This is a tricky period for asset markets, warns Citi's Steven Englander. Positioning still reflects a risk-on view but the risk-on enthusiasm is in EM, equities and Asia rather than peripheral Europe. Investors are still long risk, despite the geopolitical tensions and Fed Chair Yellen’s modest nod to the risk of faster than expected tightening, Englander cautions, concluding that investors continue to anticipate a soft landing despite all the discussion to the contrary.
Via Citi's Steven Englander,
This is a tricky period for asset markets. Positioning still reflects a risk-on view but the risk-on enthusiasm is in EM, equities and Asia rather than peripheral Europe. There has been some buying back of USD against G10 but investors are long Asia Pacific versus USD in its place. Geopolitical developments in Russia/Ukraine and the MidEast are having localized impacts, if that. Investors took note of a somewhat changes Yellen tone, but are treating the Fed as an outer-orbit risk rather than as an asteroid taking dead aim.
The two big risk events are the US CPI and next week’s FOMC. We already saw equities come off a little today, short and medium term note yields move up, and 10yr Treasury yields fall in line with equities. We suspect that investors will hedge a small part of long risk positions in coming days, but only languidly. They have begun to discount non-press conference meetings as being like the ECB’s non-forecast meetings, unlikely to generate much waves.
Despite the backing up of US two year yields, sideways moves in equities and some strengthening of USD within G10, investors are not really prepared for any sort of fixed income unfriendly event. So we are likely to see modest upside risk-positive response to low inflation or dovish surprises and significant position cutting if expectations of Fed normalizing were brought forward.
Consider Figure 1. Below which shows d/d, w/w and MTD currency moves against the USD. What is surprising, as indicated by the little red arrows, is that all G10 currencies are down versus USD on a MTD basis and generally on a d/d and w/w basis as well. The impression of USD weakness comes because most major EM currencies are stronger, despite geo-political concerns and it is more common for EM to be a high-beta version of G10 than to have the opposite sign. When we get high yielders outperforming this way, we are not in a market afraid of a liquidity squeeze.
Within G10 continental Europe is doing worse than the commodity currencies or UK.
The correct interpretation is that investors are still long risk, despite the geopolitical tensions and Fed Chair Yellen’s modest nod to the risk of faster than expected tightening. However they have shifted away from European risk towards even higher beta risk, but risk that is less exposed to economic weakness in the euro zone and fallout from the Russia/Ukraine crisis.
Some of this we can directly measure. Our CitiFX flows show a lot of buying of Asian currencies in recent months, but pace of buying has diminished sharply over the last month.
Figure 2a, 2b: Real money and leveraged have bought a lot of Asian currencies
Similarly CitiFX Access shows a that the long Asia position increased sharply in Q2.
...and looking the correlation of HFR’s daily macro return index with asset prices the strongest correlation by far remains with equity prices, although there may be some recent hedging of these positions by shorting Treasury notes.
Bottom line is that we continue to see investors anticipating a soft landing despite all the discussion to the contrary.