“Navigating the World with an Inverted Yield Curve”, Michael Churchill, Churchill Research

David Osman of IRF is joined by Michael Churchill, the founder of Churchill Research.

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In this podcast Michael discusses the economic and financial implications of the worst bond yield inversion for 40 years. He argues that the curve inversion is saying that the Fed is overdoing it.

Historically, that is a recession predictor – albeit with a long lead time. But so far other indicators are not corroborating a near-term deflationary recession. He points out that the 2020-21 helicopter drop was of world-historical enormity – and now it’s being worked off. This has created all kinds of uncertainties and risks. He notes that US M2 growth is negative YoY, but still 38% above pre-COVID levels. This is a classic conflict between level and rate of change. The rate of change is weak, but the level is still high. He observes that over enough time, the rate of change always wins.

Michael emphasizes that the 2020-21 M2 boom was a one-off, but people misinterpret it as systemic. He sees that as being very dangerous. The big risk is that the Fed keeps hiking until lagging indicators give it the slowdown it wants (particularly rising unemployment). The hotter the economy runs in the meantime, the bigger the risk of Fed overshoot.

Michael points out that the “option value” of holding cash is rising given the obvious risk of Fed error. He notes that the gold price is tracking the 12-month Fed Funds future (inverted) tick for tick. Put differently, the dollar is following funds-rate expectations very closely. He finds it bizarre that the 350 bp rise in TIPS yields hasn’t pulled gold down much further and interprets this to mean that money is not as tight as the inverted yield curve suggests. With respect to his various portfolios, Michael explains why he has been adding to his weighting in Japan and discusses the adjustments he has recently made to his weightings in various sectors, including airlines, processed goods and raw materials.

Churchill Research analyses the world from both the top-down and the bottom-up. The first cut is macro, using their supply-side economic model to identify countries and sectors that are likely to outperform or underperform. Next, they apply their bottom-up analysis, looking for interesting individual companies within targeted countries and sectors. These stocks are included in their various portfolios.