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Editor's Note: Hamish Risk | October 27, 2020
The VIX spiked yesterday as hopes of a fiscal stimulus deal fade, but the most recent positioning data from the VIX futures markets suggests the smart money is looking beyond this and still betting on a relatively calm reaction to the US election result. But a lot can change in a week, and with markets showing signs of nerves, in today’s Macro Briefing Macro Risk Advisors highlights what to look out for – and who to follow – when the last set of positioning figures prior to the vote are released. Meanwhile, Jefferies explains why forecasts for a decisive win for the Democrats is just one factor causing a “silent” steepening the US yield curve and supporting equities, while Longview Economics explains why the case for going short bonds is rising amid growing hopes for a global economic boom and increasing inflationary pressures. Pennock Idea Hub sounds a note of caution, however, warning of the myriad of risks to the reflationary trade, while 4X Global research sets out why investors should not bank another factor in the reflationary narrative – the continued weakness in the dollar – at least against the renminbi – to continue to fuel demand for US assets.
equity derivatives event risk VIX Macro Risk Advisors
1. VIX futures positioning – who’s the smart money?Volatility investors should follow hedge funds’ lead ahead of major risk events according to Ed Tom at Macro Risk Advisors, the derivatives and risk management specialists. Tom has put out a note highlighting the historically high percentage of net speculative shorts for the VIX futures, which suggests the “smart money” is currently biased towards fading the risk premia that the US presidential election may inject into the market. Tom sets out to answer two questions: whether investors should follow the “smart money”, and of the four major investor groups – dealers, institutional hedgers, hedge funds and retail – who exactly should be considered the “smart money”? He finds systematically tracking “smart money” dealer and hedge fund volatility positioning provides investors with a marginal edge in more normal times. However, according to Tom, as conviction increases prior to a major catalyst that is likely to induce a material impact on volatility – such as the current election – tracking the net positioning of the hedge fund community has historically given investors an edge, and an informed indication of subsequent major volatility moves.
cyclical rotation yield curve Jefferies
2. A silent steepeningSean Darby at Jefferies says the long end of the US bond market is confirming what US Presidential polls are predicting – a clean blue sweep next week, which should add to the positive outlook for US equities. He says the prospect of a Democrat expenditure package post the election is positive for stocks and one factor that has seen the US curve steepening even as the Federal Reserve’s recent Beige Book was, to say the least, lukewarm towards the US economy. Darby points to other factors that have supported that steepening: a recovery in pricing power and volumes in the manufacturing sector and growing inflation expectations. Much like the “quiet” dollar devaluation since April, Darby says the “silent” treasury steepening has been accompanies by strong US equity markets, and the “very, very” good news is that credit spreads have tightened as the yield curve has steepened and this should mean that equities remain in vogue from investors seeking yield. Part of Darby’s analysis outlines which sectors traditionally benefit from steepening yield curves.
Economic recovery Inflation Rates Longview Economics
3. The case to short bonds is growingLongview Economics say the case for being short bonds is growing. From a macro perspective the stimulus in the pipeline is especially large, and the case for a global economic boom next year is growing (if/assuming a vaccine is successfully released). Added to that, Longview think medium term inflationary pressures are building (at least in the US). Furthermore, market signals and models are further confirming this scenario with copper starting to outperform the gold price, while risk appetite amongst global sectors is deeply depressed and likely, therefore, to start mean reverting. Both those factors suggest higher bond yields. Positioning, consensus sentiment and technical factors also all support that expectation. Longview say the likely triggers to cause a break above the 200 day moving average of 10 year yields include a successful vaccine and, with that, a return to more normal patterns of spending; and/or an election outcome which results in another fiscal stimulus package. If Longview’s thesis is correct, the move above those key levels would likely signal the start of the next Kondratieff wave for bond yields. Typically these are 35 – 40 year affairs/cycles, with the last sustained long cycle move higher in yields starting in earnest in 1951 (at the time of the US Treasury Accord) and ending with the peak in yields in 1981 (and the imposition of Volcker’s tight money policy). For those 30 years, though, in contrast to the last 40, every rally in bond prices was an opportunity to sell bonds.
Equities The reflation trade Pennock Idea Hub
4. Buy the cyclical and reflation trade?The global economy seems to be setting up for a strong recovery on the back of a combination of easy monetary policy, slimmed-down supply chains and a rebound in consumer confidence, according to Cam Hui at Pennock Idea Hub. He says, however, investors need to be aware of a number of key risks to the cyclical and reflation thesis, namely another potential wave of COVID-19 infections; a loss of economic recovery momentum; the uncertainty of additional fiscal stimulus; and the effects of rising inflationary expectations on Fed policy. Under these circumstances, according to Hui, investors need to recognise that the sources of alpha are multidimensional, and so is risk. While investors can always hope for the best, he says, bad outcomes are very possible in these conditions. It is important, therefore, says Hui to repeat the adage that the only free lunch in investing is diversification, and only a diversified portfolio can weather this diverse array of risks.
currencies Inflation Renminbi 4X Global Research
5. PBoC likely to keep renminbi on tight leashThe 4.4% rise in the renminbi against the dollar since the end of July has led some to speculate that the People’s Bank of China could take aggressive measures to stem its currency’s climb. Olivier Desbarrres at 4X Global Research, however, says Beijing is likely to take a more sanguine approach. Speculative FX inflows into China, attracted by the country’s rapid economic recovery, have undoubtedly played their part in putting the renminbi under appreciation pressure, he says, but they are only part of the story. Foreign direct investment into China has also played its part in the renminbi’s climb, as has a rising merchandise trade surplus, according to Desbarres, meaning the currency’s strength since the end of July has seemingly so far had little impact on export competitiveness. Indeed, he says the fact that FX inflows into China have not just been speculative explains in part why the PBoC has seemingly been comfortable, so far, in allowing the renminbi to appreciate – or put differently why it has not tried to neutralise let alone reverse these flows. Rather than taking any drastic action, Desbarres says he has sympathy with a more benign near-term view that the PBoC is likely in a first instance to slow the pace of renminbi appreciation and ultimately arrest the currency’s climb.