When Stage 4 - 11.01.23

As Stage 3 continues, the eagerness to prep for Stage 4 builds. Some of these things include longing gold, the dollar, and ultimately bonds. The Compound Landing has been playing out quite well since its introduction in late August. Although the landing framework was officially formalized in August, it’s something we’ve been covering since the Fed lifted rates in ‘22. Those who’ve been following us for the last year and a half already know this, but this is how everything’s summed up so far:

Stage 1 + 2 (Trade of Lost Souls #TOLS)

The trade of lost souls was predicated around the idea that the economy priced things in way too quickly and there was room to “bounce” with sentiment so poor and people positioned so bearishly. The term “lost souls” comes from the idea that many wouldn’t be able to believe what they were about to see, and fight the move all the way through. The TOLS consists of equities going UP, bonds CHOPPING, and the dollar going DOWN. - Aka Stage 1+2 (where the economy doesn’t experience a recession and rate hikes are still yet to be felt). TOLS is what fuels the idea of a “soft landing” becoming a reality, specifically as you pivot through Stage 2 and into 3. Stage 3 is where soft landing euphoria peaks, before cycling through the last quarter of the program (Stage 4).

Stage 3 (Normalization) -Since 8/29/23

Stage 3 is basically the realization that after all of these lags and policy actions (Stages 1 and 2), we’re still not in a recession. It brings life into the idea that just maybe the Fed didn’t actually overtighten and can realistically pull off a “soft landing”. In the process, demand remains resilient as growth holds onto positive territory. What can be expected in Stage 3 is: stronger commodities, the yield curve reverting due to a bear steepener, and the overall economy attempting to normalize because nothing “broke” yet. Because nothing broke, the FOMO grows thinking nothing will break down the road. This simply just adds more fuel to the fire for the final chapter of this story as less and less people can see it coming with even tighter financial conditions in the process.

*The bear steepener reversion is the act of the yield curve attempting to revert by long term rates going up and exceeding short-term rates. The typical reversion is due to what is called a bull steepener where front end rates fall below long-term rates. This is due to an economic slowdown and rate cuts from the Fed.

Stage 4 (The Last Straw) -Pending

The end of the Compound Landing. Stage 4 is where the cards are thrown on the table and things normalize as they should during an economic slowdown. It’s a natural part of the cycle and is known formally as the hard landing/recession. For Stage 4 to run its course a few important things need to happen; until they do, we’re stuck in Stage 3, and the drums of choppiness, confusion, and ultimately capitulation into the “soft landing” beat on.

Here’s what we’re watching for Stage 4 roughly in the order they occur:

The System

The first main signal will be a RISK-OFF regime on the System - we’re already there.

US Dollar (DXY)

The Dollar needs to be in a bullish trend, solidifying a Risk-Off regime - it is already there.

Commodities (DBC)

The commodities index needs to be in a bearish trend - it is currently in a bullish trend.

Breakevens (T5YIE)

5-year breakevens need to be back under 2.0% - it is currently at 2.36%.

Real Yields (US10Y-T10YIE)

10-year real yields need to be in a bearish trend - it is currently in a bullish trend.

Bonds (ZB1!)

Long bonds need to be in a bullish trend - it is currently in a bearish trend.

Unemployment

Unemployment needs to accelerate higher - it is currently flatlining at 3.8%. There isn’t a specific level, it differs through every recession. What matters is the rate of acceleration and continuation of the rise. This is a delayed recession indicator, but adds confirmation to the move. We’ll very likely be positioned for Risk-Off before we see this.

Real GDP Contractions

Real GDP QoQ will print in negative territory OR flatline ever so slightly above 0 chopping around where it's negligible to the upside…aka it’s dead. This is a delayed recession indicator, but adds confirmation to the move. We should be well into the Risk-Off trade by the time we see this.