Hedge Fund Ramblings on Risk

I often have exchanges with old friends who are institutional HF managers. I’m lucky to have such a sharp, experienced and dialed-in network. Sometimes I clean up my side and post it. Here’s the latest stream of consciousness on the current state of risk over the medium term. It lacks nuance and respectable syntax. But I hope you can still infer the questions and arguments that provoked it. And I hope it’s helpful.

Thanks for your thoughts. I think the rolling global deleveraging we’re going thru keeps a loose cap on Fed rate hikes. Also think the Fed wanted to get a hike on the books to shake the risk tree early and get out in front of growing financial stability concerns, what I call ’Avalanche Patrol’.

On oil, not sure where it goes, but the correlation to other assets has been dropping and guys have stopped trying to trade every tick. For me, this opens a lot of encouraging doors. I’m looking to a flip to positive in the euro and SPX corr to confirm USD M-T top. Could even happen w/o it, but I suspect not.

I think the selloff in equities was recession fear coupled with ‘QE coming out of system fear’, splashed with negative rates. Agree no recession, but I think the QE coming out of system was a scare, not a reality. It never really went into the system in the 1st place and the economy/earnings have largely caught up with asset markets. The effect beyond pockets of fixed income was mostly psychological, IMO. The new-found ‘impotence of the Fed’ argument is a reflection of that. The money trade last 8 yrs has been fading fear of Fed, and I think it still is; it’s just to a much lower degree these days, as many have figured the transmission mechanism of monetary policy out by now.

Chinese depreciation is likely. Agree they need it. Dollar unit labor costs went up massively there. A euro rally would take much of that pressure off. Muddle thru way more likely than collapse.

The deval play in CNY IMO is not a good one. The ‘they’ll be forced to print and this means big depreciation’ story has too many holes in it, empirically, for me to even start rebutting here. China will go slow and take every precaution not to do anything destabilizing. This has long been their MO. And the outsized reaction to their small Aug. move scared them.

Also, much of my broader view on risk assets is really about how much sentiment swung. The breakout in things like iron ore and AUD is much more about reversion from extreme sentiment than identifiable fundamental change. But it could run a long way–possibly long enough to give fundies a chance to come around. Late last year I started saying it was too late to short EM and commodities, and now, at this stage, I want to be with it, not just not against it.

Agree Brexit has long term implications for the EU–which is L-T unsalvageable–but I don’t think it would be a huge market mover in the near term: if it happens it will have largely bled in prices by then. The really bad stuff in EU (I think) will now be well into the future and driven by politics, not market-induced financial shocks. ECB et al have finally got out in front of this concept.

Lastly, look at the chart of BBDXY (most representative USD index IMO). It’s on the cusp. All the macro guys I talk to are still bullish USD (tho less positioned; tell me if you hear/see differently). If you add to that the stretched move in EM FX, the move I cited in iron ore and AUD (and other assets), the deepening realization that the Fed, structurally, is going to go super slowly and is not committed to its dots, I want to bet on a weaker USD. I am waiting for Draghi next week and corr to SPX for definitive signs. Had a really good year trading last year which, paradoxically, may have made me too cautious–afraid of the hubris effect, or that the luck has run out. In short, I want a really good pitch. Hope Mario and market reaction don’t disappoint!! It’s really easy to be wrong at junctures like this. But the asymmetry here is good (e.g. euro stop at 1.08 vs, say, 1.22 upside).

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