Below we provide key conclusions from our derivatives-centric models and screens. We publish key conclusions ~monthly in cohesion with shifting trends. The point is to hash out observed consensus views with our own to 1) Find asymmetric pressure points and 2) Generate alternative ways to play our macro themes. Because many of these factors shift in the short-term, this note is intended to be a summary of process.
In this month’s update we’ll revisit our #StrongDollar theme and its ripple effects through the lens of consensus positioning and hedging activity. While we use some derivatives-specific jargon in some of the commentary below we would sum-up the main takeaways and underappreciated prospective risks as follows:
1) Global macro consensus appears to be increasingly betting on higher rates across the treasury curve – we’re on the other side. This view has many asset class and sector implications, some of which we discuss below.
2) USD strength has wreaked havoc across global markets, but just because this view is explicitly less non-consensus, we’re changing nothing about the playbook at the current juncture.
We provide one visual per bullet at the bottom of this note but would direct you to a more extensive slide deck with a section devoted to each bulleted call-out below. Click Here for the slides.
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CFTC Positioning: We look at futures & options open interest on a net basis (shorts minus longs) for the “non-commercial” crowd which is the speculative pool of investors in the financial markets to make money and not hedge “business risk.” With the exception of minuscule relief w/w in 10yr short positioning, net open interest that is SHORT bonds (long rates-rising) continues to make new all-time highs in 5yr and 10yr contracts. This set-up gets our attention as 1) We’re on the other side with our rates call and 2) We see this higher-rates view embedded in the cost of hedging in equity markets as well - it's not isolated to a single data point.
#StrongDollar Update: There is no question that crowded USD shorts expressed across global currencies heading into Q2 have been forced out, making our prospective call more consensus on the margin - this trend is a fact that is explicitly shown in the slide deck across various metrics not limited to derivatives-market open interest, relative volatility expectations against the USD, and directional-hedging in currencies (i.e. volatility skew and risk-reversals).
With that being said, long USD is one of the macro exposures where we have most data-tested conviction in a #QUAD4 deflationary environment which is where our GIP Model (Growth, Inflation, Policy) has the economy squarely tracking in Q4. The market is always front-running what we don’t yet know for certain, but given the set-up within our framework, closing out our Strong USD call “because it’s already moved a lot and is more appreciated by consensus” is not the call we’re making today.
Second Order Effects of #Rate Consensus: Sticking with the intent to use this month’s update to highlight potential underappreciated risks, we’ll focus on the cost of hedging in domestic equity markets. Visual color is included in the slide deck link at the top. Put simply, the market is not discounting coming #QUAD4 risk. We see relatively expensive hedging costs in slow-growth yield sectors like Utes & Staples (i.e. growth accelerating, rates-rising position from consensus). If the market was worried about #Quad4, the set-up would be exactly the opposite.
As another example, it’s never been cheaper to hedge the Russell 2000 Index for 6 months. Even if you were just looking to hedge out some small-cap, domestic growth exposure which has had a fantastic run, it looks opportunistic to do so. With its heavy weighting to financials, insurance, etc., long-term Russell 2000 volatility expectations have been strangled by little movement in long-term interest rates over the last few months.
