The negatives are seemingly outweighing the positives, Nomura’s Charlie McElligott writes, in his Friday morning note.
What are the negatives? Well, the weakest pace of industrial output growth since 2002 in China is one issue weighing on sentiment to close the week. In addition to that, there’s news that India is set to hit back at the US with retaliatory tariffs after Trump yanked the country’s GSP status earlier this month. The India story was lost in the shuffle amid the Mexico drama but pulling India’s GSP designation was a serious escalation.
In case you missed it: While You Were Distracted With Mexico And China, Trump Started Another Trade War
Those two stories, McElligott says, are outweighing what might otherwise be a trio of “equities short squeeze inducers” including an agreement between the US and China to suspend IP theft litigation in the WTO until the end of the year and an MNI sources story about Xi and Trump talking at the G20 (these MNI “exclusives” occasionally move markets).
Generally speaking, Charlie says folks “hate the vibe in equities into the G20” as nobody has an edge. And yet stocks remain buoyant, which he calls “typical bullish behavior into June’s serial OpEx.”
The big story, of course, remains in the rates space, home of a multitude of “psycho-bid” (to quote Bloomberg’s Cameron Crise from the other day) expressions which Charlie reiterates are “the most crowded trades in the world”, all in one way or another predicated on the same thing (Receiving in Rates, long ED$ / USTs / Duration, long Steepeners).
“Will there be further follow-through of the ongoing ‘stress event’ in USD rate vol. space, as the upper left is evidencing tremendous pain for dealers who are hedging their short ATM positions and exacerbating this outrageous front-end squeeze?”, McElligott asks, on the way to getting a bit more granular as follows:
USD Rate Vol Dealers- (long wings but short ATM) are seemingly being LIT ON FIRE (along with systematic “Short Vol” strategies to a lesser extent, as the whole surface is ‘bid’ i.e. 30Y tails in the vol cube below) by the stunning- moves in the “upper left” of the USD Swaption / Vol grid, as “Short Gamma” / “Negative Convexity” strikes again.
And so, it continues. “This is further exacerbating the grab into ED$ futures, with seemingly perpetual short-dated UPSIDE expressions trading”, McElligott adds.
Meanwhile, gold has broken out, moving above $1,350, the highest since April of last year, amid collapsing US reals and a mounting sense that the dollar might have finally run out of luck as the Fed gears up for an easing cycle.
“Gold breakout equals the ultimate ‘Short USD’ expression into mounting dollar pessimism across macro, as there is no central bank on the ‘other side’ who can pivot more dovish to offset the Fed’s coming easing cycle”, Charlie writes.
Remember, part of the dollar’s resilience in 2019 is down to the FOMC’s global counterparts leaning dovish as the Fed pivoted. Once the Fed becomes an “active” easer (so to speak), it will be impossible for other central banks to offset that and if the US economy rolls over, both pillars of dollar buoyancy would crack. Obviously, the US fiscal situation is dollar negative too (see the US budget deficit widening to $738.6 billion in the first eight months of the fiscal year, a ridiculous 38.8% increase versus the same period a year ago).
“US Real Yields are collapsing as the data and inflation slows, along with the mounting potential for an ‘activist’ Fed, all of which sets the table for this conditioned commencement of Fed easing cycle / QE-trade winner”, McElligott writes, of gold. There’s obviously a haven bid going on too amid worsening geopolitical tensions.
(Bloomberg)
Coming back to the rates trade, McElligott quotes Nassim Taleb as follows:
Anything that provides you with very, very stable income, very stable conditions–maybe generally stable, that often, it masks real risks, risks of blow-ups.
I’m not sure Nassim has that exactly right. It should be something akin to: “Anything that provides you with a seemingly stable income in very, very stable conditions most of the time can be a source of blowup.”
As one strategist I spoke to on Friday noted, a counterexample is very long dated volatility in rates. “It rolls up positively [with] annualized carry around 3.5%”, this person said, adding that “you can lose your premium, but you are long convexity and can never blow up.”
Taleb is basically just reminding you that while you may feel healthy, you might have an aneurysm that could kill you where you stand.
Gold’s apparent ‘break out’ above USD $1350 THIS MORNING MAY HAVE BEEN A ‘HEAD FAKE’ AS IT HAS SINCE DROPPED BACK TO $1340 +/-.
It’s called “resistance” for a reason.
It’s been acting more like a ‘hard cap.’ Clearly major forces (Central Banks?)don’t want to let the ‘genie out of the bottle.’
Could you expand on the “very long dated volatility in rates” strategy?