 4 ). All told, it would be wise for investors to test their portfolio holdings for, at best, an ISM manufacturing statistic low of 40 this fall.
The case of the bull
US inflation momentum continues to decline sharply, likely causing the Fed to pause after a last rate hike in September. The improvement in real incomes leads to the positive inflection of growth: the soft landing.
Bayesian Spotlight: The July Consumer Price Index (CPI) release represented the river map in a trio of data points: July Services ISM PMI, July Employment Report, July CPI, all of which lend credence to the soft landing view. While the downside surprises on headline CPI (0.0% m/m vs. 0.2% estimate) and core CPI (0.3% m/m on the other against 0.5% estimate) were to be celebrated, the bulk of the good news came via the sharp slowdowns in the median CPI (-250 basis points to 6.3% m/m annualized) and sticky CPI (-270 basis points to 5.4% m/m annualized) because these indicators track core personal consumption expenditure (PCE) – the Fed’s preferred inflation gauge – better than the most other CPI time series. If the deceleration in these leading indicators continues unabated and historical correlations persist, we could be looking at annualized month-over-month core PCE rates of around 2% in August or March data. september. These are obviously two very big ifs, especially since we are devoid of historical examples of this kind of non-recessionary inflationary momentum on which to adequately model. Either way, the possibility that the Fed could head into its Nov. 2 meeting with “clear and confirmatory evidence” that inflation is likely to return to its 2% target within a reasonable timeframe is shocking to grab it, but we have to grab it, since the August PCE is released on September 30 and the September PCE is released on October 23.
The bear case
Incipient deceleration in inflation dynamics stalls at levels inconsistent with the Fed’s price stability mandate, prompting Fed tightening through 2023: hard landing.
Bayesian Spotlight: The labor market is overheating at double that of pre-COVID trends. The highly controversial 528,000 month-over-month “non-farm payrolls” figure for July obviously stole the show from a market response perspective. The further acceleration in the three-month annualized growth rates of aggregate payroll (+40 basis points to a three-month high of 3.5%) and private payroll (+30 basis points to a three-month high of 3.7%) is suggestive of a labor economy that is not responding to the policy tightening we have accumulated so far. While the three-month annualized growth rate of private sector average hourly earnings slows slightly (-20 basis points to a two-month low of 5.7%) alongside flat -1.2% growth in average weekly hours in the private sector, it is clear that the +10 basis point rise in aggregate private sector monthly earnings – to a three-month high of 8.3% – was largely due to more workers have found work.
This is a guest post by Darius Dale. The opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc. or Bitcoin Magazine.