“He respond to the offer? What? What the hell’s Cromwell doing giving lecture tours when his company’s losing 60 million a quarter? I guess he’s giving lectures on how to lose money…if this guy opened a funeral parlor, no one would die, this turkey’s totally brain dead…” – Gordon Gekko
In trading, sometimes you are hot, and you can do nothing wrong. Every trade you put on seems to be in magical sync to the market. Even your errors end up being winners. Other times, it is just the opposite. You end up being the Cromwell of the trading world. All of your trades, no matter how well thought out and planned – go against you. You try harder, and it only makes things worse. That is the picture of my trading over the last couple of weeks.
It therefore should be no surprise that yesterday’s release of the Fed minutes showed the precise opposite of what I had predicted. I expected the hawks’ concerns about the heating up labour market to shine through. Instead the minutes showed a Fed that is increasingly concerned about the US dollar rise and global economic weakness. I have long argued that this was one of the most dovish Feds in history, but even I didn’t expect them to panic so quickly. I thought that we would at least get through the end of tapering before they started setting the market up for the interest rate hikes to be postponed. But the following paragraph from the recent Fed minutes gave the markets the clear sign that the US dollar’s strength was doing the tightening for the Fed, and therefore the rate hikes should be put off into the future.
“During participants’ discussion of prospects for economic activity abroad, they commented on a number of uncertainties and risks attending the outlook. Over the intermeeting period, the foreign exchange value of the dollar had appreciated, particularly against the euro, the yen, and the pound sterling. Some participants ex-pressed concern that the persistent shortfall of economic growth and inflation in the euro area could lead to a further appreciation of the dollar and have adverse effects on the U.S. external sector. Several participants added that slower economic growth in China or Japan or unanticipated events in the Middle East or Ukraine might pose a similar risk. At the same time, a couple of participants pointed out that the appreciation of the dollar might also tend to slow the gradual increase in inflation toward the FOMC’s 2 percent goal.”
Have a look at the shift in the Fed Funds futures curve.
I had been trading the short end of the Eurodollar curve from the long side, but had unfortunately been shaken off the trade last week.
In hindsight it is now obvious that too much hot money was set up for a Fed that was going to follow through with their forecasts. The Fed is giving some confusing signals that is wreaking havoc in the markets. On the one hand they have these “dots” that outline the Fed Governors’ anticipated path for monetary policy. Over the last few months the backing up of yields at the short end of the curve has mainly been the market following the “dot” guidance. Even when short term yields were at their highs a week ago, the yield curve had still not fully discounted the Fed’s predicted path. The market did not completely believe that the Fed would be as aggressive as they forecast. At the recent Fed meeting, some of the Governors even noted this fact. Yet at that same meeting the Fed gave the signal that the US dollar strength was going to delay the tightening.
The market is probably giving the Fed much too much credit that they have any clue what they are doing. They are flying by the seat of their pants. The dots should probably be ignored all together. This Fed is going to be super slow in raising rates. Full stop. Period.
That doesn’t mean that short rates are not going higher. It just means that they will only go higher once it becomes blindingly obvious that they need to be raised.
The recent backup of short term rates with the corresponding US dollar rally was the result of fast money front running the Fed’s forecasts. The large speculative short interest in short term fixed income futures was indicative of how the hedge funds and other fast money types were pushing their luck.
The specs pushed up short term rates because of the Feds’ “dots”, but then in a surprise move, the Fed quickly cried “uncle.” The market was surprised at the dovishness of the Fed and had to scramble to cover all the positions.
Once again we learn that we should avoid any trade that is popular with the hedge funds. I have to continually re-learn this lesson, and although usually I am extremely weary of any trade that is popular with the hedgies, lately I have fallen for too many of their stories.
As to where we go from here, I am not sure. The longer term trend is for higher US short rates and a stronger US dollar. But the hot money is suddenly offside on both of those trades. They had thought they could count on the Fed, yet yesterday’s minutes brought the Fed’s conviction into question. I expect the hedgies to continue covering those positions.
Yesterday on the release of the minutes, I covered my long US dollar positions. I even bought a tiny little bit of gold and silver. This was just for a trade. I am weary of expecting anything more than a short covering rally in precious metals or a cleansing out of the weak longs in the US dollar.
There can be no denying that Friday’s unemployment release was a “all baked in” top for the US dollar. We are now in correction mode. But this is a strong trend and we should be careful of not expecting the correction to be too deep. The move from 79 to 87 was roughly 8 handles. A 3/8s retracement would put us around 84. I will start buying there, with the idea of adding more if we get to a 50% retracement.
QE is bond bearish!
I continue to be surprised at how the idea that Quantitative Easing is bond bullish refuses to die. I have shown how the end of QE has resulted in some of the biggest bond rallies, but I came across this great chart by Gavekal that approaches it a little differently. The chart measures the change in the Fed balance sheet versus the US bond yield.
You can see that as the Fed expands its balance sheet, rates rise – not fall as conventional wisdom dictates.
I have been watching the German 10 year bund market closely. Although the yield had a little bit of a backup when Draghi promised to expand the balance sheet and followed up with the first TLTRO, since then the ECB has done very little easing. Without the ECB expanding its balance sheet, the bund has continued to rally.
I believe that Draghi will eventually follow through with his plans to expand the ECB’s balance sheet. Europe is just… European… It will take a while. When they finally announce the actual implementation of the balance sheet expansion, I will short bunds. Until then I will sit and wait.