Ok, so it’s Tuesday, which might as well be Monday thanks to the US and the UK being closed yesterday.
I don’t mind penning “news-ish” market updates, but as regular readers here are probably aware, I prefer to outline my take on market themes or macro trends that I think matter from a big picture perspective. Even my coverage of LendingClub is more about what I think is a broad misconception of P2P than it is about LendingClub in particular against which I have no particular grudge whatsoever.
That said, there are certain inflection points when documenting or, and I’ll use a term I despise here, “recapping” today’s moves in certain asset classes becomes a necessity - one of those “we’d be remiss if we didn’t” type of scenarios.
Not to put too fine a point on it, but we are at one of those inflection points.
You gotta watch the 10Y. You gotta watch the USD. You gotta watch crude. You gotta watch the CNY fix every night. Gold - eh. Own it as an inflation hedge, but as I wrote earlier this month, when the apocalypse comes, it’s pretty much the last commodity you want to own. Unless you need to beat a zombie with your physical bullion.
Anyway, the point is this: when the Fed shifted the rhetoric following the release of the April Minutes, it suddenly became critical for equities traders to watch all of these things closely. Every day. The market is forward looking and you need to get a read on how your positions are likely to react after a June or a July hike. Fortunately, you can indeed get a sneak peek by keeping close tabs on everything mentioned above. I quoted BofAML on Monday and I’ll do it again here because I think they really capture the essence of this concisely:
“While the combination of 60% market probability for a hike by July and 2090 on SP500 seems like a near term win for the Fed, the underlying ripples are already noticeable - the dollar is up 2.3% mtd, USDCNY is at its highest levels since Feb and market expected terminal rates are lower. Softening the blow somewhat has been the continued discounting of the Fed's projections for 2017 and 2018 and the rally in oil. Nevertheless, this re-iterates our central theme over the next several months - the ability of the Fed to deliver a ‘dovish hike’ will be repeatedly questioned, with the market fighting back with a dollar rally, lower breakevens and lower terminal rates, every time the Fed nudges it to price in higher probabilities.”
In other words: as trivial as 25 bps may seem (and most certainly is), the market believes it matters, and that obviously becomes self-fulfilling.
As I also put it on Monday, the idea of the “dovish hike” means the Fed essentially needs to hike without hiking and the fate of your portfolio might just depend on how successful they are.
In my opinion, you should ignore (or at least be wary of) any analysis that purports to define “success” or “failure” by any one specific measure. For instance, real yields. Or the USD. A knee-jerk move in any of the relevant variables will be bad news if it doesn’t partially reverse itself by the end of the session after the hypothetical 2 p.m. ET hike, or at the very least by the end of the relevant week. Let’s take Deutsche Bank’s analysis for instance which I quoted here on Monday: “...the policy error comes if real yields return to their December 2015 highs, around 80 bps in 10s.”
Now sure, all of this moves in tandem to a certain degree, but trust me, real yields below 80 bps on the 10 will be small comfort to you if someone over at the PBoC abruptly sets the yuan fix 2% lower overnight. Or let’s say, for instance, that a thoroughly spoiled market doesn’t view the hike as a vote of confidence in the US economy but rather as the product of the Fed boxing themselves in with their own rhetoric and the result is a flight to safety. What happens then? Does the 10 rally? Does the yen get a safe haven bid? That would be a disaster for equity investors as well.
All of this can get confusing. Especially if you’re the type who just says “hey look, I just want to trade equities and equity options and make money, and all this other stuff is a real annoyance to my thought process.”
But you needn’t fret over the details of what counts as a “policy error” or muse about what a bunch of unelected PhDs may or may not be thinking. Let me tell you what you need to watch for. Put the 10Y on your radar if it wasn’t already. And the dollar index. And Brent. And WTI. And (this is important) the onshore yuan fix. That last one is easy if you have a terminal. If not, don’t worry. Just Google it in the morning. If the previous night’s fix came in notably low, someone will be talking about it.
What you want is rational, measured moves that reflect the reality of the current environment without suggesting someone, somewhere is - to be colloquial - freaking out.
You don’t, for instance, want to see a sharply lower yuan fix followed in relatively short order by a steep sell-off in crude.
Or some kind of irrational USD spike that completely spooks US markets by creating exaggerated fears about US corporate profits.
Perhaps worst of all, you definitely do not want to see a sharp repricing of US rates and a concurrent panic in EM. If you see that, you might want to raise cash.
Fortunately, you’ve got time here. You’ll get ADP this week, then of course NFP on Friday and you’ll even get Yellen again on June 6.
So far I have to say, things have been relatively orderly (as the above cited quote from BofAML suggests). Here’s a look at the 10:
(Chart: CME)
I show the YTD to give you some context on the size of the recent repricing around renewed expectations for a summer hike. You can clearly see the sell-off around the hawkish Fed speak and the pronounced weakness on the April Minutes release but let’s compare that to the taper tantrum. Then, yields rose something like 130 bps in four months.
How about oil? Well, it’s back near $50 ahead of this week’s OPEC meeting which most expect to be a non-event despite the tensions between Saudi Arabia and Iran around this year’s Hajj. Generally speaking, that’s probably bearish over the long-term as tensions between the sectarian rivals will likely cause them to both keep the spigots open essentially just to spite each other, but in the near-term, I’m not sure that really matters considering everyone is already pumping at record rates and has been for months. “Strong U.S. consumer spending data also supported oil prices,” Reuters wrote Tuesday, “despite concerns that a robust economy could encourage the Federal Reserve to raise interest rates soon.”
As for the USD, well it’s of course trending higher lately, as it should given the hawkish Fedspeak, but let’s look at positioning:
(Chart: Citi)
Citi sums up the situation quite nicely: “Net positioning in our aggregate USD index flipped back into net long territory [but] it’s noteworthy how none of this current FX positioning seems particularly stretched in a historical context.”
So what’s the takeaway? There’s really nothing to write home about right now.
You should be aware that China did set the yuan fix at its lowest level since 2011 last week, and Bank of Singapore FX strategist Moh Siong Sim said today that the currency could very well face more pressure going into next month. The reference rate was cut to its lowest level since February last night, but in absolute terms, the move in the fix was just 0.01%.
In a way, it’s “all quiet on the Western front,” so to speak. But keep your eyes open and remember, this is an increasingly interconnected global market, so when a butterfly flaps its wings...
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