Shorting the USD during US QE (1-3). Shorting the EUR during the ECB’s LTRO and QE programs. Shorting the JPY during the BoJ programs. Making the most of the unwinding QE long USD, and so on.
It’s not just currencies that this has worked for as the flip side of the currency trade has been the equity side. Being long the S&P, DAX or Nikkei as each currency deprecated has also been a winning strategy for the past six years.
However, the central bank divergence strategy is starting to blur – and the ‘stable markets’ that have been created through central bank policy is starting to break down – except for one: the US.
The state of play
- The non-farm payrolls (NFP) data on Friday were stellar. The reaction to the fact the US economy is clearly still firing ahead was muted as economic growth is still being met with fear of sooner-than-expected Fed fund rate hikes.
- The interest rate markets are clearly telling you that the volatility in the bond market is back at 2013 ‘taper tantrum’ levels.
- Sovereign bond markets have seen a 3.7% decline since the April highs. Individually, the movement in the Bund market is staggering as the ‘short of the year’ saw huge selling as the narrow trade unwinds.
- The US bond market is clearly ahead of the curve and is positioning for the ‘signalled’ hikes. (Although not on the same level, selling in Australian bonds has also been seen.)
- Volatility has seen a large divergence developing between credit and equities markets (particularly US markets). Selling has started in equities but not in conjunction with the selling in bonds. History shows this is not normally the case and credit and equity markets tend to move together (in direction).
- The divergence in credit to equites markets like those currently developing tend to develop around big shifts in the macro cycle, ie. rate hikes or macro uncertainty.
- That begs another question: Are we seeing a global equity divergence? In short, yes we are.
- For us in Australia last Friday marked the worst trading week in three years and we are now within 101 points of a technical correction (the level to look for is 5397, 10% from the intraday high of the market in April). That side looks unlikely to abate today either – the SPI is pointing down 17 points today at 5478.
- However, the DAX has corrected, for example. The Eurozone volatility has seen most continental equity markets at volatility levels not seen since 2011.
- The S&P is in its tightest range in over 21 years, and the VIX index in the US is holding in the complacent levels of 10 to 14. US trading is also about to enter summer time trading – low volume, low price action and low volatility.
- I think the equity divergence is only going to extend.
Ahead of the Australian open
We are currently calling the ASX down 20 points to 5478 from its close on Friday. The short week looks like it’ll be starting on the back foot.