European Inflation Is Rising, But Get Out Of Treasury Shorts Says Macro Voices

Headline European Inflation is expected to rise – playing into the hand of US central bankers, who indicated today they are wary of a market bubble – and the US dollar bull run is not expected to have legs, a Macro Voices March 2017 report noted. What’s more, the tightening of financial conditions – the withdrawal of central bank quantitative stimulus – is going to be felt in the near future.

European Inflation

Surprise index is topping and likely to turn negative, might want to reduce Treasury short exposure

Economists were caught off guard in 2014, when the CITI Economic Surprise Index, which is known for its relatively consistent swings, approached the 53 level and then backed off, dropping precipitously. That sharp decline almost matched oil’s fall from the heights above the $100 level to ultimately take out the $30 level in a short period of time – without an equally significant change in fundamental data.

The surprise index has since rebounded, due in no insignificant part to the reflation trade. But now, after “playing catch-up,” the surprise index is set to surprise again and is now “the perfect contrary indicator” pulling up to “a bullish top.”

While economic surprises might be in the near future for markets, Julian Brigden, co-founder of Macro Intelligence 2 Partners, thinks the short treasury trade – playing on rapidly rising interest rates – might be a touch overdone, a tragedy akin to overcooking a prime piece of meat.

The macro analyst had been “aggressively bearish” on US Treasuries, heightened by concern expressed in June. They are now advising investors to exit US fixed income short exposure, pointing to a dip in ISM Manufacturing data.

There is European Inflation, Macro Voices says, with secondary signs of inflation appearing on the horizon

Brigden is not “structurally bullish” on US fixed income, they are “just playing a correction in the trend.” One fundamental reason they are not structural bulls is their modeling points to falling – and this call comes before Trump spends a penny on fiscal stimulus. He is looking to Europe where bond prices have not adjusted to the same levels and growth appears to be on an upward trajectory without any tightening of financial conditions – yet.

Looking at Europe, Colorado-based Brigden thinks that the European Central Bank is underplaying inflationary pressures. ECB President Mario Draghi, for instance, thinks inflation is primarily an oil-based issue, but that doesn’t mesh with the signals Brigden watches. He sees signs of secondary pressures on inflation.

He says demand has allowed firms to raise prices, as average prices charged for goods and services rose at their steepest rate since June of 2011. There is also emerging evidence of rising wage growth and supply chain pressures that is indicating demand is outpacing supply – and when that occurs prices rise.

To chart this, Brigden looks at two relative value measures and compares them against one another. There has been a divergence in the US Ten Year Treasury vs Bunds spreads when compared to the US versus European industrial output models. The correlated measures diverging – what investors are willing to receive in terms of interest off government ten year bonds – relative to what the economic factors that such bonds are typically tied to.

Government bonds and the sovereign currency are often correlated assets and “this in turn has implications” for currency investors. When rate differentials contract the euro should strengthen, he noted – all of which plays into a dollar topping thesis.