Ok, well it’s safe to say that former FX trader Richard Breslow has his “ear to the street” or his “finger on the pulse” or whatever other cliche you want to conjure to convey the notion that someone is generally aware of what’s going on.
Breslow’s Wednesday missive was spot-on and he’s back on Thursday with another piece, documenting the preponderance (he calls it an “explosion”) of large block trades in rates, something we have flagged repeatedly this week (see here, here and here, for instance). Recall this screengrab from Tuesday:
Breslow also notes that the Fed is effectively laying the groundwork for a “currency Cold War,” by consistently undercutting a USD that’s already on the back foot thanks to jitters about gridlock in Washington and the Trump-Russia probe. Remember what happened to the greenback just as the Fed decision crossed:
Finally, do note that Richard thinks the Fed has made a mistake by leaning dovish, kicking the can, and giving themselves an out if they need it (recall the “relatively soon” line from the July statement).
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I’ll leave it to others to debate if and when the FOMC will ever learn to communicate effectively with the market. Or the efficacy of what they seem to think is an holistic approach to monetary policy-making by conjuring up convenient and, sometimes, dubious headwinds or tailwinds to justify every halting decision. What they did was very simply kick the can down the road to avoid making any decision before the start of autumn. And it has nothing to do summer liquidity (myth), saving up for Jackson Hole, nor a “somewhat” new interpretation of inflation trajectory and slack in the employment situation.
- It’s that they are only human and well aware of the fact that August has repeatedly been a cruel month for upsetting their best-laid plans for September. They bought themselves the optionality they crave, even if they unwittingly paid up for the privilege. It’s always easier to be a free-spender with other people’s money
- So while we wait, what should we be thinking about? First off, they are conveniently forgetting that foreign exchange is a two-sided trading instrument. They’ve frequently complained about the drag from dollar strength. In enacting a policy approach that is meant to stoke inflation from currency weakness they seem to believe that exporting deflationary pressures to the likes of the euro zone or Japan will go unnoticed, unremarked upon and ignored
- It’s certainly been a home-run trade this year to be short dollars but don’t expect the ECB to respond to a hesitant Fed by becoming more aggressive in their tapering rhetoric. There’s going to be a lot more volatility as the market shifts back and forth on handicapping what could easily morph into a currency cold war of “He said, she said”
- It would be prudent to be very calculating when selling vol here. As we’ve seen in the rates markets, even in the context of very low measures of volatility there have been some extraordinary opportunities for tactical longs. And tactical success can lead to strategic re-assessment
- There’s been an explosion in the use of large block trades across rates markets. They move markets, but also confuse the algorithms, magnifying the short-term effect. There’s been nothing continuous nor smooth in the volume charts. This strategy promises to become increasingly popular among major players and makes short-term trading all the more problematic
- It’s worthy of note that the preponderance of these trades of late has been to the sell-side, which very well could help explain the price action after 2 PM yesterday. This might show a growing consensus on where things are eventually going. But a word of caution: they can’t be front-run and whether they have a lasting effect will be known only in retrospect when it will have been obvious and not very useful. We could very well be seeing a market-structure change right before our eyes. Something to regale your interns with
- It looks pretty obvious that despite analysts telling us that the Fed would do nothing yesterday and being proven right, traders got hurt on the news. My guess is, rightly or wrongly, once the pain subsides, no one’s deep-seated views will have changed. But navigating the price swings may require a new approach going forward