“Soft Landing” Very Unlikely As Global Inflation Crisis Rages On | Darius Dale & Juliette Declercq

Episode Summary

Executive Summary: Juliet de Klerk and Darius Dale argue that macro is unusually confusing because strong U.S. demand and labor markets are now the main risk to risk assets: they keep the Fed hawkish, prolong tight financial conditions, and delay a liquidity pivot. They see stocks, credit, and parts of Europe under pressure, while the dollar and select commodities may stay supported.

Main Topics: Why macro feels contradictory right now (Priority: 5/5): The guests say old playbooks are failing: recession fears can be bullish for assets if they trigger liquidity, while a strong economy can be bearish because it keeps the Fed tightening. Fed tightening, liquidity drain, and lagged effects (Priority: 5/5): Darius emphasizes QT, reverse repo runoff, and the historical >90% correlation between liquidity and equities, while Juliet stresses long lags between policy, demand, and inflation. Inflation driven by labor strength and inequality shifts (Priority: 4/5): Juliet argues inflation is being sustained by strong labor markets, especially at the lower-income end, which fuels spending, credit use, and goods inflation rather than demand destruction. Hard landing risk and the limits of soft-landing hopes (Priority: 5/5): Both speakers think a significant slowdown is likely and that the Fed will likely overshoot before seeing enough weakening to pause, making a hard landing more probable than a soft landing. Europe’s sovereign and currency dilemma (Priority: 4/5): Juliet is notably bearish on European sovereign bonds and the euro, arguing the ECB has limited tools amid fragmentation, rising spreads, and inflation near 10%. Asset allocation: short risk, long commodities, cash, and selective China exposure (Priority: 4/5): Darius advocates short U.S. equities/credit, long energy and agriculture, and cash for future opportunities; Juliet prefers trading rather than long-term investing, with caution on Europe and interest in China. Earnings risk and market valuation (Priority: 4/5): Darius says Wall Street earnings estimates remain unrealistically high and that profit recession is likely, making current equity pricing vulnerable to further downside.

Key Arguments: The main macro problem is not recession itself but the Fed’s need to fight persistent demand and labor-market strength, which keeps monetary policy restrictive. Liquidity, not underlying growth, has been the dominant driver of equities since 2009; with QT and reverse repo tightening, that support is fading fast. Inflation remains stimulatory because it encourages inventory gains, wage freeze-based labor adjustment, and front-loaded consumer borrowing. The Fed is likely to overshoot because policy works with long lags and neutral rates are unobservable, so it will keep tightening until something breaks materially. Financial conditions are still not tight enough to meaningfully cool demand; equity and credit markets still have more downside before the Fed can pivot. Europe faces a worse policy trap than the U.S. because inflation is high, growth is weak, sovereign spreads are widening, and fiscal/monetary tools are constrained. U.S. earnings expectations are too optimistic relative to unit labor cost inflation and weak productivity, implying a likely profit recession. A stronger dollar and weaker stocks may do part of the tightening work that higher rates would otherwise do, especially if global growth remains desynchronized. Longer-dated bond rallies likely require more growth damage first; until then, bonds may continue to struggle alongside equities.

Data Points: Fed meeting timing: June 14–15, 2022 - The discussion is framed around the FOMC meeting announcement due the next day. Potential liquidity reduction: $900+ billion - Darius estimates combined QT and reverse repo effects could drain this amount by year-end. QT comparison: More liquidity removed in 7 months than the 2017–2019 QT program removed over 21 months - Used to illustrate the aggressiveness of current tightening. Correlation since 2009: Above 90% - Darius cites equity market correlation with the Fed balance sheet and global central bank balance sheet. Federal funds terminal rate implied by forwards: About 3.9% - Juliet references market pricing for the Fed’s terminal rate. Aggregate income growth: 8% three-month annualized - Darius says this is still too hot for consumer demand to roll over meaningfully. Unit labor cost inflation: 8% year over year - Darius cites this as the fastest pace in four decades. Non-farm productivity: -0.6% year over year - Darius says this is the lowest in four decades. SP 500 next 12-month earnings yield: 6.09% - Darius gives the current earnings yield and says it could rise further in a recession. Equity market downside target / fair value range: 3,200–3,400 on the S&P 500 - Darius says this is where the Fed may pause and liquidity may return. Goldman Financial Conditions Index: Still narrowly in accommodative territory - Darius argues financial conditions are not yet tight enough. Real wage expectations split by income: Bottom 33% expect real wages to rise; top 33% expect real income to fall - Juliet cites Michigan survey dynamics showing a major inequality shift. Lower-income inflation expectations: 6% next year - Juliet references short-term inflation expectations from the New York Fed/Michigan context. Credit impulse timing: Recession in roughly 3 months once credit is removed and real wages are the only demand driver - Juliet says credit impulse is the key leading indicator. Balance sheet / liquidity cycle: Deep negative liquidity cycle downturn - Darius says the cycle is still worsening. European inflation: Near 10% - Juliet describes Europe’s inflation as mostly supply-driven.

Pivotal Quotes: "the worst danger, at least at the moment, for stocks and for risk in general, is actually the strengths of the US economy" — Juliet de Klerk: Explaining why strong demand and labor markets can be bearish for risk assets because they keep the Fed tight. "the real driver, at least over the last sort of 10 to 12 years, has been the liquidity cycle" — Darius Dale: Describing why equities have tracked central bank liquidity more than headline economic growth. "the sooner we get into recession, the more likely it is we get a rebound in asset prices" — Darius Dale: Arguing that a sharper slowdown could force the Fed to pivot and eventually support markets.

Implications: Listeners should expect continued pressure on equities, credit, and possibly bonds until growth visibly weakens. The likely winners are cash, energy/ag commodities, and perhaps select China exposure; Europe looks especially fragile, and the Fed may need a deeper slowdown before pivoting.