• 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