Is Inflation About to Derail the Rally?

Andreas Steno Larsen (0:06)

Hey, guys, welcome back to Macro Mondays. I'm Andreas Steno, and it will be me, solo for the next 20 to 30 minutes as my partner in crime, Mikkel, had a, I think it's called a parent-teacher conference today. It's probably the first one for him. So anyway, we'll have a great show today, and I'll provide you with a bit of a sneak peek into my State of the Union speech that will be live for Real Vision members tomorrow. Before we continue, last week, we basically had our two-week Festival of Learning. All the sessions are on Real Vision for free. That's all you have to do is to sign up via the link that hopefully shows up on the screen below. And tomorrow for Real Vision members, my colleague Mikkel will be hosting Rory Johnson at 9 a.m. Eastern to discuss what's happening in oil markets, also within geopolitics and everything related to the energy prizes ahead of the midterms. And at 3 p.m., as already mentioned, I will be hosting the monthly State of the Union speech for pro members today. I'll provide you with a little bit of a sneak peek into that. Before we get to the sneak peek from the State of the Union speech, let's have the laugh of the week. I found this tweet from the European Commission earlier today after I have tweeted quite a few times about what was going on in France, particularly over the weekend, where we had a pretty decent escalation of things down there. And this is a real tweet from, I think it was May earlier this year, where the European Commission basically ridiculed everyone that dared to tweet that France was, quote unquote, on fire. Now France is literally set on fire. We've seen a couple of town halls being set on fire, being put on fire this weekend. And the riots in the streets are whitening, as far as I'm concerned. I've obviously chatted with quite a few people in town. And most parts of Paris are still fairly safe to walk around. But these riots, they're incredibly...

Brian, you need to mute, sorry. They're incredibly white-scaled and they're incredibly violent. So why do I bring up this topic of France? Well, we've seen a material whitening of credit spreads, also in the sovereign bond space. So we've seen a whitening of credit spreads in Europe, not least in France, where France is trading like a distressed credit more or less. And interestingly, France is now trading as a weaker credit than, for example, Greece or some of the countries that we were grown accustomed to see as the weaker credits in the Eurozone. It is obviously related at least partially to what's going on currently with all of these riots. But it's also more fundamentally driven. You know, the European Central Bank is now maybe even midway through a hiking cycle. We've seen a couple of hikes and they're still planning on doing more.

We've obviously seen a lot more focus on the fundamentals now that the hiking cycle is alive and kicking both in the Eurozone, but also in the US and elsewhere.

And it all makes sense. I mean, it's nothing out of the ordinary to see a lot more focus on credit, a lot more focus on budget fundamentals, balance sheet fundamentals when there is a hiking cycle. You tend to neglect such stuff when money is free or when money is easy. And now that we've seen the turning tide, where we've gone from a cutting cycle to a hiking cycle, all of this naturally shows up again. It's nothing out of the ordinary. You see it every single time there's a hiking cycle. Then you start to focus on, you know, what's the weakest link in a credit cycle? Where do we have to focus our fears and so on and so forth. And in Europe, that is currently concentrated around France to some degree fair. I still think France will turn into a fantastic buy once the dust settles here, but I'm not currently super keen on getting involved myself. But in the US, it feels like we're currently more focused on the weakest link in the AI supply chain. Just last week, we had a lot of focus on the credit space of some of the NeoCloud companies, those companies building out AI data centers and renting them out. And when you look at the current market assessment of things, it seems like we're stuck in a narrative or a tape that is incredibly negative again. If you look at page four, you can see that at the close of Friday, we had an extreme fear in the fear and greed index. I think it was at level 18 versus, for example, the October 2022 low of 12 or the March 2020 low of 2 So we're getting there. A lot of fear is embedded in markets. It's not like on an index level that we've seen a massive sell off. I think Nasdaq was down a little less than a handful of percent last week. But if you look at, for example, the hedging activity by put options on page 5, I think we're getting there. On Friday, we had almost 10 million input option volumes. So basically more or less a record in terms of put options. So we have a lot of hedging activity going on right now. A lot of people trying to protect themselves against the downside. And currently, it feels like it's very AI fear driven and paired with the risk of blowups in the credit space due to the rising price of money. But my thesis is that there's at least partially masking the uncertainty that is actually related to what's upcoming in just a few weeks from now, namely the midterms. So if you look at the typical equity and credit market seasonality around midterms on page six, it's actually nothing out of the ordinary to see this kind of price behavior around the midterms. Typically, we tend to bottom in the very late parts of October, ahead of the early November date obviously for the midterms. So in that sense, it kind of rhymes with what we've seen in earlier midterm years. And interestingly, I saw on X, from Ryan Detrick, one of the great statistical wizards on X, that we've never had a down year in the 12th month that followed a midterms election if we had sort of either a hung parliament or sort of a split between a red White House and a blue Congress, for example, or vice versa. So it is actually the preferable outcome from a market perspective when you look 12 months ahead that you have sort of a gridlock on Capitol Hill. And I guess that remains the base case for many ahead of the midterms year. So sure, I mean, there's a lot of fear around AI, but maybe this whole midterms cycle risk is the one that kind of masks everything on top of it. Having said that, I think there is something more fundamental at risk this time around with the AI build out. I mean, we've had plenty of AI scares, but this one seems a little bit more fundamental in its reasoning, given that it's related to the price of money or interest rates plus credit spreads, right? We didn't really have that during the first two or three sell-offs in the AI space. Those sell-offs were a lot more connected to sudden headlines from China or sudden headlines from Anthropic or stuff like that. While this one is a bit more linked to the underlying fundamentals of the whole build out and the debt financing of that build out.