Macro Edge #34
Originally posted on thepensivenugget.com
The US yield curve has inverted, indicating that recession risks are very real.
Pay special attention to the USD in the coming weeks and months. A stronger USD will indicate growing risks of global financial problems, as will US nominal yields turning down.
Yield Curve Inverts, Time To Watch The USD Closely
- The US yield curve between the 2s and 10s inverted last week, and remains inverted between the 5s and 10s
- Recession risk is now real, compounded by high levels of inflation in food and energy globally
- Commodities prices remain high even as they start to stabilize
- WTI is back below $100, but is still too high for a world contending with high inflation and growing recession risks
- Wheat is still expensive, although it has come back down to ~$1000
- Base metals prices remain bullish, with Copper pushing the top end of its range, Aluminum still >$3000, and Iron ore continuing its rally
- Global USD funding conditions are critical to how far financial contagion spreads, and how deep the recession gets
- Demand for USDs remains stronger than it was at its low in the middle of last year, which implies that global USD funding conditions are getting tighter — not a good sign for the world economy, and NOT helped by war
- USDCNY is the canary in the coal mine, and can tell us when stress levels in USD funding markets increase
- Higher energy, raw materials, and food costs feed into higher inflation all around the world. This combined with the inverted US yield curve and stronger USD is stagflationary at best, deflationary at worst
Trading Ideas — Performance
Trading Ideas — Commentary
- Entered into short positions in EURUSD (again) & GBPUSD
- EUR,GBP are best candidates to short vs the USD now as they are looking more bearish than AUD and CAD
- Need to wait for short term trend in AUD to realign with its medium term trend before taking a position
- Long USD positions were stopped out due to volatility
- Initial EURUSD short closed for a gain of 3.83%
- AUDUSD short was stopped out at 0.7285 for a loss of -2.03%
- USDCAD long closed out for a gain of 0.66%
- Long oil position did well (expressed via XLE in ETF Edge), and was also closed out due to volatility
- Exited straddle on TLT in anticipation of long yields turning lower, for a net gain of 18.4%
- Now looking and waiting for long yields to make a top, before going short US long yields (long 10y/30y USTs)
Trading Ideas
- Long USD:
- Well established trend, in place for >6 months in most major currency pairs
- If global economic growth does take a turn for the worse in the near future, global USD funding markets will tighten, driving the USD even higher. War in Ukraine is NOT helping
- The now inverted US yield curve (even as the Fed turns hawkish) is providing a clear warning sign
- USDCNY has started to turn higher, hinting at worsening conditions
- Serves as a broad hedge against other “risk” assets in your portfolio, like stocks
- BUT, don’t think of the USD trade as “only” a hedge
- It is entirely possible, and normal, for the USD to strengthen as equities rise. The 2nd half of 2021 provides a good example of this, where US equities rallied even as the Dollar broadly strengthened
- USD longs in general should do well, but of the G7 currencies, look to go long the USD vs:
- EUR
- CAD
- GBP
- AUD
- Long 10y or 30y US Treasuries:
- Yield curve inversion points towards the end the current economic growth cycle, which means that nominal yields will start to turn down soon
- Monthly & yearly trends in yields are bearish, and looking for an opportunity to short yields is in alignment with long term trends
- Trade can be expressed:
- Long TLT, or long TLT Calls
- Long US T Note/Bond Futures, or long Calls on Futures
- Long Gold:
- Gold has quite decisively broken out of resistance levels and looks strong technically
- The geopolitical backdrop is also supportive of higher gold prices
- Be wary of trading gold based on current high levels of inflation as it didn’t rally over the past few months on record breaking CPI data releases & headlines
USD pairs have ceased moving in lockstep for now… EUR
- EUR has fallen back to ~1.09 after its end of 1Q22 rally
- The medium term trend is still bearish, with new lows likely
- However, it has to break through critical support from its previous low and 2017’s uptrend ~1.081 first
USD pairs have ceased moving in lockstep for now… GBP
- GBP is still trading below 1.317, albeit in a sideways manner
- A retest of its 14th March lows at 1.30 is on the cards, with the broader trend still bearish
USD pairs have ceased moving in lockstep for now… AUD
- AUD broke above major resistance ~0.754, reaching as high as 0.766, but failed to sustain its breakout
- The trend remains very bullish in the short term but bearish in the medium term
USD pairs have ceased moving in lockstep for now… CAD
- CAD managed to break below major support ~1.245, but immediately sold off again
- It is now approaching resistance at 1.262, although a test of major support ~1.2314 remains possible
USD pairs have ceased moving in lockstep for now… CNY
- The CNY couldn’t sustain last week’s rally, and it remains closer to resistance at 6.385 than its March highs vs the USD ~6.3
- CNY’s future direction will be key in determining the direction of other risk assets
US long yields haven’t topped out… US 10y
- US 10y yields made a new COVID era high at ~2.6%
- Resistance lies at 2.77%, with major support a distance away ~2.06%
- Last week we asked if March 28 was the high in 10y yields; the market has answered “no”, at least for now
US long yields haven’t topped out… US 30y
- US 30y yields also made new COVID era highs, slightly above 2.65%, and could move to test resistance between 2.85% — 3%
- Critical support is far away at ~2.05%
As the US yield curve inverts…
- The US yield curve inverted last week, falling to 2019’s lows
- 5s-10s remain inverted!
- Note that 2s10s inverting is enough of a warning, it steepening again doesn’t invalidate this
And US breakevens ease but are still elevated…
- Breakevens have come down with oil prices but are still near their highs
- High inflation from disrupted commodity markets and supply chains do not go well with an inverted yield curve
- Stagflation is quite likely, if not outright deflation
European yield curves steepened sharply this week…
- Last week’s flattening turned out to be a headfake as European yield curves steepened sharply this week
- When this trend ends, it could mark the start of another global downturn, especially if CNY has weakened even more by then
Oil falls back below $100…
- WTI is now trading <$100, with support at $92
- Resistance stands at $116 and ~$128, with 7 March looking increasingly like a top
- But, supply remains tight vs demand; a sharp drop in demand is needed for prices to really fall
As Copper remains firm near the upper end of its range…
- Copper is still trading close to the top of its range ~$4.79
- Given the geopolitical situation and flattening yield curves, Dr Copper probably isn’t rallying because of global growth
Iron Ore continues to rally…
- Iron ore continues to rally strongly, and is approaching last July’s high at 1033
- The base metal is looking more and more bullish by the day
Aluminium trades sideways, but remains expensive…
- Aluminium has still failed to regain its previous highs ~$3880, and seems to have settled into a period of consolidation
- Although prices remain elevated ~$3000
Gold trades in a tight range ~$1900…
- Gold has settled into a tight range slightly above $1900
- As long as support at $1875 holds, another run higher (maybe to test March’s $2080 high) cannot be discounted
Wheat prices consolidate too, but are still painfully high
- Wheat is also trading sideways, ~$1000
- High wheat & fertilizer prices, due to major war related supply disruption, continue to threaten prolonged global inflation & possible social unrest
Comments