To The Moon

Macro Edge #33

Originally posted on thepensivenugget.com

The US yield curve continues to flash huge warning signals to anyone willing to listen.

As the potential for deflationary outcomes increases, smart traders/investors need to position themselves accordingly.

If you would prefer to read this article in a slideshow format, you can do so at: https://bit.ly/Macro_Edge_33

The Yield Curve Is Flashing A Huge Warning Signal

• The US yield curve between the 2s and 10s is very close to inverting, and remains inverted between the 5s and 10s
• Indicating much reduced potential for long term growth-driven inflation, even as US breakevens stay elevated

• Volatility in Commodities remains high even as prices of the most affected commodities pull back a bit
• WTI has fallen back to ~$100, which is still too high for a world contending with high inflation and a flattening/inverted US yield curve
• 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 headed back to record highs, and Iron ore rallying

• Global USD funding conditions are critical to how far financial contagion spreads:
• 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
• USD eased off in the past week, with CNY in particularly rebounding strongly vs the Dollar
• Keep an eye on USDCNY for indications of increasing stress in USD funding markets, and the resulting increase in deflationary potential

• Higher energy, raw materials, and food costs feed into higher inflation all around the world. This combined with the flattening/inverted US yield curve and stronger USD is stagflationary at best, deflationary at worst

Trading Ideas - Performance

Trading Ideas - Commentary

• Long USD positions were stopped out due to volatility
• 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%

• Might be wise to wait for better entry points in long USD and long gold positions, perhaps on retests of previous levels
• EUR,GBP are best candidates to short vs the USD now as they are looking more bearish than AUD and CAD
• AUD is trading at major resistance, which might offer an opportunity to go short if it fails to breakout

• 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 for confirmation that long yields have topped out, if not waiting for them to make their highs, 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 flattening, and now inverting 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 - given current strength, it would be wise to wait for the short term trend to realign with medium term bearishness before re-entering this position

• Long 10y or 30y US Treasuries:
• Highs in yields (lows in price) might be in, though further confirmation is needed in the days and weeks ahead
• 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 eases off… EUR

• EUR bounced over the past week and rallied back to the top of its bearish channel, where it sold off a little
• Should it breakout, resistance lies a fair bit away ~1.138
• The medium term trend is still bearish, with new lows quite likely

USD eases off… GBP

• GBP has broken below support at 1.317, with the level now acting as resistance
• A retest of its 14th March lows at 1.30 is on the cards, with the broader trend still bearish

USD eases off… AUD

• AUD has rallied to reach major resistance ~0.754, but has yet to breakout
• While the trend still looks bearish, AUD might be carving out a broad range between 0.7–0.754

USD eases off… CAD

• CAD continues to rally vs the USD and has fallen to test major support ~1.245, where it managed to catch some bids
• If it breaks below, next major support lies ~1.2314

USD eases off… CNY

• The USD’s rally against the CNY got close to, but didn’t really test, major resistance ~ 6.385 before turning down again
• CNY’s future direction will be key in determining the direction of other risk assets

US long yields might have topped out… US 10y

• US 10y yields rallied to 2.56%, close to resistance ~2.6% before falling back down
• Support lies a distance away ~2.06%
• The 28th of March could have marked the high in 10 yields, although further confirmation is needed

US long yields might have topped out… US 30y

• US 30y yields rallied to 2.63%, close to resistance ~2.65%, before falling back down to break below support ~2.5%
• Closest support lies ~2.4%, with critical support far away at ~2.05%
• 30y yields could also have made their top

As the US yield curve keeps flattening and starts to invert…

• The US yield curve is still flattening with 2s-10s now ~5 bps, and looks likely to invert to 2019’s -0.04 level
• 5s-10s remain inverted!
• Higher commodities prices associated with Russia’s War will exacerbate this weakness, regardless of the Fed

And US breakevens ease but are still elevated…

• Breakevens have come down a little but remain close to their highs
• High inflation from disrupted commodity markets and supply chains do not go well with a flattening/inverted yield curve
• Stagflation is quite likely, if not outright deflation

European yield curves start to flatten…

• European yield curves have started to flatten (finally), although it is still too early to tell if this marks the start of their own moves toward inversion

Oil also eases off a little…

• WTI remains very volatile and driven by war headlines, but is trading more bearishly having dipped below $100 again
• Resistance stands at $116 and ~$128, with 7th March looking like a possible top

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 managed to reach its early March highs before easing off, and is looking increasingly bullish

Aluminium remains expensive…

• Aluminium has yet to reach its previous highs ~$3880, although a retest still looks likely as prices remain elevated

Gold continues to consolidate in the $1900s…

• After a sharp fall to ~$1890, Gold has rebounded back to its previous area of consolidation ~$1930
• Another run higher is possible if war time uncertainty continues, and support at $1875 holds

And Wheat prices begin to fall, but remain painfully high

• Wheat briefly fell < $1000 this week before bouncing higher again
• High wheat (& fertilizer) prices, more than oil, have the potential to spark social unrest in countries dependent on Russian/Ukrainian supply

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