Look Beneath The Headlines! Macro Trades You Must Know

  1. Long USD:
  2. Straddle US 30y rates:

Macro Edge #26

Originally posted on thepensivenugget.com

Opportunities lie beneath the headlines this week. As the USD dips and oil keeps rallying, many will mistake this to herald a global economic boom. Other markets (read: the yield curve) beg to differ.

If you would prefer to read this article in a slideshow format, you can do so here.

Dollar Dips, But Stagflation Risks Remain

  • The USD rally took a breather over the past week, in tandem with the broad rally in equities, but the overall trend remains one of USD strength, which is a cause for concern
    - Demand for USDs is clearly increasing around the world, which implies that global USD funding conditions are getting tighter — not a good sign for the world economy
    - Commodities aren’t broadly weaker, but commodity currencies, AUD and CAD, are not doing well. Especially CAD which can’t rally vs the USD, even as WTI stays ~$90 a barrel
  • Interest rates remain close to their recent highs, BUT:
    - The US yield curve keeps flattening, and US breakevens aren’t rising
    - Both simply aren’t pricing in much potential for long term growth-driven inflation
  • The rally in WTI towards $90 hasn’t been accompanied by one in base metals
    - Copper remains locked in its range, while iron ore has rallied but remains far below last year’s highs
    -If oil prices continue to rally, or simply remain where they are, and the US yield curve keeps flattening, conditions can quickly turn stagflationary

Trading Ideas

Long USD:

  • Well established trend, in place for >6 months in most major currency pairs
  • If global economic growth does take a turn for the worse in the near future, global USD funding markets will tighten, driving the USD even higher
    - The potential for this downturn is currently underestimated, especially in the mainstream media
    - The flattening US yield curve (even as the Fed turns hawkish) and poor Chinese economic data provide clear warning signs
    - Look for USDCNY to turn higher, i.e change its trend, for an indication of worsening conditions
  • Serves as a broad hedge against other “risk” assets in your portfolio, like stocks. BUT:
    - Don’t think of the USD trade as “only” a hedge
    - It is entirely possible, and normal, for the USD to strengthen as equities rise. The past 6 months provide a good example of this, where US equities rallied even as the Dollar broadly strengthened
  • USD longs in general should do well, but of the G7 currencies, look to go long the USD vs:
    - EUR
    - AUD
    - CAD

Straddle US 30y rates:

  • 30y yields look poised for either a break above 2.17% towards 2.5%, or to fall back and test 1.67%
  • This strategy will also profit from a fake out/bull trap, i.e if the 30y breaks above 2.17% but quickly falls back down
  • Downside comes from 30y yields trading sideways for a prolonged period of time; and straddles are expensive strategies since they involve purchasing puts and calls
  • Trade can be executed:
    - With options on US T Bond futures, or options on the TLT ETF
    - Or going long in the spot market, either with actual T Bonds or the TLT, and hedging the other direction with puts/calls; which would be a less aggressive strategy

USD bulls take a breather… EUR

  • EUR has bounced vs the USD, in tandem with how equity markets traded over the last week; although the single currency remains in a well established bearish channel

USD bulls take a breather… GBP

  • GBP also bounced vs the USD after picking up bids in the 1.335 region. The broader trend remains bearish, even after the post BoE rate hike surge, with major support a fair distance below current levels, at 1.317

USD bulls take a breather… AUD

  • AUD also rallied after last week’s weakness, but remains in its bearish channel even without broad weakness in commodities (Copper still firm and Oil keeps rallying). Watch for a test of support just below 0.7

USD bulls take a breather… CAD

  • CAD also rallied vs the USD, but not by much, even as WTI remains close to $90 a barrel. The overall trend points towards continued USD strength

The CNY is on holiday. Happy Lunar New Year!

  • CNY remained in the 6.36 region before Chinese markets closed to celebrate the Lunar New Year. It’ll be interesting to see where CNY opens next week

US long yields consolidate near key resistance… US 10y

  • US 10y yields start to consolidate at the top end of its bullish channel, between 1.7% — 1.9%; a little away from their 1.95% pre-COVID levels

US long yields consolidate near key resistance… US 30y

  • US 30y yields are also consolidating just below key resistance at 2.17%, and look poised to either break higher towards 2.5%, or fall back to test 1.67%

Even as the US yield curve continues to flatten…

  • The US yield curve has now flattened to ~60 bps. This, together with the strong USD, is a major cause for concern

And US breakevens remain off their highs…

  • Breakevens rallied a little over the last week but remain off their highs, in line with what the US yield curve is signaling. The markets simply aren’t pricing in much long term growth-driven inflation

Although European yield curves seem more optimistic

  • European yield curves have stopped steepening for now, although they remain at, or close to, pre-Omicron levels. Will they start to flatten in tandem with the US curve soon?

Oil remains firmly bid…

  • WTI prices came close to hitting $90 a barrel before coming off a bit. It remains in the high 80s, which should keep the CPI elevated (the US yield curve indicates that this will likely lead to stagflation)

Copper is still treading water…

  • Copper still isn’t doing much as it bounces around $4.5. From a broader perspective the base metal isn’t indicating a global economic boom, as it remains locked between $4.05 — $4.8

Iron Ore takes the week off in China…

  • Iron ore managed to rally slightly above the top of its bearish channel before the Chinese futures market shut for holidays

And Aluminium takes a little dip…

  • Aluminium prices remain elevated, and are close to last year’s highs, although prices did dip a little over the past week

As Gold falls back to $1800

  • Gold has fallen back to hug its trendline, around the $1800 level, and has yet to meaningfully test $1875 resistance and $1750 support in 2022