Current positions 6/18
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If you’ve been reading my inflation series you’ll know my view that global inflation will continue climbing higher than policy makers think, and that it will take more tightening and economic weakness to get inflation back down. Historically, inflation (when above 5%) has not come down on its own accord without the Fed tightening Fed Funds rate above CPI.
All of my positions are an expression of this view on inflation. All central banks are behind the curve, but some are more behind the curve than others.
The best way to express this view in my opinion is by being short front end rates and bonds (betting on more aggressive rate hikes). While this may be obvious to some people, many in the market are overthinking this and believe there is a limit to how aggressively central banks can hike rates. Their argument is that aggressive rate hikes would send economies into recession and cause dislocation in the financial markets. I do agree that will happen down the line, but we are a few months to a couple quarters away from this being the main concern for central banks.
Short JGB futures
This is the trade I’m most excited about because it’s the market where reality is the most out of line with fundamentals, and therefore the return profile should be pretty asymmetric. The Bank of Japan is keeping 10 yr JGB yields capped at 0.25% by buying an unlimited amount of bonds to defend that level. This makes it the most dovish central bank in the world. The yen has been weakening a lot as a result, making imports (esp energy) more expensive, and the large number of bonds being purchased is keeping financial conditions very loose.
The JGB bond market doesn’t think the BoJ’s 25 bp yield is credible or sustainable, and has therefore been hitting the bid aggressively all week. Nothing is ever 100% certain, but it feels like there is only one direction yields can go, and that is up. The last inflation print was 2.5%, but that was the April number (which came out in late May). We’ll get the May number next Friday, and it could be a zinger. Maybe it’ll convince the BoJ that inflation is a problem that needs to be addressed. If the BoJ lifts the cap, they might reset it to 50-75 bp, and I wouldn’t be surprised if the market gaps there quickly.
Short June 2023 euribor futures and German 2 yr Schatz futures
I discussed this trade in my June 9 post and I think it is still in the beginning stages of playing out. The market is pricing in only 2.75% in hikes by the ECB (from a starting point of -0.50%) while inflation is going to reach double digits by the end of the year. At some point this year I think the ECB will start panicking about inflation and start hiking in chunks of 50-100 bp.
Long 5 yr Treasury puts (108 strike expiring Aug 26)
I originally had 10 yr Treasury puts (first mentioned on Jun 9) but I swapped them out for 5 yr because I think the shorter end of the curve will lead as the Fed gets more aggressive with its hikes. I believe Fed funds will exceed 5% at some point in this cycle.
Long Nasdaq puts (11k strike expiring Sept 16)
First mentioned in the June 9 post. Lower equities will be a natural by-product of higher yields and QT. I wouldn’t be surprised if Nasdaq draws down 50% from the high in this cycle. The worst has yet to come for the equity market.
Long WTI
I stopped out of this trade for a 5$ loss today on the sharp selloff in oil. I’ll revisit going long Brent or US gasoline futures if the market settles down.
Long Natural Gas and Soybeans
Small positions to get additional energy and soft commodities exposure
Short ETH/BTC
Took profit for a 13% gain. BTC and ETH both reached my downside targets so I’m expecting this cross to stabilize at current levels along with the broader crypto market.
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With inflation and rate hikes, will equity markets fall further? If that happens, will commodities also fall? War end at some point?