We also spoke about macro economic cycles and how such polarities in the major economies have created exclusive opportunities in the financial markets.
With the current market climate hallmarked by panic, fear, and ephemeral swings, we have identified a couple of opportunities over the last couple of weeks that look promising in their own rights. In the last 2 weeks alone, a few records have already gone down the record books.
Reading through anecdotes on various news wires reveals the sentiment behind the recent corrections in asset prices. Sentiment that is synonymous with fear, panic, and other esoteric forms of self harm.
We say this because we feel this is heaven for opportunists.
In today's note, we wish to share our views and ongoing opinions on how we view the current market landscape and the strategies that we are and will likely be implementing to take advantage of the substantially different dynamics in today's environment.
For those short on time, we have complied the following key points that outline our baseline views and which shape our strategies going forward.
In brief, we are compelled to build a short dollar position against a set of currencies we seem to be fundamentally superior, all while being mindful that bursts of volatility in the dollar and dollar-based assets should be expected.
We are mostly neutral on the euro, and prefer to establish pair trades involving the currency.
We feel the recent selloff in global equities, notably Europe, should be bought with caution but are bullish in the mid to longer term. American equities will remain bid but might continue to trade in a range for a while.
We are bullish on crude oil as we outlined in our January note calling the bottom in oil prices. For reference, read our March note where we called for an inflection point in oil prices near the end of the last down leg.
Instead of going outright long on crude oil, we prefer to establish a similar exposure with currencies of major oil exporting economies, chiefly the Canadian dollar and the Norwegian Krone. The idea is to hedge out some volatility that is native in commodities, especially energy.
Overall, most of the market moves we saw in April were amplified by strong technical factors such as acute phases of massive liquidations where heavily one-side trades (long dollar, short euro, short oil) were unwound, all inside a market that was thin on liquidity. Fundamentally, not much as changed, but the market makes it seem like a lot has with price action.
- Intermediately bearish US dollar, long term bullish; expect volatility
- Massive unwinding of long dollar positions, strong inertia remains
- Weak US economic data vis-à-vis expectations;
- Very weak 1Q15 GDP growth, blamed on weather and "transitory" factors;
- Strong dollar adversely affecting US trade balance; latest data shows largest deficit in 6 years, largest deficit on record ex, petroleum exports;
- Corporate earnings suffering due to expensive dollar;
- April FOMC statement leaning more dovish, date reference to rate "liftoff" removed;
- Long term bullish view on basis of eventual rate hike in October or later
- Intermediately neutral to slightly bearish euro
- Improving European economic activity and growth;
- ECB revised higher inflation and growth forecasts;
- ECN reference rates will not be lowered further;
- PSPP on track, firm commitment by ECB to maintain purchases;
- Remote possibility of enlarging PSPP size will limit euro downside;
- Comments by Draghi challenging market to short euro seems to have set floor under euro;
- Largest short euro consensus trade ever winding, technical flows out of short positions continue to put upward pressure on prices;
- Selloff in European (mostly Germany) stocks and bonds amplifying effect of short squeeze in euro;
- Greek crisis bears low contagion risks
- Cautiously bullish global equities with preference of US stocks
- Selloff in European and Asia-Pacific equities mostly technical, offers buying opportunities but risks remain;
- Preference of US stocks as dollar rebalancing continues;
- Timing of Fed rate hike largely irrelevant; rotation from treasuries/bonds to equities will pick up in 2H15, stocks to benefit;
- Global economy in slowdown but far from being recessionary;
- Global central bank easing cycle has climaxed, backstops are largely in place, downside risks in equities muted
- Intermediately bullish crude oil, upside fairly limited
- Fundamentals slightly changed; production growth in US finally stalling, OPEC policy softens;
- US oil and petroleum reserves seeing declining marginal increases, first draw in Cushing inventories;
- Saudi-Yemen conflict places slight upwards pressure on prices;
- Majority of bullish momentum result of unwinding short positions;
- Technical price action formations on Brent & WTI puts upper $60s and mid $60s into target, respectively;
- Original fundamental impetus of slowing global demand amid increasing supply has died off;
- Weaker dollar to support higher prices
- Bullish oil & energy currencies as alternate proxy for long oil play
- Safer to hedge volatility in direct exposure to oil with currencies of oil exporting nations;
- Preference of Canadian dollar, Norwegian Krone;
- Fundamentals of major oil exporting economies improving healthily; bolstered by surge in oil prices (WTI +24% in April);
- Bank of Canada sees strengthening Canadian economy partly due to pick up in oil revenues;
- Bank of Canada has no intentions to ease monetary conditions with further rate cuts;
- Canadian economic data improving steadily; inflation expectations gradually rising;
- Norway also improving economically; propensity of central bank to leave rates as they are;
- Pick up in demand from Eurozone seen to boost Nordic economies
King Dollar Dead, Sinks All Boats
If the saying is true that a strong tide lifts all boats, then a weak dollar should also sink all boats. Precisely this has happened.
Starting off with currencies, there is no question that market participants across the wold have been fixated on the greenback, more than anything else. The month of April saw incredible choppy trading in the major currencies but it was mostly the result of confusion onboard the long dollar consensus trade, in our opinion.
For a long while now, we have been bullish the US dollar for reason orbiting a rather hawkish Fed and an ECB that was firm in its path of monetary easing. Up till March, the long dollar trade was actually playing out well and bulls were generously rewarded. Back in December 2014, we opined that shorting the euro against the dollar was the easiest trade all year.
However as we transitioned into April, things started to shift; markets were becoming nervous about the overly crowded trade that was being long the dollar. With US economic figures missing like a retired Marine sniper Marksmen way past his prime, we had every reason to bear skepticism. The flummoxing twist had always been what the market was telling us through price action, and what we were seeing through our own eyes.
The straw that broke the camel's back for us was March's extremely dismal non-farm payrolls report in which only 129,000 jobs were added when the market was calling for 245,000. We covered that critical development in this note; readers are encouraged to digest what we said back in the beginning of April because it contains anecdotes that we will be espousing in this outline.
On 5th April, we called on dollar weakness and warned that its intermediate bullish trend had likely climaxed.
Market calls aside, we foresee continued weakness in the dollar for the intermediate time frame. This bias is founded on the premise that the market should continue adjusting to decelerating economic growth in the US, as well as a cooling labor market, which was once the strongest pillar of the recovery.
April's FOMC statement was also quite telling. The committee decided to ditch any sort of date reference for a rate hike, although they did not reinstate "patient" as part of their language.
The FOMC cited the weak 1Q15 GDP growth (0.2% MoM vs. 1.2% exp.) as the result of "transitory" factors along side the weather (a colder winter than usual). Recall that in Part 1 we stated that GDP growth figures were backward looking, and that whatever that was reported has actually happened lot ago.
Saliently, the 1Q15 GDP figures cemented the observations across numerous economic indicators, that momentum was decelerating rapidly in private sector and business activity.
Looking into the components of last week's GDP print, private consumption grew only by a tiny amount, partially offset by a surge in healthcare spending (à la Obamacare). The juggernaut however was the collapse in fixed capital investment growth by private sector corporations (CapEx, or capital expenditures); such a downturn in capital expenditures normally signifies weakening confidence and outlook by businesses.
Apart from macro economic fundamentals, we should not underestimate the effect of technical factors. Said technical factors being the unwinding of one of the most crowded consensus trades ever to bestow the modern financial markets.
Futures and options data from the respective US exchanges show that net positioning amongst speculators had reached extreme longs on the dollar, especially against the euro. It came to a point where both sentiment and positioning reached such a fever pitch that the currency markets (EURUSD) became hugely imbalanced, and unstable.
While open interest in long dollar positions have come down in the last 3 weeks, we suspect the market will now be faced with a dearth of committed buyers. The sheer unpredictable nature of the markets has deterred many market participants. In fact, we actually anticipate the arrival of fresh dollar bears.
Technically, price action of the dollar index tells us that the trend is incontestably in bear territory for at least the next 2 months.
As such, we are compelled to shorting the dollar with caution and prefer to do it against fundamentally strong currencies whenever we get tactically corrections in the currency crosses we watch. Notably, and as stated in the onset, we like going long oil currencies such as the Canadian dollar and Norwegian krone; both of which have been stellar performers (read the aforementioned Bottomline for details).
We suggest diversifying risk across a basket of currencies to muffle out volatility.
Ultimately, as we near year's end the dollar will likely start to regain the bullish composure that has been lost in the current flurry of developments. Until then, we favor a weaker dollar.
Euro Rebalancing, Offers Attractive Premiums
One of the strongest currencies in the second half of April was the euro, and that has left many traders exasperated.
With the ECB etched firmly in the path of QE, it makes little fundamental sense to be bullish the currency apart from technical reasons.
We believe the reason for the euro's strength is the mammoth short squeeze in the last 2 to 3 weeks, coupled with improving European economic data and comments from Mario Draghi which served well to defend bulls.
The capitulation in the currency market was the single most impactful event that rattled markets all over the world, we believe. Global stocks and bonds have all corrected sizably as a result of this colossal shift in market sentiment and positioning.
In such a case, we feel that the euro now trades at a fair discount to what fundamentally-link models (such as the swap spread model) imply.
Our bias is slightly bearish to neutral for the intermediate future. Although we favor shorting the euro, we are selective about the counter currencies that the euro should be sold against.
We are bullish on the EURUSD pair and would not suggest traders try to time a short there. Our preference is to short the EURCAD and EURNZD pair once upside momentum weakens.
It is a prerequisite that the euro should only be sold against a fundamentally strong currency, preferably of countries whose central banking policies lean towards tightening.