I have been laying out my views explicitly in the substack chat across the last couple of months, you can follow the themes I’ve been tracking and WHY I have specific directional ideas on equities, fx and rates.
Firstly, see the most recent report below for context surrounding my views today.
Jackson Hole was a pivotal moment, as it typically is, and has created a level in FX, bonds and rates that serves as an invalidation for my thesis in being short both ES & ZT:
The positive stock-bond correlation we’ve seen is very telling, bonds are selling off as inflationary pressures mount up while equities get dragged by the repricing of rates.
The views I have for equities, rates and FX will be invaldiated if we break these levels below.
There was around 15bp of hikes ADDED to the forward curve after Jackson Hole, and the meeting strip has been left looking like this:
So there’s now over 60bp of hikes priced in and I’m watching the 2s30s to see HOW restrictive the long-end believes the short-end is vs the growth and inflation backdrop. If we begin to see flattening across the next two weeks, that’ll also be confirmation that ES could trade lower but mainly that there is probably an extreme in SOFR here (I can’t see three hikes being realised in the curve).
The repricing of the forward curve of course DIRECTLY dragged the front-end up and the 2s10s bear flattened in the following sessions, which could finally be an indication that the makret thinks the Fed is restrictive enough on the inflation and growth backdrop. Remember, the long-end prices ANY mistake in the front-end, and for a long period of time the steepening in the 2s10s was a reflection of the Fed not being restrictive enough. But Warsh made it CLEAR at Jackson Hole that inflation is the focus, leaning hawkish and causing ES and ZT to sell off as the dollar bid.
As you guys know, I took off my short USD positions before this event and I made it clear that I was waiting for some moving parts before entering, which we haven’t seen yet. It’s likely that I will flip back to bearish USD once my views on equities and bonds have change. But for now, I expect equities and bonds to continue to sell off as the dollar holds a bid because of the repricing of the front-end.
I also mentioned that going into this week, I will be monitoring these correlations (see image below) before adding ANY risk to my short USD thesis.
It’s extremely important that we begin to see the dollar move with a higher correlation to the forward curve (which we have began to see, if you look at the top chart in the image above). Once these correlations spike it means that the thesis can begin to be built around that single variable (although that won’t be the only input to this trade), and there will be more of an extreme in price, which makes it easier to get onside compared to when the dollar is lacking correlations to its main drivers and is being thrown around my more random variables.
The same goes on the equity side, I want to see the market linkage between equities, rates and the dollar rise above 50% before adding.
My tactical target sent in the Substack chat for ES was 7,655 (which we hit). I am currently still holding this ES short exposure after the target was met and won’t hesitate to hold towards 7,325 if:
The dollar continues to bid as bonds sell off
The Russell underperforms NQ, NQ underperforms ES (risk curve)
Equity vol makes a series of higher highs throughout the next week
2s10s & 2s30s continue to flatten across the week
There are also scenarios where these variables above DON’T play out, yet ES still sells off due to the repricing of short-end rates and oil rallying and holding above $90. It seems to be the case that there is MUCH more in favour of being short here, although my view on the macro regime itself has little changed, I think this will be a smaller drawdown in the grand scheme of things.
Let’s also not forget that there is movements in terms of the carry trade with the Yen continuously being thrown around, bidding hard and then mean reverting as the intervention struggles to defend many levels.
It’s likely the case that if there is no monetary or fiscal policy change in Japan, the Yen will eventually just sell off back to levels it was at pre-intervention. However, the crucial tail-risk is that if there is either 1) continuous intervention which bids the Yen past the levels we’re at or 2) monetary or fiscal policy change, then equity positions WILL be taken off by big players and it could lead to further drawdown in ES because the Yen is funding a tonne of positions.
Also, the whole enegry shock story really isn’t over. Consideirng this conflcit began with the idea that it’ll be resolved with speed, we’re now many months in and oil is back above $90 which only increases the likelihood that this inflation feeds into core CPI. This is of course another tail-risk that ia posing to equities. Inflation is clearly the risk, growth has been mitigating these risks for a long period of time but we’ve now come to a crossroad
Thanks
Alfie
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