Volatility to pick up again
If you’ve followed my notes and or twitter feed, may have noticed it’s been a good several weeks trading up and down these wild swings, particularly in US equities. Charts are still looking bearish for the most part and I favour fading strength this week. I also think USD will make a come back and make new highs. More below.
LAST WEEK’S ACTION
A mostly risk-on cross-asset profile last week:
- Having closed at the lows the prior week, nearly all currencies rallied against the USD. EUR rally seemed to have taken the driving seat in FX markets last week. JPY and USD sold off almost equally with USDJPY flat for the week even as US real yields rose to new highs. Risk currencies struggling to hold onto gains.
- ECB signalling the possibility of rate hikes later this year saw a 25bps rise in Bund yields, and 35bp rise in the Schatz making the EUR the strongest performer in FX while upsetting European equities
- US equities followed through on the prior week’s reversal but struggled to hold onto gains.
- Treasury futures sold off with yields higher across board.
- Crude Oil continued to rip higher, metals benefiting from a softer USD.
EQUITIES
European equities the weakest, NASDAQ led gains in the US while Canada’s TSX has overtook India’s NIFTY and Sweden’s OMX, all of which were among the top yr/yr performers last year.
MSCI World and ex-US pulled back and closed around the key pivot area after rallying above. Technicals (trading below the short-term 20/50day moving averages) still suggest selling on rallies is preferred despite the strong the 2-week bounce.
Rally in European Developed markets (VGK) falling short of the 20/50dma’s while Asia-Pacific Developed markets (VPL) is holding onto the 100dma after closing the gap.
NIKKEI, HSI and XJO produced a bullish inside week hinting at some potential follow through in the coming days for APAC equities, however it seems unlikely gains can be sustained above the pivot area close above.
Looking at the stronger performers NIFTY OMX and now TSX, which I like to monitor to gauge broad sentiment, the former two have reversed from the upper ranges last week and looks likely to drift lower. TSX on the other hand shot back up towards ATH’s after a string of strong earnings results. It has lagged behind behind some of the top performing benchmarks over the last 2 years but still one of the more bullish looking charts out there and one to watch for failure, especially as we approach the end of earnings season.
Lastly, looking at large-cap US equities, last week saw a strong bearish reaction from key pivot levels which from a technical perspective looks to be ‘shouldering’ after breaking away from the upper ranges i.e. the ‘head’. Ominous signs should these lose last week’s gains in the days ahead.
I’ve been a seller of the rally after closing my longs in NDX as somewhat expected and planned around the “major pivot level roughly 3% higher from here” noted last week. I probably shouldn’t have been as surprised to to see it rally as much as it did, particularly NDX extending 5.13% from last week’s close.
Confusingly, this happened as bonds sold off and yields surging higher, which ‘should’ counteract rallies in the high duration NDX — a good example of outsized moves caused by dealer short-put delta hedges unwinding, and very likely we will see more of this type of action.
Now that we appear to be ‘shouldering’ off to carve out a broader head and shoulders pattern and risk premiums having reset as a result of the big bounce, I expect to risk premiums and negative dealer gamma to start building back up again to produce another bout of volatility.
Should be fun and more importantly, some great 2-way action to take advantage of!
RATES
Global yields surged higher last week:
EUR yields rose ~20+bps…
exceeding the rise in US yields which rose ~15bps last week.
I’m sounding like a broken record mentioning the same point since the end of last year but Yields just continue to make new highs. Real yields (Green, bottom) is ever more likely to stay well off the 2020/21 lows as the 10year (Blue, bottom) looks to go above 2% while long term inflation expectations (5yr 5yr Forward) moderates towards the 2% mark.
TIPS also saw the largest outflows since April 2020 which clearly shows investors are no longer concerned about longer-term inflation.
We’ve seen elevated rates volatility again coming into February. USD strength tends to follow elevated rates vol which should continue to increase should the 10year yield take out the 2% mark.
COMMODITIES
CRB commodities index (Orange) continues to rip higher, and even more eye-watering is the CRB ex-Energy index (Purple)…
Energy and Agriculture, also being less anchored to real rates, appear likely to sustain upside as the easing of supply chains is likely to take time while demand remains robust, as well as some Geopolitical risk.
Gold is looking increasingly vulnerable as it is unable to hold gains for very long. Further as noted above, Real yields has with near-certainty bottomed with all the major Central banks tightening policy to turn inflation expectations lower. Interestingly the 1year 1year forward (Green) made new highs last Monday, the highest since May 2020 and should be interesting to track if trading Gold. Should nearer-term inflation expectations (Green and Blue lines) rollover, Gold and precious metals would be increasingly vulnerable. Gold is trading more like a deflation hedge now and even with that in mind, price action has been confusing me recently.
FX
- USD & EMFX — USD pulled back last week mainly due to EUR strength, as well USD longs continuing to cover as well as getting squeezed on some sharp risk-on moves. I’m particularly interested at the fact that Speculators are net short again vs EMFX as I like selling ZAR and MXN this week. We saw a surge in major yields last week, and should some of those trends continue, barring EUR, I think FX has some catching up to do, especially the more rate-sensitive EMFX.
- EUR — has followed rate differentials higher but has since dropped off as US yields played catch up. Still to early to say whether this is simply attributable to the difference in timezones, so I will be watching rate spreads and 1 and 3month risk-reversals for topping signals. For now, EURUSD looks on path towards the 1.17 handle.
- GBP — is showing tentative signs of topping, and in-line with my view for risk drifting lower, GBP is likely to suffer from the risk off. GBPUSD printed a bullish engulfing on Friday, and the 3month 25delta risk-reversal moved lower while cable moved higher from mid-week onwards.
- Commodity Dollars —is looking rather bearish on the above index view. If I was to go short one these currencies, it would most likely be the CAD as it has IMO the largest potential of rate hike pricing being too excessive, while economic data momentum is with the Antipodean currencies. Also as an albeit weak but added factor, Oil rally is getting extremely stretched and I think a technical pullback is in order. Newsflow of improving Diplomatic relations with Russia while OPEC+ continuously looking to expand output as well as production capacity to take advantage of higher prices would help to trigger a correction.
TRADE VIEWS/IDEAS
- Short Nasdaq — could get seriously ruffled by the rise in yields as it was mostly obliviously to the big rise last week, being distracted by a large short-covering squeeze. Could get nasty if Nassy starts to play catch up.
- Long USD (thematically speaking) — rates volatility has been picking up recently and USD strength tends to follow. I also further expect Equity vols to pick up again which would fit in nicely with the rising yields backdrop as to cause some VAR shock. Furthermore, the effect of higher US real yields and a potential recession on the horizon could keep USD well supported into the medium-term and beyond.
- Long USDMXN (possibly USDZAR) —for reasons detailed above.
- Short CADJPY — not only has the CAD trend turned technically bearish, there are a few factors which could help the CAD lower — rate hikes overpriced, and overbought Oil vulnerable to correction.
