Macro Trading Ideas You Need To Know: Volatility Hides Deflation
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Commodities reverse last week’s crazy spike higher (at least for now), and long yields skyrocket. Volatility is higher, but underlying realities haven’t changed.
The US yield curve is still flattening and is putting out more of a deflationary signal than inflationary one, although the Fed obviously disagrees or chooses to be blind to it.
The USD remains in a broader uptrend as Dollar funding conditions tighten, and Russia’s war in Ukraine is only making matters worse.
- Commodities have mostly reversed last week’s spike higher, although prices for most remain elevated
- WTI is back around $100, which is still too high for a world contending with high inflation and a flattening US yield curve
- Grains are still expensive, especially wheat
- Global USD funding conditions are really beginning to tighten:
- Demand for USDs remains stronger than it was at its low in the middle of last year, which implies that global USD funding conditions are getting tighter – not a good sign for the world economy, and NOT helped by war
- CNY is also starting to noticeably weaken against the USD. If this continues, it could mark the start of a global deflationary trend
- The US yield curve keeps flattening, indicating reduced potential for long term growth-driven inflation, even as US breakevens remain elevated
- Higher energy, raw materials, and food costs feed into higher inflation all around the world. This combined with the flattening US yield curve and stronger USD is stagflationary at best, deflationary at worst
Trading Ideas – Performance
Trading Ideas – Commentary
- Long USD positions were stopped out during last week’s volatility
- EURUSD short closed for a gain of 3.83%
- AUDUSD short was stopped out at 0.7285 for a loss of -2.03%
- USDCAD long closed out for a gain of 0.66%
- Long oil position did well (expressed via XLE in ETF Edge), and was also closed out due to volatility
- Decision to straddle US 30y rates rather than take an outright long or short position is paying off as the volatility in long yields increases
- Given the current geopolitical situation, it is looking unlikely that long yields will spend the next few months trading in a narrow range
- The trade is poised to profit if the Russian-Ukrainian war keeps driving long yields lower, AND also if the war is resolved quickly and long yields continue their upward trend
- Might be wise to wait for better entry points in short GBPUSD and long gold positions, perhaps on retests of previous levels
- 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. War in Ukraine is NOT helping
- 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 2nd half of 2021 provides 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:
- AUD – given current strength, it would be wise to wait for the short term trend to realign with medium term bearishness before re-entering this position
- 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
- Long Gold:
- Gold has quite decisively broken out of resistance levels and looks strong technically
- The geopolitical backdrop is also supportive of higher gold prices
- Be wary of trading gold based on current high levels of inflation as it didn’t rally over the past few months on record breaking CPI data releases & headlines
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