The four forces: rates, growth, inflation, liquidity
Lesson 1 · about 10 min
Every price you trade is a claim on future cash flows, discounted back to today. That one sentence is the whole of macro. Change what people expect the cash flows to be, change the rate they discount at, or change how much money is around to bid for the claim, and the price moves. Macro trading is the study of those three levers and the fourth thing, inflation, that pushes on all of them at once.
You do not need an economics degree. You need to know which force is currently in charge and which instruments are most sensitive to it.
Rates
The policy rate is the price of money for one night. Everything else is priced off it: the two-year yield is roughly the market's guess at the average policy rate over the next two years, mortgage rates sit on top of the ten-year, and a stock's valuation is a bet about earnings far in the future discounted by something close to the ten-year plus a risk premium.
When the discount rate rises, the present value of distant cash flows falls faster than the present value of near cash flows. That is why long-duration assets (unprofitable growth companies, thirty-year bonds, gold) react more to rate moves than a bank that earns its money next quarter.
Growth
Growth is what fills the cash flows. Stronger growth means more revenue, more employment, more tax receipts. Equities generally like growth; bonds generally do not, because growth pulls rates up. Commodities like growth because growth uses copper, oil and freight.
Growth is measured slowly (GDP comes out quarterly and gets revised for years) and guessed at quickly (PMIs, claims, retail sales). Traders mostly trade the guesses.
Inflation
Inflation is the change in the price level. It erodes the real value of fixed cash flows (bad for bonds), raises input costs and can compress margins (mixed for stocks), and above all it changes what the central bank does next. Since roughly 2021 inflation has been the variable that drives the other three, and CPI day has often been the most volatile scheduled day of the month for index futures.
Liquidity
Liquidity is how much money is available to chase assets. It is the fuzziest of the four, and the one most abused by commentators. Concrete versions include the central bank balance sheet (expanding through asset purchases, shrinking through runoff), bank reserves, the Treasury's cash balance, and the amount of margin credit in the system. Rising liquidity tends to lift everything with a risk premium; falling liquidity tends to make everything correlate and fall together.
How the forces map to instruments
| Force up | Index futures (ES, NQ) | 10-year Treasury (price) | USD | Gold |
|---|---|---|---|---|
| Rates | Down, NQ more than ES | Down | Up | Down |
| Growth | Up | Down | Mixed | Mixed |
| Inflation | Down (via rates) | Down | Up (via Fed) | Up, unless real yields rise more |
| Liquidity | Up | Up | Down | Up |
Read the table as "the usual direction when that force moves alone." In practice two forces move together, and the net effect depends on which one the market cares about that week. A strong jobs report is growth up (good for ES) and rates up (bad for ES); in 2019 the first effect won and in 2022 the second one did. The next three lessons explain why.
Key idea: Every asset is future cash flows discounted at a rate and bid for with available money. Growth changes the cash flows, rates change the discount, liquidity changes the bidding, and inflation changes all three through the central bank.
Which force is in charge
A useful habit is to write down, once a week, which force the market is trading. Some tells:
- If stocks fall on strong data and rise on weak data, rates are in charge.
- If stocks and bonds rise together, liquidity or falling inflation is in charge.
- If cyclicals and commodities lead while bonds sell off, growth is in charge.
- If everything sells off together and the dollar rallies, liquidity is draining.
You will be wrong sometimes. The point is to have a hypothesis that the next data point can confirm or break, rather than a narrative you defend.
Try it: Pull up a daily chart of ES and the 10-year yield for the last three months. Mark the five biggest down days in ES. On how many of them did yields rise? On how many did they fall? That ratio tells you whether the market is currently trading rates or growth.
Recap
- Four forces: rates (the discount), growth (the cash flows), inflation (pushes on all three through the central bank) and liquidity (how much money is bidding).
- Long-duration assets like NQ, long bonds and gold are more rate-sensitive than short-duration ones.
- The same data point can be good for growth and bad for rates; which effect wins depends on the regime.
- Write down each week which force the market is trading, and test it against the next release.
See it drawn
Original diagrams for the ideas on this page. Illustrative, not real market data.