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Editor's Note: Hamish Risk | March 16, 2020
In today’s Macro Briefing we focus on the ongoing turmoil in global markets as the effects of the coronavirus and plunging oil prices continue to make their presence felt. Macro Risk Advisors address reports of a huge position in the equity options market that could add to the instability in equities ahead of this month’s expiries. HSBC gives an honest appraisal of the outlook for government bonds as Treasuries hit extreme levels, and CLSA turns to South Korea in an attempt to identify the real COVID-19 contagion rate – crucial for any meaningful forecast of its longer-term effects, and to highlight one company that is set to benefit from the global demand for testing kits. Elsewhere, Trend Macro asks whether Russia’s real target in the oil-price war is the US fracking sector, and sets out what President Trump can do about it, while Eurasia Group explains why Moscow might return to the negotiating with Saudi Arabia sooner that the market expects.
geopolitics oil markets Russia Saudi Arabia Eurasia Group
1. Russia likely to come back to the table
The latest note from Eurasia Group explains why Russia will likely return to the negotiating table with Saudi Arabia after the collapse of last week’s oil talks resulted in an effective price war. All sides probably have incentives to avoid an extended price war, says the firm, which believes there is a 60% chance Moscow will relent and agree to talks within two months. In contrast, according to Eurasia, there is a 40% chance of the deeper and more extended price war in which Saudi Arabia tries to take back meaningful market share from Russia and the US. In the meantime, supply will almost certainly far exceed demand in the coming months, says the firm, as producers fight for market share while consumption contracts amid the coronavirus outbreak. Given Saudi Arabia’s move, Russia will also likely respond with rising production, according to Eurasia, which could equate to an extra 1 million bpd coming to market over the next month. Add in US production of about 13 million bpd, and the world’s top-three oil producers could be churning out an unprecedented 35 million bpd by April, 5 million bpd more than during the peak glut of 2016, according to the firm.
Oil Russia Saudi US shale TrendMacro
2. Has Putin declared war on the US frackers?
Trend Macro’s latest bulletin highlights reports that that Vladimir Putin, who triggered chaos on global oil markets with the decision not to follow Saudi Arabia’s lead and agree to a production cut, may have deliberately declared war on the American fracking sector. The firm says in driving prices down below the US producers’ break-evens may be an attempt either to gain revenge on the US for sanctions against the construction of Russia’s Nordstream 2 gas pipeline or simply to drive US oil frackers out of business. Trend Macro warns of wider implications, since the oil price collapse could open up a financially systemic dimension of the coronavirus risk. By putting cash-flow pressures on highly-levered US oil producers and explorers, low prices raise the risk of defaults by borrowers whose coupons or maturities come due during even a short crisis, says the firm, and with 16.1% of the US non-investment grade bond market is issued by the energy sector, a default could be systemic, first in the sector and then at large. Trend Macro notes says with the US restricted in the near term as to what it can do to support oil prices, its best course is private personal diplomacy. Click here to contact the provider directly for the full report and discover why if Donald Trump put in a call to the Crown Prince in Riyadh asking for higher oil prices, he’d probably get them. Just as we publish this, TrendMacro has published an update on the latest reports that say Saudi and Russia may resume talks.
Biotech healthcare CLSA
3. Key COVID-19 diagnostic developments
One factor of the COVID-19 outbreak that has puzzled analysts is trying to assess the true mortality rate, says CLSA in its daily Theorality report. The firm says the Korea experience is interesting here, since the number of cases is high, however the testing efficiency is also extremely high (simply put, massively more people are tested each day). In this circumstance, notes CLSA, the mortality rate is about 70 basis points, lower than that observed in other countries. To that end the firm has invited Seegene, a Korean company with specialist diagnostic products and skills which has just secured approval to ship its COVID-19 diagnostic kits globally and already has orders from over 30 countries, to do a call for investors to help them to better understand the evolving situation.The report also includes links to the latest news in the sector, including: “Crowdsourcing and home-testing for COVID-19” : With the shortage of COVID-19 test kits in US outbreak epicentre Washington State, Seattle-area biologists are working to develop a globally crowdsourced test. “COVID-19 is proliferating non-human delivery” A Beijing-based autonomous delivery van start-up which has the backing of Alibaba and JD.com, is seeing burgeoning demand for its vehicles across China as COVID-19 presses for reduced contact in all facets of daily life. “Amazon is secretly working on a cure for the common cold”: According to sources familiar, Amazon has been secretly working on a cure for the common cold under the name of ‘Project Gesundheit’.
Global rates inflation-linked bonds yield curve HSBC
4. Global rates: Game of two halves
Brave and honest is the person that says “I don’t know”, and when the experts lack the necessary facts to make predictions about COVID-19, HSBC says it is left with educated guesswork for bonds. That said, with US Treasury yields already comfortably below its year-end forecast for 2020, the bank questions whether it is worth chasing what could be the last 10% or so of the move. In the short-term, HSBC says, yields may fall further, but it may be better to look at 2020 in the Treasury market from the perspective of the old sporting cliché “a game of two halves” in which the first half (January- to-June) is dominated by the uncertainty stemming from COVID-19 while the second half (July-December) is somehow different. Considering the various possible scenarios in the second half, the bank says it is sticking to its current year-end yield forecasts as, quite reasonably, it doesn’t know whether the score in the first half of the game will get reversed in the second.
HSBC says it does wonder whether the US Treasury market may become over-extended versus others, such as the eurozone, however, and perhaps whether there are better places to invest than the ultra-long part of the US conventional curve, with the long-ends of Europe potentially offering a better defensive play for investors. With this in mind, HSBC still has a strong preference for US TIPS, as they have continued to be both a good source of diversification and an opportunity to fade the recent move lower in Treasury yields.
equity derivatives S&P500 US equities Macro Risk Advisors
5. SPX put strikes are a potential accelerant to further equity market chaos
Back in October the WSJ published a piece that purported Bridgewater had spent an impressive $1.5 billion in option premium on equity index hedges, which brought a response from Ray Dalio: “I want to make clear that we don’t have any such net bet that the stock market will fall.” he was quoted as saying in response to the story. Dean Curnutt, CEO of Macro Risk Advisors, is the market’s leading expert on exchange traded derivatives and the VIX, so we wanted highlight his analysis of this unconfirmed position, and its potential market implications. At the time the WSJ story was published, Curnutt wrote that it was difficult to judge the accuracy of the article, but his observation of the SPX vol term structure was that there was a large position building around the March 20 expiry. Based on the allleged premium paid, Curnutt reverse engineered the theoretical structure of the trade, and given where the SPX was trading at that time, calculated the strike could possibly be 2800. Curnutt notes that in the context of when the trade was done, this may have been a hedge around an Elizabeth Warren Presidency as the primaries came near their conclusion. Which brings us to where we are today. Assuming the above is true and this trade exists, Curnutt argues that there is huge vega and gamma risk for the counterparties who are short volatility on the trade. That’s because these put strikes traded at 18 vol in October and are now at 58 vol and are nearing the money. Curnutt places particular emphasis on the gamma, that is, the speed with which the delta hedge changes, and this only accelerates as it moves closer to the money, and near expiration. The bottom line: While Curnutt says this is just a story of course, if the Bridgewater hedge is real and open, and if the option sellers have exposure on both the gamma and vega front, there’s the “accelerant” risk of having to sell more and more SPX futures as the market falls. Again, taken all at face value and making lots of assumptions, these puts went from nearly nothing to being worth billions in three weeks, adds Curnutt.