A Cautionary Approach in Uncertain Times

In this blog post, we'll delve into the concept of the base effect and its influence on the inflation rate, highlighting the importance of considering trends rather than single data points. Additionally, we'll discuss the smoothed inflation rate and how it reveals the current trajectory of both inflation and core inflation. While the Federal Reserve's soft pivot may benefit certain assets, we must remain cautious about potential risks in uncertain macroeconomic conditions, such as the possibility of a recession leading to a liquidity crisis.

Understanding the Base Effect

The base effect refers to the impact of the reference point used to calculate a given metric, particularly evident in the rate of change of the Consumer Price Index (CPI) or its equivalent for core prices. An illustrative example shows how deviations around the trend, caused by spikes or drops in the CPI 12 months ago, can affect the inflation rate, making it crucial to focus on the broader picture rather than isolated data points.

By smoothing out the volatility that creates the base effect, we can gain valuable insights into the underlying trends of inflation and core inflation. The smoothed inflation rate, calculated by averaging the CPI over a rolling window, indicates that both inflation and core inflation have been easing for at least 3 months, prompting economists to take notice.

The Soft Pivot and Future Rate Hikes

The Federal Reserve's soft pivot, though not equivalent to restarting the money printer, is expected to benefit certain assets like Bitcoin and risk assets. The likelihood of future rate hikes appears to dwindle, with the latest inflation print indicating decreasing expectations for additional hikes. However, the Fed may need to loosen rates further if the US economy faces a recession, as indicated by the Leading Economic Indicator contracting in June.

Navigating Uncertain Macro Conditions

In the current ambiguous situation, investors must weigh the potential benefits of a soft landing against the risks of a possible recession and liquidity crisis in the next 6 months. Following trends is a prudent strategy, but doing so blindly can lead to risks. FOMO-driven investments have driven certain assets, but caution is warranted due to the lingering risk of a recession. Preparing for potential liquidity issues is essential, and investors are advised to focus on the most liquid markets and exit positions promptly if signs of trouble emerge.

Understanding the base effect and analyzing trends in inflation are critical to making informed investment decisions. While a soft pivot from the Federal Reserve may favor certain assets, uncertainty remains regarding potential economic downturns and liquidity crises. Cautious optimism and careful risk management are essential for navigating the complex and uncertain macroeconomic landscape.

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