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  • Writer's picturePatrick Ling

Is This The Great Normalization?

I wrote in August last year about the big gap between CPI and the Fed Funds rate when I asked the question Is Inflation Under Control? With the latest March CPI release, I am happy to report that the gap has closed.


CPI vs Fed Funds rate
CPI is now back in line with the Fed Funds rate

It is also worth noting that the latest CPI came in below market expectations. The last time this happened was for the November CPI release in 2022.


CPI Actual vs Forecast
The actual March CPI came in below the market's forecast

Incidentally, towards the end of last year, I also wrote that A Macro Shift Is Under Way. We are now moving toward the middle of 2023, and based on the price movement of the major asset classes, we are indeed experiencing a new market regime. We can call it the Great Normalization from inflation. In this new regime, whatever worked in 2022 is now reversed.


Regime shift from inflation to normalization
Regime shift from inflation to normalization

Part of the reason I felt a regime shift was underway was I thought that cross-asset correlations were reaching a historical peak in November last year. Indeed, cross-asset correlations have come down since.


Cross-asset correlations
Cross-asset correlations have reverted to the long-term average

So where do we go from here? Given the unprecedented pandemic that resulted in significant supply chain shocks and structural labor market changes, I think the normalization process still has legs. If you are wondering whether we are headed for a recession, you might be interested to read about a little study I did.


What Could Derail Normalization?


Markets are fluid, so what could potentially derail the current normalization process? Well, the obvious one is commodity prices since that feeds into everything downstream. Commodity prices have been on a downtrend since the middle of last year, but the CRB Index has moved up quite a bit recently, likely due to a cut-back in oil production by OPEC.


CRB Index
Where do commodity prices go from here?

The saving grace is that inflation expectations remain well-anchored, at least according to the 5-year breakeven rates.


5-year breakeven rates
Inflation expectations remain anchored close to 2% for now

Markets can evolve, but we should be fine if we stick to our proven multi-strategy approach.


 

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