Trading Desk Notes August 12, 2019Submitted by Polar Futures Group on August 9th, 2019
Long bonds is the most crowded trade in the world. It’s been a hugely profitable trade the last 9 months but the rally may be over. Bonds have been the epicenter of the interest rate repricing trade and if bonds start to fall then the “positioning risk” in those markets will create “mean reversion” trading opportunities everywhere.
On July 27 I wrote, “The aggressive re-pricing of future interest rate expectations has caused some markets to become very “crowded trades” (positioning risk.) That doesn’t necessarily mean that it’s time to “take the other side” of the trade...but it does mean that it’s time to watch for signals that it’s time to take the other side of the trade...because a crowded trade is vulnerable to reversing quickly.”
Bonds had a classic hammer reversal on Wednesday when fear gripped the market...US stocks were down hard, VIX was hitting 7 month highs and gold had rallied over $100 in 5 days.
Another kind of signal was “talk” this week that Germany might issue bonds (at negative rates, why wouldn’t they?) to fund environmental programs...a politically acceptable way of getting started on funding fiscal stimulus by issuing debt. Why was that a signal? Because the European bond rally has been a “supply shortage” story...with everybody front-running the ECB...who were going to buy every bond in sight...but...if the paragon of fiscal rectitude can contemplate issuing paper to pay for fiscal programs maybe “others” will also decide to hit the bid to fund a range of “badly needed” government programs. Does Italy come to mind?
Last week on the MoneyTalks radio show (www.Moneytalks.net) I mentioned that the Swiss could borrow money for 50 years...and be paid to do so. I said that if it was me I’d take the money. I’ve thought about that idea all week and I bet there are a lot of people in “high places” who are beginning to think that taking the money...issuing paper at negative rates...might be a very good idea. There goes the supply shortage idea.
I took an initial short position in TNote futures Wednesday when the contract dropped through Tuesday’s low.
I took advantage of a great triple-wammy “mean reversion” opportunity in S+P options this week. On Wednesday the market made a “higher low” after the nasty spike low on Tuesday while implied volatility indices were at multi-month highs. The skew (S+P puts were WAY more expensive than calls) had short dated OTM puts with IV of 26 – 27%. I shorted OTM puts...essentially buying the S+P and selling high-priced Vol in the same trade. The put premiums shrank as stocks rallied, Vol fell and time slipped away.
The devaluation of the Chinese currency rocked markets this week. Last week I noted that the major European currencies (save the Swissie) and the Renminbi had fallen to 2+ year lows...with the RMB dangerously close to that “7” level. I also noted that markets had not anticipated Tariff Man taking another swipe at China and wondered if retaliation was coming. Well it came Sunday night and definitely hit risk sentiment hard as it was seen as a major escalation in the tensions between the US and China.
The Yen puzzled me this week. It rallied hard Aug 1 – 3 as global stock markets and bond yields tumbled...the typical relationship...fell back on Aug 6 when stocks and bond yields rose...but then the Yen kept rallying even though stocks and bond yields were rising. It’s clearly the strongest currency in the world the last 2 weeks...and it’s also strong longer term...USDJPY is at 17 month lows and EURYEN is at 2 year lows...and its off the charts strong relative to AUD and EMFX. Maybe it’s as simple as a “safe haven” bid. Even the Euro is up ~2% Vs. the USD since August 1 while EMFX has mostly been clobbered. Are the FX markets worried that Trump may take action to devalue the USD?
Gold rallied more than $100 in 5 trading days to hit a new 6 year high. It feels toppy to me...the options skew shows that people are paying up aggressively to buy calls...but it’s got momentum on its side and I don’t see any good solid signals that it’s time to do a mean reversion trade in gold. I don’t want to pay up to buy it here so I’ll just leave it alone...and wonder how I missed buying it!
My short term trading: I came into the week flat and just watched the show for a couple of days. I sold OTM puts on the S+P and shorted TNote futures on Wednesday and will maintain those positions into next week. I’ll be watching for more “mean reversion” opportunities across markets!
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