Ok, so Wednesday’s column from Cameron Crise is good.
One of the things Cameron is particularly adept at is pissing off Jeff Gundlach. But another thing he’s good at is taking a simple, readily observable dynamic, breaking it down, looking more closely at the numbers, and just generally fleshing it out.
Here’s the readily observable dynamic:
Spot the odd one out since the election.
Again, that’s as 30,000-foot–ish as possible on purpose. That is, it’s just the simplest way of visually communicating the fact that equities (at least at the benchmark level, although if you look under the hood the picture isn’t as pretty) are still ebullient even as yields and the dollar are clearly priced to reflect the reality of the situation: namely that Trump’s growth-friendly agenda is D.O.A. and the incoming data has been lackluster, especially on the inflation front.
That obviously raises questions about the extent to which fiscal policy is prepared to take the baton from monetary policy or, translated, it suggests Janet Yellen can’t be too aggressive.
Positioning reflects this. TY longs are now at 2+ standard deviations (going back 5 years):
And you already know the story on positioning in the dollar (black line is agg.):
So that’s the setup for Crise’s latest and his point is that although there are plenty of reasons why yields and the dollar look like they do, at a certain point “bad news gets more than fully priced in.” And indeed that’s why extreme positioning can be a contrarian indicator.
Read below, and do note that what Cameron wanted to do was channel Team America, only he couldn’t use the word “fuck.”
Tuesday’s edition of this column suggested that asset markets might need to price in an element of “Team America” style geopolitical risk. The reference, of course, was to risky assets like equities and credit where volatility is low and there seems to be lots of good news in the price. Fixed income markets, on the other hand, arguably skew too far the other way — pricing a litany of bad news that will prevent monetary authorities from tightening or otherwise normalizing policy. For bond traders, problems could arise if markets take a look at the U.S. and say “America! Heck yeah!” .
- Let’s be clear: the U.S. has offered plenty of disappointments thus far in 2017. From the failure of Trump’s business-friendly fiscal agenda to weak inflation to a string of poor early-year growth figures, there are reasons why the dollar has sold off and bonds have rallied
- At some point, however, bad news gets more than fully priced into rate markets — and it looks like we’re there. One month dollar OIS swaps one year forward are now just 17 bps above the level of effective Fed funds. That’s the lowest since the mid-2016 growth scare, which broadly coincided with lows in the dollar and Treasury yields
- While Wednesday’s Q2 GDP revisions are obviously backward-looking, they do paint the picture of a fairly healthy economy. Consumer spending grew above 3% Q/Q and business investment growth was strong. Moreover, both the Atlanta and St. Louis Fed’s nowcasts project Q3 growth above 3% as well. That’s hardly the stuff of ending a rate cycle, now is it?
- To be sure, the risks sketched out in the earlier column remain, and they are one of the reasons that it makes sense for the market to price less tightening than the Fed projects in their infamous dot plots. That’s particularly the case given the uncertainty over who will lead the Fed in 2018 and beyond. Still, the gulf between “pricing less than the dot plot” and “pricing almost no tightening” is still pretty wide
- We also shouldn’t forget that expectations tend to mean-revert. Since the start of 2015, there is a decent negative correlation between the amount of Fed tightening priced over the next year and the subsequent three-month change in Treasury yields. If past relationships hold, the current level of Fed pricing suggests that 10y yields should rise 20 bps over the next few months
- Successful trading and investing is all about identifying asymmetries and exploiting them by deploying capital and managing risk. For now, those risks are skewed toward more rather than less Fed tightening being priced