“Transitory Goldilocks” Is Here | Darius Dale

Episode Summary

Executive Summary: Darius Dale argues markets are in a transitory “Goldilocks” phase—growth is holding up, inflation is cooling, and China’s reopening/stimulus is boosting risk assets—but the underlying economy is still in deflation and the Fed remains more hawkish than markets expect. He sees U.S. recession risks rising later in 2023, with likely volatility around the March and June FOMC meetings and the debt ceiling, while favoring cyclical, beta, and China-linked trades in the near term.

Main Topics: Transitory Goldilocks vs. underlying deflation (Priority: 5/5): Dale says markets are pricing a short-lived Goldilocks regime because growth and inflation are both improving relative to bearish expectations, but in real macro terms the economy is still in deflation and the improvement is temporary. China reopening and stimulus as a global catalyst (Priority: 5/5): He views China’s end of zero-COVID and likely fiscal/monetary stimulus as a major positive growth impulse for China, Europe, commodities, and risk assets globally, especially in the first half of 2023. Fed hawkishness and labor market focus (Priority: 5/5): Dale argues the Fed has shifted its emphasis from inflation to labor market tightness, implying more rate hikes and fewer cuts than the market expects, with the March and June FOMC meetings as key catalysts. U.S. consumer and labor market resilience (Priority: 4/5): He believes the U.S. economy can avoid recession for longer than consensus expects because household balance sheets, cash levels, debt service ratios, and employment remain strong despite higher rates. Timing of recession and second-half risk (Priority: 4/5): His modal view is that recession begins in late 2023, with the second half carrying the real growth and liquidity risk; a sooner recession is possible but not his base case. Liquidity, debt ceiling, and Treasury cash management (Priority: 4/5): He highlights Treasury general account drawdowns, higher T-bill issuance, and debt-ceiling politics as near-term liquidity supports that could later reverse into a negative liquidity shock. Asset allocation across beta, cyclicals, Bitcoin, and China (Priority: 4/5): Dale recommends leaning into cyclicals, commodities, and higher-beta assets during the current window, but says upside is capped and that he would be more cautious as valuations extend.

Key Arguments: Markets are reacting to better-than-expected disinflation and growth data, but this is a “transitory Goldilocks” setup, not a durable regime shift. The Fed’s December pivot increased its evidentiary bar for easing and shifted its reaction function toward labor market weakness rather than inflation alone. The Fed’s own SEP implies recession-like assumptions because its 2023 forecasts require unusually large decelerations in core PCE and unemployment to hit target paths. U.S. households remain unusually healthy: high cash balances, low debt service ratios, and manageable mortgage leverage reduce near-term recession pressure. A recession is more likely in the back half of 2023 because monetary lags, tighter policy, and weaker growth should eventually hit corporate profits and employment. China’s reopening plus expected stimulus creates a powerful external growth impulse that supports commodities, cyclicals, Europe, and risk assets in the short run. Net liquidity may be supported in the first half by TGA drawdowns and T-bill issuance, but these forces may reverse later and hurt markets. The market is pricing in about 200 bps of Fed cuts, but Dale thinks the Fed is more likely to hold higher for longer and possibly raise above current expectations. If recession comes earlier than his base case, current asset prices have not priced that in, especially in credit spreads and higher-beta assets. Bitcoin and high-beta assets can work in a weak-dollar, Goldilocks-like environment, but the upside likely has a ceiling once the Fed and macro backdrop reassert themselves.

Data Points: Probability of Goldilocks: 25% to 35% - Dale said this was the elevated probability range for achieving Goldilocks in the U.S. and global economy from December through spring. Core services ex-rent of shelter (3-month annualized): 1.2% - He cited this as the most important CPI subcomponent, down from 3.2%, showing disinflation. Median CPI (3-month annualized): 5.5% - A Cleveland/Atlanta Fed-style underlying inflation measure he said has fallen sharply but remains above the Fed’s comfort zone. Initial jobless claims: 205,000 - He used this as evidence of continued labor market strength and said it was a secular low. Continuing claims: 1.6 million - He said continuing claims had fallen from roughly 1.75 million, indicating labor-market resilience. Real PCE growth (3-month annualized): 3.0% - He cited this as evidence that consumer spending remains strong. Nominal employee compensation (3-month annualized): 6.1% - He used this to argue wage/income growth remains strong and keeps the Fed focused on labor. December core PCE forecast in SEP: 3.5% by end-2023 - He contrasted this with the then-current 4.7% and noted the implied deceleration is historically recessionary. December unemployment rate forecast in SEP: 4.6% - He noted this would be a 110 bps rise from 3.5%, historically associated with recession. Fed Funds futures pricing: ~5.0% then 50 bps of cuts by year-end - He said markets expected the Fed to reach 5% and cut later in 2023. Potential Fed Funds peak: 5.5% to 6.0% - Dale said the Fed could easily go above current market pricing. Consumer cash on balance sheet: $7.9 trillion - He cited this as evidence of unusually strong household liquidity. Checkable deposits + money market fund shares: 5% of total assets - He said this is the highest level in the history of the series. Household debt / disposable personal income: 101 cents on the dollar - He used this to show household leverage is below prior cycle peaks. Peak household debt / disposable personal income (GFC): 134 cents on the dollar - He compared current leverage to the pre-GFC peak. Household debt service ratio: 9.8% - He said debt service remains near an all-time low. Mortgage debt / disposable income: 66 cents on the dollar - He used this to show mortgage leverage is well below prior cycles. Mortgage debt service ratio: 4.0% - He said this is practically an all-time low despite higher mortgage rates. Effective nationwide mortgage rate: 3.42% - He said this explains why homeowners are reluctant to move despite 6%-7% new mortgage rates. U.S. GDP share from services: 82% - He used this to downplay the informativeness of manufacturing PMIs for the overall economy. U.S. employment share from services: 86% - He said services matter far more than manufacturing for the labor market. S&P 500 range he expects in first half: 3,800 to 4,100 - He described this as a choppy range where the market can trade with a bullish bias. Potential upside S&P level before caution: 4,100 to 4,200 - He said valuations become hard to justify above this zone. Investment-grade credit spreads: ~160 bps - He compared this to much wider levels seen in prior recessions. High-yield credit spreads: below 400 bps - He said current spreads are far tighter than recessionary averages. Net liquidity setup: Potentially flat-to-up in 1H 2023 - He said TGA drawdowns and T-bill issuance could support liquidity before reversing later. Bitcoin annualized return in Goldilocks: 400% - He cited a backtest showing Bitcoin performs exceptionally well in Goldilocks regimes. VIX range in transitory Goldilocks: 18 to 20 - He said Goldilocks is not consistent with a VIX above 20. China/Goldilocks cyclical window: 1 to 2 quarters - He said the favorable risk-asset window likely lasts only through the near term.

Pivotal Quotes: "We are now in an area where the markets are apt to look around for Goldilocks-type signaling. And that's exactly what we're getting, both from an economic and policy standpoint." — Darius Dale: He explains why markets have rallied on better data and China stimulus. "We are technically in what we call deflation. It's just a more milder form of deflation than we had experienced in recent months." — Darius Dale: He clarifies that asset prices may behave like Goldilocks even though macro conditions are still deflationary. "I think you can, at the best, as an investor, try to front run the Fed by analyzing and forecasting the data that they have their eyes glued to." — Darius Dale: He describes his framework for anticipating policy rather than fighting it blindly.

Implications: Near term, cyclicals, commodities, China, and higher-beta assets may keep working, but the window looks temporary. Investors should expect volatility around Fed meetings and the debt ceiling, and prepare for weaker markets in the second half if growth and liquidity roll over.