Inflation vs disinflation is the hottest topic in the macro-space when moving into 2021.  Now, we are in the middle of 2021 and the debate has shifted to transitory inflation vs long term inflation. It is amazing to see how fast narratives can change in the macro world.  There are multiple arguments from both sides. In my opinion, regardless of being transitory or long term, what matters for an investor is to understand—where are we in the cycle, what risks are ahead of us, and how to construct portfolios to navigate the markets.

In this article, I want to share my 10000-foot overview of the economy, and my macro-playbook for 2021 and beyond.

What happened since March 2020?

More stimulus, pressure on the dollar and reflation

Let recall where were we prior the covid crisis. US economy was in a deflationary environment. FED was cutting down interest rates , while in the meantime, nominal yields  and inflation expectations were falling rapidly since early 2019.

Real rates dipped sharply which helped gold prices to soar up even prior to the COVID-19 pandemic.  Then, COVID-19 became a catalyst for this massive deflationary shock causing real rates to go to an extreme negative territory.

Historically foreigners were the biggest buyers of US treasuries.  However, during the Covid pandemic,  we saw a massive amount of US treasury sell-off by foreigners (~1 Trillion) to cover their liquidity requirements.

After March 2020 market meltdown, FED announced unlimited QE which led to massive M2  growth and expanded its balance sheet to a new level.  Nevertheless,  tech is the only sector that benefitted during the Covid-19 lockdown. Hence,  we saw capital flow back to US equities, as the US has the biggest tech sector in the world and this helped to offset the pressure on the dollar even in the absence of foreign treasury buyers.

Then,  vaccine roll-out in the US  resulted in re-opening trade and capital started to rotate from tech to value and inflation beneficiaries. Investor consensus during the second half of 2020 was that a massive amount of QE   will eventually create inflation. The pent up demand and supply shortages are two other factors that further supported this consensus resulting in an reflationary pressure that caused an aggressive sell-off of bonds (long end of the curve), the rise of real yield. These events pushed gold sell-off, and investors were risk on again. As yields went higher, stocks with high P/E multiples ( which happened to be tech) started to underperform compared to the stocks with low P/E multiples (value/cyclical stocks-energy, materials and financials).

The sheer amount of QE put a lot of pressure on the dollar and many expected the dollar to weaken paving the way for the emerging markets to outperform. However, the dollar is still remains range-bound since 2015, because all major central banks are doing QE, even though it’s at a critical juncture. In addition, DXY is not the best vehicle to compare the dollar as it is a EURO weighted basket, however it is a decent proxy to understand dollar flows at the margin.

Passing the baton from Monetary to Fiscal Authorities

At end of 2020, we saw that FED was urging for support from Fiscal authorities to help with the economy as they moved into AIT (average inflation targetting- 2%) regime. Another reason for high inflation expectation and rotation from growth to value was, significant increment of treasury TGA  and Biden’s fiscal spending plans becoming a market catalyst for commodities and value stocks.

In addition, we saw direct stimulus packages to the unemployed citizens (which will extend until September 2021) which became a massive catalyst for the growth in consumer spending. In a recent  CNBC interview, Stanley Druckenmiller mentioned that FED is “playing with fire”.  According to him, this loose fiscal and loose monetary is the worst combination that he saw in his career, and FED is overdoing it – the speed of the retail sales growth and reduction of the unemployment rate is staggering. Furthermore, he argues that with the competitive pressure from China,  FED’s actions impose tremendous pressure on the dollar and he believes that the US might lose its reserve status in the next 15 years. 

Where are we now

Business Cycle

From the business cycle perspective, we are gently moving into the recovery phase from the covid recession. Looking at the high yield spreads and the yield curve (10yr-2yr), I do not see any sign of a double-dip recession in the near future. However, there are plenty of market risks out there if FED starts to react to inflation.

Inflation, QE tapering and rates hike?

The current debt level and excess liquidity in the system is still a major concern going forward. Also, securities held by the FED is still in an uptrend.

Recent CPI prints suggest that 2% AIT is an underestimation by the FED. I won’t be surprised if we see high year over year (averaged monthly) CPI numbers in the next quarter as well.  corporate Nordea has an interesting article ( Week ahead: A 3 bps inflation scare! WOW, JUST WOW) on the topic and they believe the inflation is not transitory.

In my opinion, for persistent inflation to happen, there has to be a global event or a mega-catalyst. Historically,  when we were coming out of World War II where every government had to spend a huge amount of money on the infrastructure which was massively inflationary.  I think the ESG theme will be able to provide a similar type of catalyst for governments to spend on infrastructure to support various renewables and green energy projects.

As I mentioned earlier, we can not rule out the FEDs reaction to inflationary pressure and rising real rates. I think the rate of change is the key here. Recent reverse Repo operations (opposite to what we have seen during late 2019) suggest that FED is paying some attention to the excess bank reserves.

Furthermore, in April FOMC signalled that QE tapering is on the table for discussion. This is usually negative for risk-on assets (2013-2014 taper tantrum) in general. If the market wobbles again,  we know what will be the reaction.. more QE.

Moreover, the annual Jackson Hole conference is happening on Aug 2021, this is a platform used by central bankers to signal changes in the monetary policy.  There is already a  large  Eurodollar (priced off three-month Libor ) option bets put on by traders anticipating quick rate hikes (slightly lower than 0.25), which will expire one month after Jackson Hole.  The positions are now the third-largest of any Eurodollar options.

Another argument to consider is the taper tantrum in 2013-2014 that was due to a lack of communication from the FED.  Now, the general consensus is that this time they will communicate it clearly. FED is aware that massaging is important to set the correct sentiment in the market.  I  think that FED is in a dilemma that if inflations are really transitory, reacting fast will put the economy under pressure pre-maturely. Moreover, I believe that  FED is politicized and no longer acting as an independent entity. It seems to me that FED is trying to be accommodative to Biden’s fiscal policies because it’s important for his mid-term election in 2022.

My base case is that FED will proceed gradually and cautiously. If they want to go with a taper, then it will be by end of the year or early next year. They already announced that they will sell some of the cooperate bonds and mortgage securities they bought during QE. Moreover, the chances of yield curve control are higher to backstop real rates rise (long end of the curve).  Interest rates hike will be the last option if inflation starts to run red hot.  Furthermore, the interest rate hike will be delayed until  2023. These topics are on the FED’s table for the second half of the year, hence the uncertainty is real. Markets are always forward-looking. The question is “how fast markets will react to FED’s massaging?”

FED is trapped

In a nutshell, What the FED ideally wants is, to see 10 year yields between 1.5% & 2% and AIT at 2%. So, there won’t be any wobbles in the market until they get down to their desired unemployment target while keeping the dollar at a stable range. This will facilitate them to keep the bond market stable and support the equity market hence the labour market. Meanwhile, they want fiscal authorities to take the charge of stimulating the GDP for the US to come out of the current debt load.

Apart from monitoring economic data, FED pays closer attention to three things on the Market side-  Bond Market, Interest rates and the Equity Market.   FED want to manage all these things properly. But I think FED is in a situation where saving one has to sacrifice another.

  1. Bond Market – Loose fiscal and monetary policy is an ideal combination for inflation; As it will come at a risk of the rapid rise of real yields, inflation, and missing AIT of 2% significantly. This will put pressure on the US Dollar and equity markets (the US equity market is dominated by tech).  The much weaker dollar is what we need for globally synchronized reflation. But, does the US wants to risk its reserve status?
  2. Interest Rate – If the FED hikes interest rates to manage inflation, the equity market may wobble because of the larger amount of debt in the system. Speed of the rates hike is the key; but debt in the system has no signs of slowing down and structural disinflationary forces are still intact (velocity of money is collapsing and ageing demographics). Does FED want to put the US coperations under preasure? Actually, they can do that and let markets figure themselves out. But,  if equity markets wobble then it will spill into the labour market as well.
  3. Equity Market – Eventhough FED does not show any interest on the Equity Market, Fed wants to keep an eye on it because it is tied to US labour market. Moreover, tighter monetory and loose fiscal is good for the dollar, hence the US stock market in general. But the  FED is in a situation that they can not run tighter monetary policy for too long. On the flip side, loose fiscal and loose monetary will weaken the dollar. That is not good for the US overvalued growth stocks, but good for cyclical and international stocks.

There are a lot of interlinked moving parts and uncertainties as we move into the second half of 2021. Personally, i don’t think FED is trying to solve anything by being proactive rather trying to manage the situation.  From there I will formulate my base case.

My Base Case

  • I believe loose monetary and loose fiscal policies will continue into 2022.   I think tightening by the FED will be a gradual process (already see some early signs of it) in order to accommodate the fiscal policy. If they want to start QE tapering aggressively, it will be by end of 2021. If there is any rates hike, it will be in 2023 or 2024. However, markets are looking into the future and FED’s messaging is important.  In addition, considering how far we came out in the yields and seasonality factor (August to September), reducing some risk in the second half of the year seems logical to me.
  • Therefore, in the medium-term (2021 second half to 2022), I am a bit uncertain. I am not expecting a market crash, but a decline due to the reflation theme (consensus view) gets shaken out.
  • The decline of the long end of the curve might favour growth over value in the medium term. Risk/reward-wise, gold & crypto looks  attractive to me if the real rate continues to fall more, and it’s also a fiat debasement beneficiary.
  • Long term – Overall, I am bearish on the dollar. I am bearish on US exceptionalism and bullish on global synchronized growth. Global exposure makes much more sense to me. Biden’s 6 Trillion budget plan is anecdotal evidence of what is about to happen in the next 3 year. When I take a step back and look into the big picture, the structure of the economy has changed a lot since covid-19. Recency biased view thinks that tech will continue to do well in the next decade as well. Sure, there will be some pockets of opportunities in tech, but my macro view supports global value.  I think they will outperform tech in the next 3 – 5 years.
  • The most important secular trend in the 2020 decade will be ESG and emphasis will be more on “E”.  This will be a ‘megatrend’.

My Macro Playbook

As a Macro trend follower, my portfolio trades are arranged into a  6 areas- Commodity Trend, Equity, Fiat Alternatives, Alternative investments, Long vol, and Bonds/Cash Secured Puts.  However, the weightings of each constituent vary based on how much I risk-on vs risk-off on the outlook. Currently,  I am risk-on, but i will be cautious in the second half of the year. In addition, trade ideas can be divided in to two groups within the portfolio based  on my conviction level.

1)  High conviction trade ideas -I have given a mandate that up to 50% of the portfolio can be allocated to my high conviction trade ideas. High conviction ideas to me are the ideas where  my long term macro view has an alignment with a long term secular theme. I tend to take concentrated positions on my highest conviction ideas of which I have two at the moment.

  1. Crypto (BTC & ALTs) is the highest conviction idea(massive right tail trade) for me since late 2019 and i think this will continue for another 6-8 months.
  2. Carbon credit market looks like a massive asymmetric opportunity because governments are on our side.  I have already put on a trade in April this year and I have plans to size up the trade as I average out profits from my crypto trade.

2) Positioning – The idea behind positioning is to place trades to take advatage of  my macro outlook or macro shifts that are not yet reflected in the markets. In here, small size bets are being placed in a diversified portfolio which can be sized up accordingly in a later date when thesis gets played out.

  1. Inflation beneficiaries (commodity trend using producers) – Metal Miners and energy were good trades to me since the second half of 2020. I think they are a bit overdone right now. I will be trimming my positions in the second half of the year. But, I am long term bullish on  Cu, Ni, Uranium, Natural gas and Li in general, because of the ESG theme.
  2. International Stocks (value tilted) – long term bullish on Europe and Japan
  3. Cyclical stocks – I made some decent profits from financials (both US  and international), I will be taking some proits off going forward because reflation thesis is uncertain to me in the second half of the year.
  4. Gold miners (fiat alternatives)– I already have some physical gold in my portfolio and I will add a bit more into my gold trade using gold miners. In the medium term, if the long end of the curve drops further, both tech & gold might be a good place to be.
  5. Growth Stocks – I will be adding couple of growth names to my portfolio as short term trades.
  6.  VIX Call spreads -Tapering or sudden interest rates hikes are risks to watch out for. 

Disclaimer – ” I am not a financial advisor and this article is a construct of my personal views on various markets and the economy. Therefore, information shared in  this article should not be used as investment advice by the reader”

3 thoughts on “Macro Playbook for 2021 and beyond”

  1. Hi Solvent Trader! I came across one of your answers on Seedly and found you very intelligible with regard to the financial markets and macroeconomic policies at large. I am a student studying Business at one of Singapore’s Local U, and is also very passionate about the financial markets, with own money invested as well. Lately, I have been obsessed with market microstructures as well as macro implications be it Fed policies or the pandemic itself. I have also grown to be a skeptic about conventional investing wisdom/strategies such as ‘buying the broad market’ and ‘buying the dip’, because of the fragility and bifurcation that we see in our markets today. I highly believe that the markets are not the same as what it was 10 years ago and that recent events and developments have caused it to change dramatically.

    Not to throw shade on anyone, but I rarely see any local bloggers (I am assuming you reside in Singapore) talk about macro implications and microstructures like yourself. I also like the fact that you talk a lot about the Fed and the reaction function that it evokes following any action it takes. I also like the fact that you read market wizards (because that was on my reading list for quite a while sometimes, have yet to read it). I hope my humble comment of mine would give you a reason to continue posting as I am already a fan of your content. Just an idea, I hope you can write something about your ‘Long Vol’ or ‘Commodity Trend’ strategy. From what I know, such strategies are rather bespoke to hedge funds or advisories. It is usually not cost-efficient and may cause a lot of tracking errors for retail investors like ourselves because of how sophisticated it can be. Also, there isn’t a lot of publicly traded ETFs/Vehicles that allows retail to buy into such strategies.

    – Justin

    1. Also, can you talk more about your VIX call spread strategy? How you are rolling the positions, how are you monetizing it and how are you choosing your strikes, etc. I am largely interested in the volatility space as well, and I find such strategies really interesting considering that 2-3 historical standard deviation moves seem to be very common nowadays.


  2. Hi Justin, Thanks for your kind words and appreciate for taking time to provide a feedback. I do share the same view as you. The convestional wisdom in SG is that buy and hold broad index or keep buying the dip without any regards to fundamentals. I think that strategy is fine for many average investors who are not so keen about finance or no time to do extra work. But, it becomes a concern when such narrative push to an extreme by saying that its the only way to suceed in investment space. It does not serve the justice for people who are willing to go the extra mile to generate alpha.

    Regrading Long Vol and Commodity Trend, yes.. you are absolutely correct. Its hard to implement these strategies as a retail investor because it requires active management. Unfortunately, we dont have time, capital and resources to fully implement sofisticated strategies.

    However, my personal view is, as a retail investor there are ways to partcipate strategically in the big boys game. Some of the ways are not the cleanest expressions of the idea but they still can do the same job in a portfolio. One of the examples of commodity trend is going long or short commodity produing companies to express the view and use trend following rules. If short is not the thing for someone, one can stick to Long only approch as well. I think hardest is managing the long vol part. I can share few strategies (VIX call spread, creating synthetic options based on a large position, back spreads) that i personally use to participate in the long vol space. But I am still not a systematic Vol buyer like Chris Cole who allocates large portion to long vol . Im still a newbie to the space and dealing with carry cost deamon :). Currently, I am only allocating 3% of my risk budget to it.
    Anyway, thanks for the idea, Sure..i’ll do a write up about it soon. Feel free to share your ideas too. There are plenty of things we can learn together.

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