Category: Uncategorized

One of the strongest beliefs in currency markets is if a central bank is hiking policy rates its currency will strengthen. Nowhere is this a more powerful thought than in the US, whose reserve currency is dominant and whose policy rates set the tone for global cycles.

I know none of this is terribly new or groundbreaking, and I’ve oversimplified for the sake of parsimony, but here’s the null hypothesis:

The US yield curve reflects a global equilibrium rate for ‘risk free’ financial assets much more than it does any kind of capital formation equilibrium rate. In other words, it equilibrates financial activity, and economic activity is somewhat of a price taker.

Not only is the yield curve much more driven by financial balances these days, but, within financial balances, the share of price-insensitive demand for risk-free assets has grown sharply. And at the same time the supply of these assets has contracted.

Here are a few reasons why:

• Rating agencies were chastened by the GFC and aren’t slap happy with AAAs anymore
• Derivative structurers are, let’s say, more modest in their issuance ambitions
• Insurance companies and pension funds have endless structural demand
• Banks have higher liquidity requirements to meet
• Central bank QEs

This isn’t to say yields don’t react to economic info or don’t say anything about the state of the economy. Of course they do. But the dominance of financial drivers after 30 years of global financial deepening has made attempts to extract economic information from the level and shape of the US yield curve unhelpful–or worse, vulnerable to false positives.

Single name stocks are not my bailiwick, so get your salt grains ready. But we’ve all seen this movie before: A cult-like stock with crazy, revolutionary technology that loses to the 2nd, better funded, mouse that executes better.

And in the case of TSLA, it’s binary. Elon Musk wants the dream and will risk everything to get there. If the switch is flipped, TSLA could easily become a zero.

This is not something I wish, though I do think it is increasingly likely. Musk’s funding is not infinite, production and labor issues are mounting, and the competitors have finally woken up and are gunning for him.

Technically, we appear close to that breaking point. Investors look to the stock price as a sign of a company’s health–even when they shouldn’t. And when a company has chronic financing needs, a bad signal from the stock price–justified or not–can be fatal. The world of finance and economics can be brutally path dependent.

Here are two charts of TSLA that illustrate why the 300 level is meaningful. You can tell me until you’re blue in the face that round numbers don’t matter, but I know from experience we are not that rational. They matter. That’s why I have so may silly Dow hats (okay, not the only reason). And in this instance the round 300 level lines up with important support ranges on two important time horizons.

First, here is the one year chart:

Now, the 30 day intra-day price chart:

Even a TA tourist like me can see that the round 300 level we keep bouncing off is important support in TSLA’s price pattern.

If we close below 300 for a couple days in a row, odds are we are seeing the beginning of the end of the cult.

Everyone is starting to take a look at oil names, and with good reason this time.

Back at the end of July I posted a quick thought on oil, arguing that we were starting to price in the oil industry’s secular headwinds. We had seen a sharp rise in the price of crude starting in mid-July, yet neither big oil or oil servicer names were following. At the same time, market analysis/chatter was that EVs were inevitable and would be on the market sooner than we thought.

Since then the performance gap between crude oil and oil stocks have continued their divergence.

The blue line is WTI, the burnt orange line is XLE, and the white line is OIH.

The upshot is that we have priced in a lot of secular headwind in a short period of time, investors, desperate not to lag the indices in a super bullish year marked by aggressive sector rotation, are likely to turn to the oil sector, as a laggard, to make up ground into year end.

And the charts are constructive.

Here is OIH, from one and 5 year perspectives:

Now, here is XLE, from the same perspectives:

It probably doesn’t matter for now that valuations are not attractive (i.e. oil names are pricing in a big earnings rebound) and that the secular headwinds haven’t gone away. And it probably doesn’t matter that late last week people already started recommending the sector.

What will likely matter most—unless crude oil ‘closes the divergence’ by itself taking a dive—is that people need performance, oil names have lagged crude sharply, and their chart patterns just turned up nicely.

So much for fundamentals and the efficient market hypothesis.

Jay Powell, the all-but-assured incoming Fed Chairman, had his Senate confirmation hearing yesterday. And the whole drive to extract a hawkish/dovish angle from the proceedings missed the point, in two important ways.

One, we should have learned by now that whether someone is hawkish or dovish at a point in time is far less telling than whether they show ability to evolve over time. Powell showed balanced pragmatism, both on monetary and regulatory issues. This is also consistent with his reputation.

Two, Boris Yeltsin might have been a larger-than-life hero in the Russian constitutional crisis of 1993, but he was an abysmal administrator. Bernanke and Yellen were wartime Chairs, technically deep but pragmatic, with a courage of conviction that only comes from a lifetime immersed in the subject matter. But both were shy on political skills. Hard to forget Bernanke’s quivering lip in his first dozen or so Congressional testimonies.

Powell may not have the technical expertise or the courage of conviction Bernanke showed in the depths of the GFC, but the Fed is not longer at war. The path to normalization is all but set. Financial intermediaries have been defused. The next recession is much more likely to be garden variety than apocalyptic—irrespective of what our lizard brains keep telling us.

The challenges now are political. The Fed now needs someone who can stave off the growing efforts of Congress to politicize the Fed and ‘usurp upon its domain’. It needs someone who can keep Elizabeth Warren and GOP troglodytes at arm’s length while the tweak and streamline the post crisis regulatory framework.

Yesterday, Powell showed great promise that he can be that guy.

My longer-term currency views tend to be dominated by two factors: where we are in the global risk cycle and where the ECB and the Fed are in their tightening/loosening cycles relative to each other.

For me, the dominant long-term view today is investors are moving out the risk spectrum because US valuations seem full. This phase of the global risk cycle tends to be bearish the dollar as flows go from core to periphery in search of yield and more attractive valuations.

Pushing in the same direction is the relative cycles of the world’s two most important central banks. The US has raised rates a number of times and is about to do it again next month. It has also started to let its balance sheet run off. It is closer to the end of its hiking cycle than the beginning.

The ECB, in large part due to Europe’s poor and begrudging policy response, is several steps behind in the normalization process. They are very much at the beginning.

This too tends to be bearish the big dollar.

However, these processes are not straight lines. Up until September, the market had been skeptical of the Fed’s willingness and ability to normalize policy along the lines of its forecast. After all, the Fed has systematically over-forecast the pace of policy normalization for years. And as a result of this skepticism, the dollar, correspondingly, remained under pressure. But in September, when it became clear the tapering was going to happen as projected, this all changed, taking the attention away from the ECB’s normalization process and putting it back on the Fed’s. The market, basically, had to play catch up. From then until now, the two-year Treasury yield soared by nearly 50bps, and the odds of a December rate hike went from around 20 percent to 92. And, of course, this triggered a fairly strong counter-trend move in the dollar—one that, admittedly, chopped my currency trading up pretty well in September and October.

Here’s the time series of December rate hike odds:

But the bottom line here is that it looks like the counter-trend dollar rally is now over, and the downward trend is resuming. There are three reasons why I think the narrative of normalization is in the process of shifting back to the ECB. One, Chair Yellen last week expressed more concern than ever before that the stubbornly low US inflation may have a structural component. What’s more, this sentiment was echoed in the Fed Minutes also released last week. Two, the ECB’s Benoît Cœuré dropped a surprisingly heavy hint (one of, I suspect, several to follow) that they may have to move forward the beginning of policy normalization. And he says this against a backdrop of an ECB running out of FI assets to buy and European PMI that are moving from strength to strength. And three, the move in short term US rates and in rate hike expectations have been sharp and have lost momentum, and many currency charts are once again showing dollar weakness.

Here’s the 5 year chart of the BBDXY:

And the 1 and 5 years charts of the euro:

Now, here’s the 5 year chart of El Perro:

And,  the 5 year chart of the Brazilian real:

I have spent the last 3 weeks vacillating between signs on the one hand that the dollar is starting to roll over, and signs on the other that precious metals are on the verge of a big break down—two somewhat contradicting views. But now, at least to my eye, it looks like we have a decision in favor of a weaker dollar.

That said, it is conceivable though not likely, that we get a weakening dollar and weakening precious metals, since the crux of the narrative is that we’re now entering the European leg of global monetary tightening. At a minimum, precious metals should be an excellent funding leg for short dollar positions.

EUR in gold terms looks to be breaking out:

All these charts look to me like a new leg of dollar weakness is upon us. And it seems lined up nicely with the monetary policy normalization narrative shifting back to the ECB.

Good luck, and don’t forget to manage your risk—no matter how strong your conviction.

I’m really excited to roll out the new blog. I have been setting up the locked access functionality for a couple of months now, and linking it back to twitter. Pretty sure this twitter-blog link is a first. Subscribers to @Behavioralmacro will have access to all content on the blog, while non-subs will be able to see unlocked content. I can now seamlessly use both twitter and the blog to share my thoughts and experience.

It’s really easy for subscribers. All you have to do is be logged into Twitter or Tweetdeck (on the same browser), and then, with a one-click log-in (just like any other Twitter app), you’re in. From then on, the access should be seamless and invisible.

Those who don’t subscribe, will see the link to the subscription page if the post contains locked content.

Now, gotta get to it…

(Quick post from the road)

This is a difficult juncture.

For the past few weeks, market breadth has been deteriorating and new lows expanding, as most indices have been grinding higher. Typically, these are signs one sees before a market corrects or rolls over.

We have also started to see price weakness in some areas where investors often reach for risks: the Russell, pockets of emerging markets and EM ccys, MLPs, Agency REITs, treasury curve flatteners, high yield bonds and even vol has ticked up a little. There were a few points last week when you wouldn’t have been blamed for feeling it was just a handful of tech stocks holding the whole market up.

On the positive side, we have entered the strongest season for risk taking. Fundamentals at home and abroad are solid. Earnings on the whole have been good. Significantly, gold and gold miners appear to be cracking. This year has been characterized by strong rotations disguised at the onset of corrections, and this could just be another one. Lastly, I should add, the pain trade still feels higher.

But perhaps the trickiest part right now is investors’ short-gamma mindset. When you’re short an option, the size of your exposure increases as the market moves against you. To hedge or reduce your exposure you are forced to continuously buy if the market goes higher, and continuously sell if the market goes lower. In other words, you’re chasing, rather than fading.

The short-gamma mindset happens every year at this time as the final stretch intensifies performance anxiety, but especially so in big up years. If you are lagging–as many are–and the market powers higher, you have to be in. The FOMO is overwhelming. Some guys will play the laggards, others will want to make sure their end of year balance sheet shows healthy positioning in 2017’s winners. Either way, they chase.

But there is only one thing worse than lagging all year and then missing the end of year push higher: lagging all year and loading up for the end of year push just before the market finally corrects. If this has never happened to you have no idea how mercilessly savage this can be. And since we haven’t had a correction in so long, if one were to come it’s easy to imagine it being larger than the garden variety sort.

In essence, it feels as if traders are short at-the-money straddles and are poised to chase any sharp move that lasts more than a day. Be careful. Now, got to hop.

 

Short-term calls are always tricky, but three precious metals are approaching support levels where their decline would likely accelerate if those levels/areas are breached.

As most of you know, support tends to be support because a lot of transactions have recently occurred there. The more recent, the more significant, because memory is like an exponential decay function of time. And the basic principle is people tend–in a way that is more emotional than rational–to close out risk when an asset returns to the level where they entered the position. You know, the old “I’ll sell it when it gets back to where I bought it” kind of thing.

Here’s are the 31 day charts of silver (SIZ7), platinum (PLF8), and gold (GCZ7). The support areas are very clear, especially with respect to platinum and silver.

Silver:

You can see the level in the front silver contract is 16.60. We are at 16.67 as I write this.

Platinum:

Platinum has huge support in the 915 area.

It also has important long-term support in the 900 area. Platinum has been the weakest of the precious metals for years. Here’s the five year chart below, with a red line drawn at 900. If that breaks, the next logical stop is 810.

The front platinum contract is trading at 919.4 right now.

Gold:

The critical area for front-contract gold is 1267-1270.  We’ve bounced off it twice already. The front contract is 1270.6 right now.

GDX and GDXJ, which are often leading indicators for the metal itself, have already broken their recent lows.

My guess it that it happens and we get the breaks, but from a risk management standpoint, if you don’t already have short positions and you are watching closely, it probably makes better sense to short the break rather than anticipate it (unless you are managing very large AUM). Also, if one goes, the odds of the other two following increases significantly. And if two of the three break their levels/areas, the odds that the third one is about to go are about as good as it gets in our probabilistic business. Good luck.

Currencies are about stories more than any other asset class. There are no P/Es. There is no tangible book value. Concepts like PPP and unit labor cost differentials only exert their gravitational force over the very longest of terms, especially in today’s world of capital account primacy.

The stories don’t have to be true. They don’t have to be grounded in good fundamental analysis. All they need is to be intuitively compelling to a large part of the investor base and consistent with concurrent price action. And, if the price action also happens to run against the grain of heavy positioning, then one has the makings of a powerful trade.

Right now, the odds are good that we are about to have that kind of convergence of story, price action, and positioning in bonds and the big dollar, in particular against the funding currencies.

Patterns

First, the patterns suggest the dollar is on the verge of busting a move higher.

Here’s the one-year chart of the broad USD index that I prefer to track (BBDXY):

Now look at the yen:

The Canadian dollar is not exactly a funding currency, but the one-year chart of USDCAD looks very bid:

Now have a look at precious metals. GDXJ is the best example, in my opinion. And usually precious metal stocks lead the metals themselves. GDXJ appears to be breaking down. Here’s the one-year chart:

GDX, for what it’s worth, is similarly vulnerable.

Then there’s platinum, which most of you who follow my tweets know I often use as a “tell” for precious metals. Platinum has been flirting with 900 for the last two years and continues to underperform the other precious metals. You can see this best on the 5-year chart:

Now, let’s have a look at bonds. Here I use the 10-year note on a one-year chart:

It probably looks worse on a 5-year chart:

Positioning

The bottom line here is that bonds and bond proxies are overbought and investors are structurally short dollars. In addition, a lot of hedge funds have flatteners on. Something like long 30s, short 5s. And precious metals have very few shorts.

Here is a proxy for positioning in the euro over the past 10 years, from the weekly CFTC numbers:

It’s very high.

Here are net platinum positions for small spec over the past 10 years:

And now here are small spec gold shorts:

Low and turning up.

Here’s the CFTC positioning on the 10-year note:

It’s very high and rolling over.

Now, with respect to the flattener. Have a look at the UST 5-year futures and the UST long bond futures:

The divergence is pretty stark. Now, many of the shorts in the 5-year futures reflect mortgage bond hedges, but, still, a lot of people have flatteners on. And this flattener has massive negative carry. More on this below.

Narrative

So, what’s the story and why now? First, tax cuts and repatriation. It doesn’t matter at this point whether it happens or whether it would have the desired effect. The point is right now tax cuts have momentum, and the odds of something passing are going to grow in the near term, not shrink—irrespective of whether something ultimately passes.

The standard macro playbook (again, doesn’t matter if you and I think it’s right) says repatriation will give a bid to the dollar and stimulus will lead to higher UST yields, especially at the long end due to increased supply from larger deficits (plus, in this case, the Taper). Some may even speculate that a tax bill will lead to a more hawkish Fed, even though I don’t think it is that simple. So, in short, it’s easy to slap this narrative onto concurrent price action of a stronger dollar and a higher and steeper yield curve.

It is important to underscore that 6 months from now that this story could have already fallen apart and the relentless structural bid in the long end of the Treasury curve will have already reasserted itself. But I think for now the story meets the criterion of “intuitively compelling”.

That the Trump administration is about to name the next Fed chair and vice chair only adds to the story. Here there are two observations to make. One, most investors have felt for a long time that “policy rates are just too low”, and that a dovish Fed has impeded proper normalization. Virtually all of the candidates (with the possible exception of Powell) think—based on the same set of data—that the Fed should have started to normalize earlier. They also, like many investors, have anchored on a higher terminal rate than the Fed’s current leadership. And this, despite Trump’s offhand comments about being “a low rates guy”, is something investors are likely to keep in mind.

The second point is behavioral. Often when there is an “event”, like naming a new Fed chair, it forces markets to reappraise their views and positioning. In efficient markets, this should be discounted in advance. And sometimes it partially is. But, over my career, far too often somewhat random and sometimes disconnected events have this catalytic effect. Naming new leadership against the above backdrop is the kind of thing that could trigger it.

Within the currency space, I would expect the funding currencies to come under more pressure than the risk currencies, but this will depend a lot on what stocks do. If the bond move (should it materialize) be orderly and incremental, then risk assets could well do fine and risk currencies would outperform. I really think it’ll come down to the speed of a bond unwind.

And, needless to say, it might actually be a good tactical moment for bond vol, the trade that seems to be on the lips of everyone in the macro community. I personally would prefer to put on a 5s30s steepener to play this dynamic. The positioning is favorable, and it carries positively to the tune of about 5.5% annualized. Much better than bleeding theta by being long vol. (It is also not clear to me, despite all the scary charts we’ve seen on Twitter, and all the talk of the Target manager who sells vol, that the positioning is as attractive in vol space, given how many gorillas are long it.)

In short, I think the odds are good that positioning, patterns, and plausible story have converged for a directional push in currencies and bonds. And my preferred way to play it would be through shorting the funding currencies and precious metals, and through paying a steepener in 5s30s. But, as we all know, it is very easy to be wrong about these things, so don’t lose sight of your risk management.