“Canary In A Coal Mine Or Siren Song”?

Bright and early.

Me. An espresso (I skipped the frothed milk this morning in favor of pure, unadulterated rocket fuel). A cigar. Sunrise. Richard Breslow.

Just a normal Heisenberg morning.

I’ve talked exhaustively about the reflation trade. How it’s ebbed and flowed. How we’ve retraced over the past week or so and especially following Trump’s inauguration speech.

I’ve also tried to put extreme positioning in context. The massive spec Treasury short is a four sigma event. Not quite a black swan, but “swan-ish” – as I like to say. When you look at hedge fund positioning relative to history (and then expressed in standard deviations), the Treasury short is a tail event.

Once again, all of this – the dollar, Treasurys, and yes, stocks – are essentially a referendum on Trump and, in the final analysis, the US economy.

The Fed is along for the ride. To hike or not to hike (financial conditions seem to be favorable versus this time last year)? Should we let some of the SOMA portfolio start to roll off? If we do, will we effectively be hiking? Will tighter monetary policy short circuit fiscal stimulus? If we wait too long, will the inflation-growth mix turn sour? And on, and on.

On Tuesday morning, Breslow has outdone himself when it comes to capturing where we stand and how we should think about markets.

Below is his latest. Enjoy.

From Bloomberg’s Richard Breslow

There are a different set of basic trading rules that might help navigate markets in these unusual times. Ordinarily, I advocate trying to distill the number of factors I look at to the fewest possible. Pick a currency. Pick a bond. In normal times, fewer factors reduce forecast error. You don’t want to double count inputs replicating the same bias. Let’s face it, if it were possible to understand markets using only one input, you would have found the Holy Grail.

  • But I strongly suspect you’d be better served widening your net right about now. With so much noise affecting any given asset or asset class on any given day, perspective requires a more holistic approach. The much sought-after lilt of the canary in the coal mine is just as likely to be a siren song
  • The rise in intra-day volatility creates better short-term trading opportunities. And I much prefer knowing the actual day’s ranges when looking at charts. But I’ve switched over to tracking things by the closes. We’ve gotten way out of practice accepting that big moves on a day are as likely as not to be random walks taking bigger steps
  • Much has been made of the supposed dangers of shorting the UST 5-year. Consider that the retracement has been minuscule given where leveraged funds began building their shorts. Crowded trades don’t work — unless they’re right. And ask yourself how much of the real-money buying is just about asset-liability management
  • Be mindful of lumping all Trump trend trades into the same boat. They may have started for the same reason, but they don’t need to finish that way
  • Too much has been made of the strong dollar. Nevertheless, the up-move has stalled. For now. But push-back on dollar strength has led to much greater speculation on the Fed’s balance sheet
  • Shortening re-investment duration can be tightening without the same dollar impact, goes the argument. Something for nothing. But don’t forget Chair Yellen last week. “Shortening in the average maturity of the central bank’s bond holdings and the approach of an eventual reduction in its balance sheet could increase the yield on the 10-year Treasury note by 15 basis points this year.” It pays to read the footnotes as well as the headlines
  • It’s a complicated world, getting a lot more complicated. Even if pundits at the moment want to focus on America first and last. But this is no time to ignore all the moving parts. The chrome on the pipes doesn’t make a machine run

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