Summary

Julian began his conference call by focusing on inflation causes in the US. Inflation prices models are much higher than expected with no inclination that these increases will dissipate quickly. Prices increases in Manufacturing goods for example are over 6% higher. These price increases are expected to push through. The issue arises from fiscal and monetary policy being implemented at the same time. The underlying result of looking at data from 28 countries across 120 years combining the effects of simultaneous monetary and fiscal policy gives an incredibly good predictor of inflation.

The economy in US is fundamentally overcooked. Adding to inflation is rampant aggregate demand. Nominal PCE is 30% higher than pre-Covid levels whilst the service sector is 7% higher than pre-COVID. Assuming aggregate demand in the good sector will transfer into the service sector without causing inflation is a symptom of the economy being overcooked. Engineering a recession to slow the economy down is typically only possible once customer inventory exceeds the headline ISM rate. However currently it is manufacturers as opposed to customers with high inventory levels, due to them sitting on high levels of semi-finished goods. Should the key components for those goods arrive in the second half of the year the manufacturer inventory would roll very quickly into customer inventory, leading to a boom bust situation. With wage growth the US consumer whilst complaining about 7% inflation can fund it. This could signal the beginning of a new potential lending cycle in the United States.

The inflation situation in Europe is worse. The market eurozone composite questionnaire recorded the average price change for goods and services rising at the sharpest level yet, as firms increasingly sought to pass on persistently high-cost inflation to customers. MI2 models are beginning to signal a significant increase in wage costs, albeit not as extreme as in the US. The market again picked this up at the same time, with soaring energy prices accompanying wage increases to add to inflation pressures. The second half of the year, potentially starting in Q2, could see the biggest coiled spring of industrial production we have seen in our trading lifetimes. Inventory levels right across continental Europe, Germany's the best just example, are literally at unprecedented levels. Without destroyed aggregate demand prior to that those products will arrive with massive inflationary pressures.

The equities market is very sensitive to the speed of economic growth not the level. The market mistakenly assumed that margins would grow without inflation increasing. Either margins would stay at current levels and companies would push through the price increases, in which case you would have inflation and the Fed would bring the equity market down or they couldn't put those price increases through, and then margins would implode. The equity market is also more susceptible to changes in liquidity and is not as sensitive to interest rates. With the US moving to QT from QE, the dependence on liquidity is liable to volatility in the second half of the year.

The dollar strength typically rises for a decade then falls for a decade, hence the last become first and the first become last because of the belief we are at a decade inflection point. The MI2 long-term dollar models, that are using metrics that already exist today, suggest a very rapid decline in the dollar. The Fed has three metrics: control the equity market, control the dollar or control the bond market. However they cannot control all 3 without one metric losing out. Julian believes we are at a similar point to the 60s where the Fed subsidised bond markets and support the economy and equity market, leading to the collapse of the dollar. An equity correction is needed to create the pay, to force the Fed to make that decision. However with the backdrop on our dollar supply models is hellacious, leading to their prediction of a 30% decline in the dollar over the next few years.

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