Trading Strategies – 18 March 2020 - Doo Prime News
Doo Prime News > Important Notice > Trading Strategies – 18 March 2020

Good morning.. I wanted to get this out early as Bond markets are getting smashed. The world’s governments are embracing MMT and massive stimulus packages are being unveiled. I guess they are trying to bridge the economy while we get through this crisis but in doing so may be creating the next one as debt does matter, even with rates at zero. The next big problem is coming from the bond markets as they react to the debt piling by governments and a Tsunami of issuance is on the way and who will buy it and what will yields have to be to attract the few buyers for a ton of issuance? I recommended selling USTs yesterday and 10yr yields are already above 1% and se to climb close to 2% in my view as the curve steepens sharply. I think this keeps the USD bid and I am happy staying short EUR and Cable. The EU is especially exposed here and I am watching for further blowouts in peripheral spreads and sovereign debt is becoming a problem. Even CDSs on US debt are rising! This is starting to smell like 2008 and the Fed is busy trying to fix the funding end of the curve but still seems to be playing catch up. I think EUR could actually drop quite hard soon as I think they are not going to see Germany bail out the EU. They cannot afford a wealth transfer in the state it is in now. Bunds are dumping and global yields are on the way up. By curing one problem, another one has popped up and governments have little choice in this time of stress but to spend. Someone has got to buy that debt.. Just look at the US 30yr!! The Fed is going to be very busy today.. Take care..

Keep the Faith..

Data.. All Times GMT

10:00.. Eur CPI Core y/y (Final) Cons: 1.2% Prev: 1.2%

Eur Core CPI mom Cons: 0.4% Prev 0.4%

Eur CPI y/y (Final) Cons: 1.2% Prev: 1.2%

Eur CPI mom Final Cons: 0.2% Prev -1.0%

12:30.. Canada CPI y/y Cons: 2.1% Prev: 2.4%

Canada CPI mom Cons: 0.4% Prev 0.3%

Canada Core CPI yoy Cons: none Prev 1.8%

US Housing Starts Cons: 1,500k Prev: 1,567

US Building Permits Cons: 1,500k Prev: 1,550

Details 18/03/20

This is starting to feel like 2008! Staying long the USD and Bond yields are the next problem for the Fed: EU facing crisis:

Stocks, as ever were all over the place yesterday and I think with all the stimulus taking place both fiscally and monetarily, there is a chance that this helps; the injections are becoming quite large. Just how much in the short-term is unclear and stocks are down again this morning after another choppy Asian session, with Nikkei down 1% and HK down 3%. But before we all get comfortable there is another problem brewing and that is a massive turn coming in the bond markets. I recommended yesterday that we get short USTs and boy are they starting to move with a break in the US 10yr yield above 1% already and to my mind this is just the start.

The global debt pile is going to grow exponentially and the demand for the massive issuance is going to be insufficient and as suggested yesterday, will likely see central banks forced to come clean on the need to monetize debt. While they get that sorted out, bond yields could rip higher. That is not what any central banker wants to see but I think its coming and a rising USD will not help either.

I honestly think we may have a long-term low in place in many yields and especially the US. This, plus ongoing stress in the funding markets, are likely to keep the USD bid. The FRA-OIS spread hardly moved as the Fed offered more liquidity and blew higher into the close but the central bank seems to be tapping around in the dark when it comes to understanding where the exact problem is. After the close last night they felt compelled to go even further and took aggressive new action to shore up liquidity in financial markets on Tuesday night by allowing approved dealers in government debt, including the largest banks, to borrow cash against some stocks, municipal debt, and higher-rated corporate bonds. US bond yields hardly moved and the curve steepened. The Fed is scrambling to fix the funding market but while they focus on that, the long end is getting kicked hard and possibly for good reason.

Markets are extremely fragile but looking down the road, as indeed bond investors do, the dual stimuli from monetary and fiscal policies is a massive shot in the arm and when this crisis passes, which is unknown but not more than a few months away, all hell could break lose with economies running hot for a very long time before central banks or governments are prepared to take their foot off the gas. Remember way back when I suggested it is worth keeping some TIPs in the portfolio as they are all but free? Well, I would keep hold of them. I also think gold may start to recover as well but a rising USD does keep pressure on the yellow metal. Before the US close last night, USTs had already seen the 10yr yield rise 31bps and 30s put on 32bps.

Get those curve steepeners on now as it seems to me the forthcoming debt build is going to be an issue for bond markets and it seems there is still a real shortage of USDs out there and I would think that the Fed are starting to pull their hair out over this as they have added a lot of almost unlimited liquidity.

EDs dumped into the close last night and I fully expect more stress coming from this 11yr bond rally. I think bonds are the next big issue along with a rapidly rising USD. This (chart below) even after the Fed’s CPFF (Commercial Paper Funding Facility).

Let’s see if the Fed’s further action last night makes any impact on this spread today; the Fed seems to be playing catch up rather than beating this problem and has now done PDCF (Primary Dealer Credit Facility). The Fed is slowly putting back on all the emergency tools used in 2008 and to me that suggests they are getting scared about potential defaults. But banking liquidity did not recover yesterday; what the hell is going on and what more can the Fed do? It is also suggested that banks are hoarding dollars, as they worry about companies defaulting or asking to borrow more. This overwhelming demand has meant that the cost of dollar funding keeps creeping higher, despite the sweeping measures taken by the Fed. Corporates are also hoarding USDs to pay their debts and keep business flowing during the coronavirus pandemic, helping to send the currency higher. There is a greater threat of corporate defaults now but do not think sovereign nations, who are about to go all-in on debt, are immune to ratings, or, in some cases, possible defaults.

What is going on in the bond markets is, that not only are governments going to pile up debt and the Tsunami of issuance will flood the bond markets, there is also veiled talk of helicopter money among other things. Giving money directly to consumers. This is toxic stuff for bond investors and hence the dump in bonds. So, in trying to fix one problem, another one pops straight up! It’s like “Whack-a-Mole”. These are not normal times but it shows how broken bond markets are when the Fed slashes rates and yields start to rise but debt is now a concern for bond markets and rightly so. But I mentioned another problem for the US, as they and indeed many others, commit to massive stimulus (more debt to you and me), and that is the rising CDSs on US sovereign debt. The markets are starting to suggest that the risks of the US defaulting are on the rise.

While I do not think that may happen anytime soon it is worrying nonetheless. But the US is not the only one piling on massive debt, as the EU is doing the same and the ECB is in no place to fight an attack on EU bond markets and a default there is probably more likely than in the US. Peripheral EU bonds were blowing out against bunds yesterday; a clear canary in the coal mine. If we get a real fracture here, the EU will be facing an existential crisis as Germany is probably not going to bail the whole EU out being in the shape it is in right now.

Despite the bounce off the lows in EUR, I am recommending staying short.

It seems more than likely that MMT is now upon us and being adopted by many populist governments but just a small reminder here; DEBT DOES MATTER. No wonder the USD has had 6 days of gains.

This crisis is now so much more than about the virus and when it passes. So how bad is the credit or junk space? In the past week, junk-bond investors have suffered through two of the worst days since the collapse of Lehman Brothers. The struggle reflects the spike in economic uncertainty and how many high-yield borrowers will have problems with bank lines. However, junk CDS spreads are pricing in a 43% five-year default probability. That’s high, but in 2009 CDS was pricing a more than 60% default probability, so it can go higher and probably will quite quickly now. Ironically, IG credit is even worse, with CDS pricing in a 9.9% default probability, which is extremely high. The Fed has more to do it seems but they took all the risk premia from risky markets and are certainly to blame for a lot of this but investors piled blindly into high risk assets priced as high quality. It was always an accident waiting to happen but even a low yield was deemed worth the chase. Well, it wasn’t.

With all the Fed has done and all that governments have promised, the market remains unconvinced that any of this is enough, especially with the likes of the good people at JPMorgan warning that the world is facing an unprecedented dollar margin call, as a result of the $12 trillion synthetic dollar short, some 60% of US GDP!

There is no way the Fed is expecting or accounted for this. They will add day by day but will always be in catch up mode. In the meantime I see long end US bonds falling quite hard and the USD pushing ever higher. FX vol is back with a vengeance and we my have some strong moves or even a trend. EUR looks set to test 1.077 recent lows and Cable the lows at 1.1958 and that could be just for starters. AUD looks dreadful and could test the retracement area around .5716. I am keeping a close eye on the FRA-OIS spread, EU peripheral bond spreads, US long end bonds and the actions taken by central banks to avert a crisis. But the crisis may actually be exacerbated by the massive stimulus being forced into markets. In other words the medicine may kill the patient. The idea that debt is something we can use in some limitless fashion is going to be tested. MMT may be a popular idea in theory but it comes with some very nasty side effects which could kill the patient. Debt does matter and governments are going all-in regardless. Not much else they can do with the world shutting down, I guess. They are trying hard to get the economy through this but bonds will NOT like this.

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Strategy:

Macro:

Short EUR @ 1.1195.. Stop above 1.1250.

Short Cable @ 1.2225.. Stop above 1.2310.

Long US 10yr yields @ 0.835% (short USTs)

Brought to you by Maurice Pomery, Strategic Alpha Limited.

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