• The biggest theme in Global Markets as of late March are the reversals in the Trump trades of 2017. For example, on Tuesday 21st March, the equities market fell by 1.2% in response to fears that Trump policies, in addition to the inflationary effects of those policies, may not come through. At the same time, an associated Trump trade, the bull market in the USD/JPY, also suffered a tremendous weekly decline.
• At this juncture, it may be worth considering certain important loopholes in the dominant narrative associated with reflation, rising interest rates, and a global recovery. For example, one of the themes we’ve had in the last few months is the idea that CPI inflation is back for good, which justifies rising rates, or is an indicator of positive reflationary forces.
• However, if we were to look at energy prices which is one of the key drivers for CPI inflation, crude oil prices for April delivery is down 10% for this month. (Refer to chart) The Thomson Reuters CRB Index, which is a proxy for commodity prices, has equally fallen from 191 in early March to 183 as of Friday’s close. Other market-based inflation indicators, such as the University of Michigan’s Survey of Consumer Inflation Expectations, showed that forecasted annual inflation for the next 5 years is at a mere 2.2%, which is a record low.
• Furthermore, if we look at some of the hard economic data, as of March 2017, the Atlanta Fed is forecasting that U.S. GDP QoQ is going to fall to 0.9%. Wage Inflation, which needs to accompany CPI Inflation, has not had the same robustness of growth as consumer price inflation, which shows that real purchasing power isn’t necessarily improving.
• As for the narrative of rising interest rates, we should also consider how much capacity the Fed has to raise rates. Total debt in the U.S. is close to $20 trillion, and gross debt is 375% of total GDP. Given this extreme level of indebtedness, even a small amount of rate hikes may have serious implications for interest expenses of corporate earnings.
• So, given this weak macroeconomic backdrop, what are some of the trade ideas that may be worth thinking about? If we were to look at the CFTC U.S. 10-Year Net Futures Speculative Positioning chart, it shows us that we have one of the largest short positions ever, in the history of the Bond Market, which is a product of this narrative of Reflation and Growth.
• This offers us a unique opportunity to be long on the Fixed Income market. When investors realise that real inflation and growth are not coming, and begin to unwind their cumulative short positions in Fixed Income, being positioned bonds at this movement could provide a tremendous risk-reward ratio in the coming months.
By Nicholas Tan Wei Hong