Determinants of Demand: The Dog Days of Inflation
In basic terms, the determinants of demand can be drilled down to one phrase: disposable income. That is, the monies left over for consumption after fixed costs are taken care of. Sunk costs for individuals are the cost of living. For businesses, it is the cost to operate. For governments, it is the cost to conduct administrative and legislative activities.
From a psychological perspective, people are predisposed to spend their funds frivolously due to how we live. It’s a psychological impact to be discussed later in the future Retailers have paid for in-depth research to be done on how to design store layouts. Fast food conglomerates have paid to know which colors to have their logos colored so you can be enticed to engage their eateries. There are a lot of psychological operations being invoked on you.
Comprehending the impact behind these tactics on your pocket can counteract their desired goal. Nonetheless, many continue to be unaware, and the economy will suffer the brunt of these anecdotes because it is dependent and structured on these tactics. Once people’s disposable income reaches paycheck-to-paycheck levels routinely, the savings start to get depleted, or the credit card gets tapped. Over time a consumer’s desire to buy x, y or z is dependent on five basic tenets that change the condition of consumers demand function.
There is an acronym for that; TONIE, which stands for tastes, other goods, number of buyers, income, expectations. These are the basic assumptions that are considered with respect to what could change a person’s desire to buy a good or service. These myriad of factors can lead consumers to shift their purchasing habits. Something to note, that shift is what determines the future of capital flows. The perception of what could happen is what determines what will happen. Perplexing at first, but that is how it works.
Starting at the top, complement goods are goods that are consumed together. Naturally, these are the first to go. This already happens without any economic stressors. For example, maybe you stop purchasing that sugary cereal when that gallon of milk hits $10 per gallon. A looser example of this is how often you insure your airline ticket purchase… Yeah, me either. There is an inherent comprehension that when you are choosing to fly, everything else is taking a back seat that day. Therefore, the odds of you needing to insure that purchase is essentially nil. That is more apt for business use, not personal use.
At this point in time, substitute goods are in vogue. Substitute goods are the goods that get consumed in the place of another good whose price has perhaps increased. A normal good is a good whose demand will increase with a consumers’ income. An inferior good is a good whose demand decreases with an increase in consumers’ income. Therefore, we can rest assured that, as of now, normal goods and inferior goods are going to find themselves in a tough spot moving forward.
As of now markets find themselves at what seems to be the start of a new regime. We have the USD looking ready to roll over in terms of price, whereby momentum looks weak, and price is hanging onto what was support and is now resistance at the 105.5 area, as of this writing. Correspondingly, U.S. interest rate prices find themselves bid, with a lot of active participants being short, and perhaps finding reason to cover if prices do not stop moving higher soon. In our collateral driven market, a bid on U.S. treasury’s leads to a bid in U.S. equities. An interesting phenomenon that is playing at present (also to be discussed in the future).
The broad market sentiment seems to be that this is just a recoil move for continuation in the direction of the prevailing trend. That being higher rates, lower priced stocks, and more USD accumulation. The market loves to impose maximum pain on as many participants as possible. That is the nature of capital flows, when people base their asset allocation decisions on opinion and not capital allocation logic. The notion of lower rates invites the notion of a safe move higher in risk asset values.
In a financially centric world, risk assets are driven higher by the lower valuation of the local currency.
That is how the math works, and it is also what we see in the data. A higher valued USD implies that assets are being sold for dollars and that must lead to lower dollar values in U.S. equities. In the same tone, U.S. treasury bills with a duration of 6 months or less, are essentially viewed as cash. This anecdote drives the rest of the demand for the curve. There are many reasons behind why certain players operate on some parts of the yield curve.
While the notion of why people purchase a certain point in time on the yield curve is not important. The simple way of comprehending it is by realizing that the terms of what is accepted is not set by the buyer of the collateral (USTs – US Treasury’s), but by the institution where the buyer of the UST will be posting the collateral. The catch is never obvious, but it does drive flows. Therefore, if people want to be leveraged, they need to post cash and collateral. Apparently, to post collateral all they have to do is buy a certain UST. Therefore, collateral posted, and now we can buy all the stonks.
While erratic to the mind, our financial markets are built such that when things are bad enough, stock valuations increase because the system is structured in that way. To be continued.