Last week was one of the most interesting weeks in markets in the last two months. The key market mover was the rise in US yields, the 10Y opened on Monday 1st of March at 1.42% and closed at 1.57%, causing a small downturn in stocks, especially the one more exposed to future growth like tech, indeed the Nasdaq was the one most impacted by such move.
To us, this move is not done yet. We believe the 10Y yield is headed toward 2% and maybe more, while the spread between the 10Y and the 2Y US bond yields, will approach 1.823% in Q2-2021.
This is caused by two main reasons, first, as the economy in the US is reopening, the yield curve is discounting strong economic growth ahead thanks also to the fiscal stimulus of 1.9 trillion dollars the Congress will vote on Tuesday. Secondly, US banks are still not sure what will happen to the SLR rule that exempts USTs from SLR calculations. My idea is that some banks have reduced their exposure to USTs just to make the first move toward a possible surprise from regulators, meaning, not an extension of the SLR exemptions. But I stick to the idea that such a move in the yield curve is motivated mostly by rising economic growth expectations.
As a consequence, some sectors are going to be vulnerable in the upcoming weeks. As yields rise across the curve, especially the long-hand, future cash-flows are discounted at a higher discount rate which diminishes the present value. Therefore, equity prices are expected to come down and retrace. In case of a fast rise of yields, SPY may find support at 357 at the technical level, while reaching the 36.2% Fib retracement at 326 in the extreme case. It is worth saying that the Nasdaq would be the most impacted index given its bias toward the growth factor, be aware of it.
There is also another point I will like to point out. As the economy is re-opening, cash is being absorbed by real economic activity. Usually, in the liquidity cycle, financial markets get the liquidity first, indeed we saw a strong rebound in equity prices following the March 2020 crash thanks to the intervention of the Fed and the massive issues of T-Bills which helped the repo market. But as the economy starts to recover, this liquidity flows toward real economic activity, indeed, the GLI published by Cross Border Capital looks to have peaked in February 2021 and shows the first sign of “weaknesses”.
On the growth side, we said pretty much all, the second piece that is missing is inflation, the second global macro factor. By just looking at the ISM prices report it is clear how inflation will continue to grow for the next 3-month at least.
This is proven also by the commodities market, especially oil:
There is one point I have already mentioned this week but I think it is worth to repeat and it is the short-Euro trade against the US Dollar. You can read more here. What I want to add is a simple chart posted by Nordea where they have highlighted how the Dollar Index (essentially a Euro index), has gone too far and it seems to make any sense given the current growth expectations.
Furthermore, US Dollar positioning retrieved from the CFTC CoT report is still extremely bearish and looks great for a contrarian bet.
Trade ides
Steepening of the curve is a base trade for the moment, we like 10s2s, 2s5s, and 5s30s.
Be long inflation. We like being going oil and our target is for WTI at 100$ by the end of the year, or at least in Q4-2021. We have also exposure to Agricultural commodities via the DBA ETF.
On the commodities side, being long gold may be a contrarian trade at the moment especially because of the 1.9 trillion dollar stimulus. We are not really comfortable with it, so we prefer to play it with either a delta-hedge option strategy or by being long volatility.
We still like US Equities but we are fully hedged via volatility options, especially on those rates sensitive. We have a put spread on Nasdaq with maturity on the 1st of April 2021. We prefer to buy stocks that fit our long-term perspective, like Uranium.
We are long the US Dollar against the Euro.
Andrea - Pulsar Research