Ok, how are you positioned going into Q4?
Obviously, a lot hangs on whether the policy divergence theme between the U.S. and Europe reasserts itself. That, in turn, hinges on whether i) the Fed remains determined to stay the course on hiking again in December despite subdued inflation, ii) Trump and the GOP are able to make some meaningful headway on a fiscal agenda that’s been stalled pretty much since Day 1, iii) whether the German election marked a turning point beyond which jitters re: the persistence of populism in particular and E.U. breakup risk more generally prompt Mario Draghi to rethink plans to move definitively in the direction of normalization, and iv) whether the data continues to look better in Europe than it does in the U.S. How that all plays out will determine whether the policy divergence theme that dominated headed into 2017 reasserts itself, or whether the policy convergence theme that deep-sixed the dollar and drove up the euro this year continues apace.
Meanwhile, the EM/carry story also depends to a certain extent on the factors outlined above. Remember, Fed tightening and the effect a more hawkish lean from U.S. policymakers would have on the dollar is much more important for the durability of the EM rally than whether Mario Draghi (who is already starting from behind vis-a-vis the Fed) decides to start gingerly moving to normalize. Meanwhile, the country-specific, idiosyncratic risks are ever-present (think: Pyongyang for the Kospi and the won, the Kurdish drama for Turkish stocks and the lira, and political turmoil for Brazil, just to name a few).
And then there’s the question of whether vol. can ever sustain a bid. Truth be told, we no longer really know what would happen in the event it did spike sustainably.
So that’s the backdrop against which you should consider the following summary of where things stand from a macro perspective headed into the final stretch of 2017 by Bloomberg’s Cameron Crise.
There is a pronounced seasonality to trading thematic global macro. While there are a number of indexes that purport to track the returns of the strategy, they generally all convey the same message: that the last quarter of the year delivers outsized returns. This is at least partially a function of the fact that macro investors tend to pick one or two themes and allocate to them aggressively in Q4 to “make their year.” So the key question for investors is which themes will make the grade this year? Let’s take a quick look by asset class:
- In FX do you choose the dollar or do you choose the euro? While the decision is obviously more nuanced than that, given market correlations this is what it essentially boils down to. 2017 has seen the dollar knee-capped by political considerations and weak inflation dynamics, but that picture may be about to change. The German election shows that European populism isn’t quite dead yet, while indicators such as the new NY Fed gauge suggest that U.S. inflation isn’t, either. Ordinarily this would appear to be an ideal setup to play a dollar bounce — but that might be difficult until we know the identity of the new Fed chair
- That issue also dominates the fixed income picture. The U.S. market looks woefully underpriced for a continuation of the Fed cycle but will require a catalyst to right itself. If Donald Trump nominates a hard money/anti-regulation type to be the next Fed head, the short end should sell off — and take bonds reluctantly with them. A low rate/pro-regulation nominee, on the other hand, could see the long end perform well. Either way, a further flattening of the U.S. curve might just be the ticket
- In equities there may be some sense that stocks, like Icarus, are flying a little too close to the sun — and will crash and burn. While valuations in many sectors and regions are lofty, equities remain broadly underpinned by solid global growth and accommodative monetary policies. It may be a case of piling into what’s worked best this year — EM, most notably, despite the lack of any sort of pullback there
- In commodities, is this the time that crude oil finally breaks meaningfully above 50? I would suggest not — look for U.S. rig counts to start rising again in an “Econ 101” supply response to higher prices.
- Perhaps the most obvious trade is to go long volatility with cross-asset vol some two standard deviations below long-term norms. Then again, that trade has been obvious for months and is usually costly to carry
- Look for a catalyst to spark the market narrative coalescing around one or two themes. A Fed chair appointment is an obvious one but doesn’t appear forthcoming any time soon. ECB tapering is well-telegraphed and China’s Party Congress is more likely to influence the next five years than the next five weeks. As always, keep one eye on left field for the “unknown unknown” that could shift the market’s thinking