One week ago we warned that a major USD short squeeze is taking place, and that it has the potential to get much worse for dollar bears. Today, Nomura's X-asset guru Charlie Mcelligott explains that, in his view, the reason why the dollar has so dramatically reversed direction in the past two weeks, in the process recoupling with rate differentials, is because the "fake narrative" of "synchronized global growth" is finally over, and with it, the "hawkish central bank pivot" thesis is breaking-down as well
More, as excerpted in his latest note below:
DOLLAR BREAKS-OUT, AS RECOUPLING WITH RATE DIFFS BLEEDING LEGACY MACRO POSITIONING
- Heard this one before? DXY through 200DMA overnight is escalating the “performance bleed” from consensual macro positioning with implicit “short USD” components
- With the “synchronized global growth” narrative now being capitulated against, the Dollar has recoupled with rates differentials, as US is again viewed as the world’s leading growth-story
- In conjunction with R.O.W.’s “slower growth” trend, we have seen the “hawkish central bank pivot” thesis break-down as well—BoC, BoE, BoJ are collectively “regressing” with increasingly “dovish” rhetoric, while PBoC takes outright “easing”- / stimulus- actions
- Nomura Quant Strategies CTA model showing the “Dollar reversal” phenomenon in “real-time,” as WoW we see “short USD” positioning expressions beginning to reverse / pivot in not just FX but Equities and Commodities as well
- EM equities longs then in a dangerous position, as TFF data shows the Asset Manager “net long” position @ +2.5 z-scores, while Leveraged funds too remain high @ +0.8 z-scores
- Despite Dollar’s move, “long Crude” trade continues to hold via geopol w/ Iran decertification looking certain…yet is largely “priced-in” as a “known unknown”
- Crude holding higher is critical for the larger “bearish rates” / “re-inflation” themes
- On top of Crude “fatiguing” here, fixed-income “bears” seeing additional near-term / tactical “reversal” risks as well:
- US Treasury’s quarterly refunding statement out last night showed a monster reduction in financing needs to “just” $75B from the original Jan est of $176B (!) as cash balances came in much higher than expected post taxes
- The return of overseas demand for USTs, not just from ‘unhedged’ buyers (Japanese lifers recent investment plan releases) but also the future potential to see ‘hedged’ buyers return IF USD were to further rally going-forward (not just yet though), as the ‘punitive’ cost of xccy decreases, allowing attractive relative yields to dictate purchases
- Reiterating best “USD upside break-out” hedges: EEM / MESA PS, Nikkei CS (note: the EURUSD PS has already ‘realized’)
- Despite lower SPX yesterday, many were surprised by the outperformance of “1Y Momentum” factor (+0.7%) and broad HF L/S (-0.1%) vs SPX -0.8% / NDX -0.8% / RTY -0.9% / RIY -0.8%
- Not just the +++ forward seasonality I’ve been noting recently for “Momentum”- and “Buyback”- LONGS coming down the pipe in the months ahead—because yesterday was driven by the underperformance of “Momentum Shorts”
- “Momentum” SHORTS were pressed hard yesterday and contributed a massive +1.2% from a market-neutral perspective (vs “1Y Momentum Longs” -0.5%)
- As a reminder, the month of May can continue to “chop,” but the massive (negative) seasonal for “Momentum Shorts” that begins in earnest starting in June and running through September sees an average -3.7% drawdown (“positive” contribution from short book) since 1984 / -4.9% average return since ’00 / -3.8% median return since ‘00
DOLLAR RALLY HAVING MAJOR CROSS-ASSET IMPACTS:
New day, same story: the USD break-out is further accelerating, with the DXY taking-out its 200DMA to the upside overnight, stronger against all G10 and the entire EM universe tracked by Bloomberg.
Feel free to punch me, but I’ll say it again—consensual macro longs accumulated over the past year + period under the “weak USD” regime (as DXY traded -14.2% between Dec ’16 and Feb ’18 despite ongoing Fed hikes) in the form of “longs” in Euro, Yen, EM Eq / EMFX, Nasdaq, Crude, Gold, Industrial Metals are all at various and diverse stages of “adjusting” to this new Dollar dynamic.
The issue is the same I’ve noted in prior weeks--the "synchronized global growth" narrative is now being capitulated against, and as such, the Dollar has recoupled with rates differentials because the US is again viewed as the world’s leading growth-story. The flipside of this of course is the “slowing growth” trend in rest-of-world too has driven the resumption of the widening in rates differentials.
EU/US REAL YIELDS DIFFERENTIALS AND EUR:
With the obviously slowing R.O.W. growth trend, the “hawkish central bank pivot” thesis is breaking-down as well: the BoC, BoE, BoJ are collectively “regressing” with increasingly “dovish” rhetoric, while the PBoC has recently taken outright “easing”- (RRR cuts) / stimulus- (tax cuts) action.
We continue to see this USD-positioning reversal develop “real-time” in the Nomura Quant Strategies CTA model, where the move higher in Dollar is having meaningful WoW impacts across macro-trend positions:
Gold from “max long” through “neutral” and now -10% “short” WoW
- EURUSD “max long” cut to +71%
- USDJPY “max short” cut to -71%
- USDSEK pivots to “max long” from -12% “short” last week
- USDCHF to “max long” from “neutral” last week
- Nikkei and Hang Seng “longs” jump from +33% to +62%
- Eurostoxx “max short” now being covered
- FTSE and CAC now both to “max long” from just +33% prior
- Copper now just +27% “long” from +43% last week
- Zinc now -10% “short” from +43% “long”
Despite the U.S. Dollar’s move, the “long Crude” trade continues to hold via geopolitics, w/ Iran decertification now looking utterly-certain after yesterday’s public dismemberment of Iran. Yet, “decertification” of the Iran deal has already largely been “priced-in” as a “known unknown” over the past month +, with the Pompeo and Bolton additions to POTUS’ admin as well as the seemingly choreographed Trump tweet on OPEC and oil prices, which looked like a calculated effort to push the potential gas cost jump “blame” in front of Summer driving season elsewhere. So is this ‘catalyst’ for Crude now tiring?
Today we are indeed seeing an almost “sell the news” in Crude on yesterday’s BiBi / Iran press conference, while the Dollar rally finally begins to hit as well. A move lower in Crude is a very troubling dynamic for consensual macro positioning—both with regard to “bearish rates” and “re-inflation” themes. To see the Dollar’s rally begin to crunch Crude is a problem if it were to gain ground.
Fixed-income bears are also seeing additional near-term tactical “reversal risks” as well after the recent run of weakness. The US Treasury’s quarterly refunding statement out last night showed a massive reduction in Q2 financing needs to “just” $75B, which is down from the initial January Q2 estimate of $176B. This estimate declined preciptiously as cash balances came in much higher than expected post taxes…and will again increase meaningfully in Q3…but some of that “deficit spending issuance” catalyst for the bears just lost its shine.
Another dynamic to keep an eye on going-forward will be the potential for a further USD squeeze to impact “hedged” buyers of USTs and possibly incentivize them to return to the mkt. Recently with the release of Japanese Lifeco annual investment plans, we’ve seen numerous mentions that “unhedged” buyers are looking to increase their purchases of foreign bonds—obviously a (potentially) good sign for UST demand.
However, those investors who need to currency hedge their UST purchases have largely been absent from the UST market recently because of the punitive cost of said FX hedges (xccy) as the Dollar has been mired in its year + tailspin. So despite the seeming optics of the rates differentials, the actual ‘take-home’ yield looks unattractive when adding back in the cost of the xccy, making EGBs and even JGB’s more attractive for respective foreign investors.
Although currently we see USTs remaining still “unattractive” for these FX hedged investors, a sustained and further USD rally could stand to reverse this dynamic going-forward and in turn, create a new incremental buyer of USTs who has been absent from the market. This is “one to watch.”
Despite lower SPX yesterday, many were surprised by the outperformance of “1Y Momentum” factor (+0.7%) and thus, broad HF L/S (-0.1%), vs SPX -0.8% / NDX -0.8% / RTY -0.9% / RIY -0.8%. This dynamic made the recent mentions of the +++ seasonality for “Momentum” (with the same for “Buybacks” as further ‘overlapping’ catalyst) look prescient.
But it’s not just the +++ forward seasonality I’ve been noting recently for “Momentum”- and “Buyback”- LONGS coming down the pipe in the months ahead—because yesterday was driven by the underperformance of “Momentum Shorts.” “Momentum” SHORTS were pressed hard yesterday and contributed a massive +1.2% from a market-neutral perspective (vs “1Y Momentum Longs” -0.5%).
As a reminder, the month of May can continue to “chop” for overall “Momentum” factor, but the massive (negative) seasonal for “Momentum Shorts” that begins in earnest starting in June and running through September sees an average -3.7% drawdown (“positive” contribution from short book) since 1984 / -4.9% average return since ’00 / -3.8% median return since ’00:
So the next logical question becomes “what currently screen as “1Y Momentum Shorts”? Ask and ye shall receive…
Clearly, the “Energy” side of this “Momentum Short” seasonality trade (as well as the aforementioned Crude / re-inflation dynamic) stands in contrast to my larger “cyclical melt-up” thesis. This is a real ‘short-term’ concern—HOWEVER, I do believe that ongoing trajectory of CPI / PPI / Prices Paid / Prices Received impact is having on future inflation expectations will continue in the medium-term and ‘win out’ vs this tactical seasonality ‘risk’ to the ongoing rally in inflation sensitive assets / plays / proxies.