Constantly repeating yourself is the domain of three types of people: Parents, the insane and market strategists. Two of the three definitely apply to me (some would say more) but unfortunately, it is a sad reality that certain things simply don’t change from day to day or week to week. It is often difficult not to continue to draw an identical conclusion when the facts point you in the same direction.
For several weeks now we have reiterated time and time again that the USD is going to rally, front end rates are moving higher and that commodity and emerging market outperformance was coming to an end. We may have focused on different segments; for example, Cindy discusses on page 3 that it is too early to cover iron ore shorts. While there is always a nuance set of circumstances to each market segment we look at, at the end of the day, iron ore pricing is about aggregate commodities and the near term gyrations in the value of commodities is often driven by the USD. Get the dollar right and you generally will get the broad direction of the commodity universe correct.
So let me repeat myself and say that the USD is going to continue to strengthen into the first week of June and most likely into the Fed meeting on June 15th. While the extent of the USD rally will be determined by the potential for overshooting of interest rate expectations, the broad direction of the USD move should be straightforward. Unless we see a significant deterioration in the outlook for US or Chinese growth in the next couple of weeks, the path of least resistance for both front end rates and the USD is up. Dollar positioning is benign and while expectations for a June increase should be capped due to the Brexit referendum on June 23rd, the likelihood of a 25bps increase in rates at either the July, September (and /or December) meetings probably have further to run.
Given the already sizable bounce in the USD since the May lows, establishing new long USD positions at current levels is not optimal. However, oil stands out to me as a historic USD proxy that has defied gravity in the face of dollar strength. As we discussed in last week’s flagship report, I would expect oil to fall 10% in the next few weeks as its relationship to the USD reestablishes itself and the market realizes that Asian oil demand in Q1 was a temporary, Chinese led phenomenon. Adding to oil shorts is the only new speculative trade I would recommend for the week.
One change to the macro model portfolio this week will be reestablishing a short June SPX put / long 3 times June SPX calls hedge against our short equity position. The may hedge expired at zero last week which was the optimal outcome. If you are short equities, this structure is fantastic due to the large volatility skew towards puts.
Three Federal Reserve voting members speak this week: Bullard on Monday, Powell on Thursday and Mrs. Yellen will speak at Harvard on Friday but I would not expect much out of that speech. All eyes on her June 6th address ahead of the Fed blackout period. The week starts with Eurozone and US Manufacturing PMI’s for May. On Tuesday we will also see the May Manufacturing PMI from Japan. The Bank of Canada will publish their Rate Decision on Wednesday. Singapore and the UK will report on their GDP on Thursday with eyes then focused on US Durable goods. Friday the US will publish updates on Q1 GDP. April CPI in Japan is a core focus for the week as will be discussions between Greece and its creditors as the Europeans should complete yet another review.
Credits: Paul Krake, View from the Peak IND-X Advisors Limited www.viewfromthepeak.com.hk