The four quadrant global macro framework (part 2)
This is part 2 of my primer on the four quadrants of global macro. You can find part 1 here. If you missed the first one, I’ve added the quadrant chart above for easy reference.
In this post I’ll discuss how markets transition between quadrants and how to profit from these transitions, otherwise known as regime changes.
Quad 4 to Quad 2. Every business cycle begins with a recession, where Quad 4 dominates. As markets decline and economic prospects dim, investors extend their pessimism into the future, driving asset prices to historically cheap levels. In response, governments and central banks inject fiscal and monetary stimulus to revive the economy and markets, sparking a recovery. Over time, the economy follows asset prices upward. Since prices bottom from such depressed levels, returns from being long the right assets can easily reach triple digits, making this transition one of the best periods to be a long-only investor.
Throughout both Quad 4 and Quad 2, equities and government bonds typically maintain a negative correlation. Bonds tend to peak and sell off as equities bottom. Recurring Quad 4 scares are common as the market is often skeptical of the recovery. Examples of Quad 4 scares are the European debt crisis in 2012 following the GFC and the China deflationary bust in 2015. These growth scares tend to be good opportunities to buy the dip. Policymakers' commitment to support the economy with loose monetary policy creates a strong tailwind for asset prices, sustaining the newly minted bull market for years.
Quad 2 to Quad 3. As economic expansion continues, consumption and business activity heat up, and markets grow increasingly bullish. Inflation rises beyond central banks’ comfort zones, prompting interest rate hikes. Initially, markets often dismiss tightening as a natural byproduct of strong growth. However, as rate hikes begin to weigh on economic data, investors start questioning whether central banks will stifle the economy in their efforts to control inflation. The transition to Quad 3 is marked by the moment equities and bonds sell off simultaneously. Good economic data suddenly becomes bad for markets, while weak data is seen as good.
January 2022 marked a clear shift from the post-COVID Quad 2 boom to the Quad 3 bear market. Traders from 2018 may recall a brief Quad 3 phase in Q4 that resolved into Quad 2 after Jerome Powell’s infamous “Powell Pivot.” Quad 3 is a challenging environment as markets oscillate between Quad 3 and Quad 1, driven by shifting expectations of further tightening. Often, it’s only in hindsight that the dominance and persistence of Quad 3 become apparent.
Quad 3 can end in one of two ways:
Hard Landing (Quad 4) – Fed tightening breaks the market, triggering a deep recession, as seen in 2000 and 2008. This resets the business cycle back to day one.
Soft Landing (Quad 1) – The economy stabilizes, transitioning into a period of rising growth and falling inflation, as seen in 2023. The central bank finally has room to ease monetary policy as the threat of inflation recedes.
Quad 1 transitions
Quad 1 is inherently unstable as the combination of rising growth and falling inflation rarely lasts long. Too much growth reignites inflation, leading to further rate hikes, while too little growth risks slipping into recession. The market entered covid in a Quad 1 environment, and the pandemic violently jolted the market into Quad 4. Last December the market sold off on Quad 3 fears after the Fed was more hawkish than expected in its December meeting.
Finding your bearings
Knowing which quadrant you’re in at any given time is crucial, as it determines how asset prices interact with each other and economic data. Markets can shift between regimes quickly, making it difficult to pinpoint the dominant quad. Here are some key rules to help identify the prevailing regime:
Is the central bank in an easing cycle or hiking cycle? If easing, that means the Fed is less concerned about inflation than it is about growth, and therefore the market is likely in Quad 4 or Quad 1. If tightening, that means inflation is on the rise, so the market is likely in Quad 2 or Quad 3.
Quad 4 and Quad 2 are mirror quads, where stocks and bonds tend to have a negative correlation. Quad 3 and Quad 1 are also mirror quads but are characterized by a positive stock-bond correlation. The market tends to flip within its mirror quads often, whereas transitions between Quads 4/2 and Quads 3/1 happen less often.
In the U.S., the Fed is in an easing cycle, signaling that slowing growth is a bigger concern than inflation. Markets rallied throughout 2024 in a benign Quad 1 environment, but this has now shifted to Quad 4 as Trump’s policies dampen growth prospects.
If you’re wondering whether the inflationary effects of tariffs should worry the market, just look at the stock-to-bond correlation. Tariff announcements have led to lower stocks and higher bonds, indicating that markets are more concerned about slowing growth than rising inflation.
China, on the other hand, is emerging from a deep slowdown triggered by the deflation of its real estate bubble. The government is aggressively stimulating with both fiscal and monetary policy, and equity markets are bottoming from deeply discounted valuations. This is a classic Quad 4 to Quad 1 transition.
Once you view global macro through the lens of these quadrants and understand how the market transitions between them, you’ll be able to better understand how markets will react to events and anticipate regime shifts.
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