<p><strong>We are observing a true regime change in markets.</strong><br />And for macro investors, it’s incredibly important to stay vigilant and on top of our game at this stage.</p><p>It all starts with this: <strong>the Fed is behind the curve, and it is playing with fire.</strong></p><p>Consider this.<br />The recently released US job report showed the US private sector is only adding an average of 96,000 jobs per month over the last 3 months.<br /><strong>Such a weak pace of job creation has last been seen in summer of 2007.</strong><br /><br />The last CPI report also showed another friendly and disinflationary print: core CPI raised less than 0.2% on a MoM basis which is a trend in line with pre-pandemic ~2% yearly inflation trend the Fed targets.</p><p>So, why is the Fed playing with fire?<br />The chart below shows you why.</p><div class="captioned-image-container"><figure><a class="image-link image2 is-viewable-img" href="https://substackcdn.com/image/fetch/f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F873e219d-d9e3-4a5d-94a6-50e6490c993c_718x437.png" target="_blank"><div class="image2-inset"><source type="image/webp" /><img alt="" class="sizing-normal" height="437" src="https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F873e219d-d9e3-4a5d-94a6-50e6490c993c_718x437.png" width="718" /><div class="image-link-expand"><div class="pencraft pc-display-flex pc-gap-8 pc-reset"><div class="pencraft pc-reset icon-container restack-image"><svg class="lucide lucide-refresh-cw" fill="none" height="20" stroke="currentColor" stroke-linecap="round" stroke-linejoin="round" stroke-width="2" viewBox="0 0 24 24" width="20" xmlns="http://www.w3.org/2000/svg"><path d="M3 12a9 9 0 0 1 9-9 9.75 9.75 0 0 1 6.74 2.74L21 8"></path><path d="M21 3v5h-5"></path><path d="M21 12a9 9 0 0 1-9 9 9.75 9.75 0 0 1-6.74-2.74L3 16"></path><path d="M8 16H3v5"></path></svg></div><div class="pencraft pc-reset icon-container view-image"><svg class="lucide lucide-maximize2" fill="none" height="20" stroke="currentColor" stroke-linecap="round" stroke-linejoin="round" stroke-width="2" viewBox="0 0 24 24" width="20" xmlns="http://www.w3.org/2000/svg"><polyline points="15 3 21 3 21 9"></polyline><polyline points="9 21 3 21 3 15"></polyline><line x1="21" x2="14" y1="3" y2="10"></line><line x1="3" x2="10" y1="21" y2="14"></line></svg></div></div></div></div></a></figure></div><p>Fed Funds at 5.25% while core PCE is convincingly sub-3% represent a real Fed Fund rate of 2%+.</p><p><strong>Real rates are what matter for the economy:</strong></p><ol><li><p>Investors care about their (risk-free) returns after accounting for inflation</p></li><li><p>Debtors care about their inflation-adjusted borrowing costs</p></li></ol><p><strong>With real rates now at 2%+ for quite some time</strong>, it's important to look back at past episodes and see what happened when the Fed forced such a tight policy for too long:</p><p>A) <strong>In 1999-2000</strong>, the Fed kept real rates at 3%+ for a sustained period of time and a crisis unfolded in 2001;</p><p>B) <strong>In 2007</strong>, the Fed kept real rates at 2%+ for a while and a crisis unfolded in 2008;</p><p>C) <strong>In 2024</strong>, the Fed is keeping real rates at 2%+ and...you get it.</p><p>On top of this, the Fed is also keeping policy very tight while the US job market is showing clear signs of weakness.</p><p><strong>The Fed is behind the curve, and it is playing with fire here.<br />And when this happens, the bond market takes over.</strong></p><div class="captioned-image-container"><figure><a class="image-link image2 is-viewable-img" href="https://substackcdn.com/image/fetch/f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Faad52bb5-dceb-42ed-86f5-b012060d7375_711x423.png" target="_blank"><div class="image2-inset"><source type="image/webp" /><img alt="" class="sizing-normal" height="423" src="https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Faad52bb5-dceb-42ed-86f5-b012060d7375_711x423.png" width="711" /><div class="image-link-expand"><div class="pencraft pc-display-flex pc-gap-8 pc-reset"><div class="pencraft pc-reset icon-container restack-image"><svg class="lucide lucide-refresh-cw" fill="none" height="20" stroke="currentColor" stroke-linecap="round" stroke-linejoin="round" stroke-width="2" viewBox="0 0 24 24" width="20" xmlns="http://www.w3.org/2000/svg"><path d="M3 12a9 9 0 0 1 9-9 9.75 9.75 0 0 1 6.74 2.74L21 8"></path><path d="M21 3v5h-5"></path><path d="M21 12a9 9 0 0 1-9 9 9.75 9.75 0 0 1-6.74-2.74L3 16"></path><path d="M8 16H3v5"></path></svg></div><div class="pencraft pc-reset icon-container view-image"><svg class="lucide lucide-maximize2" fill="none" height="20" stroke="currentColor" stroke-linecap="round" stroke-linejoin="round" stroke-width="2" viewBox="0 0 24 24" width="20" xmlns="http://www.w3.org/2000/svg"><polyline points="15 3 21 3 21 9"></polyline><polyline points="9 21 3 21 3 15"></polyline><line x1="21" x2="14" y1="3" y2="10"></line><line x1="3" x2="10" y1="21" y2="14"></line></svg></div></div></div></div></a></figure></div><p><strong>The chart above goes back to 1989 and it looks at the amount of rate cuts/hikes bond markets were pricing for the subsequent 2 years.</strong><br />I focused on periods when the bond market was very, very dovish and it priced in a robust amount of cuts.<br /><br />The big question is: what did the Fed ACTUALLY deliver?<br />Did one make or lose money by buying bonds when markets were already super dovishly priced?</p><p>Let's look at the data:<br /><br /><strong>1️⃣ January 1995, October 1998</strong><br /><br />Cuts priced for the next 2 years: on average 130 bps<br />Cuts delivered by the Fed: 75 bps<br />If you bought bonds while markets were already at peak dovish pricing, you lost money (cuts delivered were less than priced in).<br /><br /><strong>2️⃣ January 1990, December 2000, September 2007, August 2019</strong><br /><br />Cuts priced for the next 2 years: on average 145 bps<br />Cuts delivered by the Fed: 412 bps (!)<br /><strong>If you bought bonds while markets were already at peak dovish pricing, you ended up making a ton of money.</strong><br /><br />The results are very interesting. <br /><br />As a rule of thumb, I always advocate that in macro you don’t make money by only ‘’being right’’. <br />That’s a necessary but insufficient condition: you also need to surprise consensus, or in other words see something before the crowd does + position correctly for it + monetize when they converge to your view.</p><p>Yet it seems like the bond market is quite good at sniffing when something is about to go wrong.<br /><strong>The bond market is sending a loud message: are you listening?</strong></p><p>But it’s not only about the bond market here.<br /><strong>It’s also about cross-asset correlations suggesting tectonic shifts are happening:</strong></p><div class="captioned-image-container"><figure><a class="image-link image2 is-viewable-img" href="https://substackcdn.com/image/fetch/f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F488bf9ec-102c-487b-90e0-c7493f094796_722x431.png" target="_blank"><div class="image2-inset"><source type="image/webp" /><img alt="" class="sizing-normal" height="431" src="https://substackcdn.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F488bf9ec-102c-487b-90e0-c7493f094796_722x431.png" width="722" /><div class="image-link-expand"><div class="pencraft pc-display-flex pc-gap-8 pc-reset"><div class="pencraft pc-reset icon-container restack-image"><svg class="lucide lucide-refresh-cw" fill="none" height="20" stroke="currentColor" stroke-linecap="round" stroke-linejoin="round" stroke-width="2" viewBox="0 0 24 24" width="20" xmlns="http://www.w3.org/2000/svg"><path d="M3 12a9 9 0 0 1 9-9 9.75 9.75 0 0 1 6.74 2.74L21 8"></path><path d="M21 3v5h-5"></path><path d="M21 12a9 9 0 0 1-9 9 9.75 9.75 0 0 1-6.74-2.74L3 16"></path><path d="M8 16H3v5"></path></svg></div><div class="pencraft pc-reset icon-container view-image"><svg class="lucide lucide-maximize2" fill="none" height="20" stroke="currentColor" stroke-linecap="round" stroke-linejoin="round" stroke-width="2" viewBox="0 0 24 24" width="20" xmlns="http://www.w3.org/2000/svg"><polyline points="15 3 21 3 21 9"></polyline><polyline points="9 21 3 21 3 15"></polyline><line x1="21" x2="14" y1="3" y2="10"></line><line x1="3" x2="10" y1="21" y2="14"></line></svg></div></div></div></div></a></figure></div><p>We are witnessing a massive regime change in markets.</p><p>Recently we experienced another large drawdown in equity markets lead by tech stocks - specifically, NVDA stock prices dropped by almost 10% in a single session.</p><p><strong>But the big news for investors is that bonds have started to exhibit one of their key features again.</strong></p><p>For the first time in a few years, bonds are acting again as a hedge against stock market drawdowns.<br />Or in other words: after a period of positive correlation which wrecked 60/40 portfolios, <strong>the stock/bond correlation is turning negative again.</strong></p><p>This is a huge deal.</p><p>The chart above shows the 6-month (120 trading days) correlation between the S&P500 and 10-year Treasury future prices.</p><p>The correlation was negative for most of the last 15 years: this means investors could count on bonds acting as a diversifier during periods of equity drawdowns. <br />But as you can see from the chart, this wasn’t always the case: for most of the ‘80s and ‘90s bonds and stocks were doing pretty much the same thing at the same time – they were positively correlated. <br />The same happened in 2022-2023 as inflation was out of control.<br /><br /><strong>Hear me out now, because this is the key message you should bring home.</strong><br /><br />When the stock/bond correlation changes sign, we are looking at tectonic macro shifts with huge implications for cross-asset portfolios.<br /><br />This is because ''bad news is good news'' doesn't work anymore.<br />The market has switched into a regime in which:<br /><strong><br />Bad news is actually bad news.</strong></p><p>Once bonds start acting as a diversifier for risky assets, it's likely we are on the verge of a massive regime change in macro and markets.</p><p>Macro tectonic shifts are happening.</p><p class="button-wrapper"><a class="button primary" href="https://themacrocompass.substack.com/p/this-is-a-true-regime-change/comments"><span>Leave a comment</span></a></p><p class="button-wrapper"><a class="button primary" href="https://themacrocompass.substack.com/p/this-is-a-true-regime-change?utm_source=substack&utm_medium=email&utm_content=share&action=share"><span>Share</span></a></p><p><strong>The launch of my Macro Hedge Fund is now imminent.</strong></p><p>If you are a professional investor and you wish to remain updated on my fund, from now onwards you can only do that if you <strong>access my private distribution list.</strong></p><p><strong>To remain updated on my Macro Hedge Fund</strong>, <strong><a href="https://forms.gle/BogCYUeAUtfsYyZp6">please leave your info here.</a></strong></p><p>It only takes 2 minutes.<br /></p>