An Apology

Well I'm glad my BoE Primer got very few views... I came out gloating before the meeting as odds on a rate hike had plummeted. Well here we are, the BoE's hiked rates. 

We live in crazy times. I was wrong, but this is probably the last BoE hike for a long time. I view this as a policy error and the BoE has totally destroyed its own credibility as a communicator of information. 

I am baffled, confused and shocked. The BoE is now like the Grinch who stole Christmas. Well, we live and learn and I apologise for my overconfidence. I think I'm technically supposed to eat my hat now, but I'm hoping my apology will suffice. 

Next up the ECB, let's see how wrong I can be there :) 

Just as a heads up, I am taking some time off writing over Christmas - there will be a couple of thematic pieces, but none of the regulars will appear for the next two weeks. 

FOMC Primer

On Wednesday at 7pm UKT we will have the next Fed decision.and at 730pm Powell will speak in a news conference and take questions from journalists. 

Every time we've had one of these meetings this year, it's felt like I've said it's going to be the most important meeting of the year. 

This time, financial market participants are waiting to see if the Fed will decide to increase the pace of its asset purchases from USD15bn/month. The consensus currently is that the Fed will decide to double the pace of tapering. There are a number of reasons for this. Firstly, inflation continues to climb higher (as in the chart below) and a growing number of Fed officials are beginning to express greater concerns. 

Source: Refinitiv 

Secondly, now that Powell is secure in the job and his reappointment has been confirmed, he may feel more secure in taking a slightly more hawkish stance. I don't believe this to be true, but that's what some people believe. 

Source: Refinitiv

The chart above shows quite an interesting picture with yields. On the one hand, the 2y yield has climbed pretty rapidly higher to around 0.8%, however, the 10y yield and the 30y yield have both come down quite significantly too. To me, this is indicative that the market thinks the Fed will act fast and then probably have to bring rates back down again to support the economy. 

It's very obvious that as debt levels around the world have mounted through the pandemic, economies will be less able to support higher levels of interest rates. Thus, I believe there is a potentially very profitable trade involving a short position in the 10y Treasury, and a long position in the 2y Treasury. I'd like to see the 10y move back to around 1.8-2%, and the 2y to drop to around 0.5%. 

What's Luke's Call? 

Personally, I think there has been enough evidence recently for the Fed to hold off increasing the pace for another meeting. We have the Omicron variant, the inflation report Friday wasn't as bad as many market participants were expecting, and some of the commodity price pressures are now abating. There is a lot of evidence to suggest that the inflation numbers could now start to drop gradually, but persistently in the coming months. 

Likewise, some US states have started to take actions to try and combat the spread of Omicron. To me, this clearly shows that the Fed will need to be reactive to possible slowdowns in the economy once again and should leave the additional policy support in place for another month. 

Either way, the market seems pretty confidence in a doubling in the pace of asset purchases. Therefore, What's The Trade? 

The trade for me this time is pretty obvious, get short the USD this week. It's an asymmetric risk in my opinion - either the Fed acts, which the market expects, and increases the taper pace, the USD flatlines. Or, the Fed doesn't act, and the USD gets significantly weaker. I'd be looking to short directly via some of the risk pairs - buying AUDUSD seems like a nice option. (I also like this trade due to the undervalued nature of the AUD at the moment so it's a win win!). 

Source: MT5 FxPro 

I like the idea of playing the 50% retracement from highs to lows on the chart above. You can see that we have now moved out of that aggressive downtrend, so I think this is definitely a good buying opportunity. 

Either way, I think this is a Fed meeting well worth watching and trading. Please do reach out with your questions. 

The Bank of England Preview

Well, it's a little too early to gloat, but the market has most definitely come around to my view that there is no chance the BoE hikes rates when it meets on Thursday. 

Markets no longer see a BoE rate hike as likely Thursday. 

It feels nice to receive this kind of vindication, the market has been pricing almost 100% chance of a hike in the last couple of weeks (they did the same at the previous meeting where, guess what, they didn't hike), and now it seems like the markets have learned there lesson. 

I have been out front on this issue for a long-time, with the economy fragile, inflation largely down to factors the BoE has no control over, and a stagnating growth environment in the face of the Omicron variant, it's pretty clear that once again, the BoE will not be hiking rates at the next policy meeting. 

The chart below shows the implied rates for upcoming BoE meetings, and clearly there is very little pricing for hikes at the Thursday meeting now. However, hikes are still priced for February and beyond. This becomes a lot trickier to predict further out, but I'd table my first BoE hike for the March meeting, again slower than the market is pricing, but I do think more caution is warranted on the UK economy as a whole. 

Source: Refinitiv 

Basically, the key thing to bear in mind with this meeting is whether there is any narrative change. The BoE has been becoming more hawkish yes, but that doesn't mean there will be hikes at this meeting. At the last meeting, the vote was 7-2 in favour of leaving policy unchanged. What's going to be important is to see whether that number shifts. If we get a 6-3 decision or 5-4 in favour of unchanged, then that could be the barometer for thinking about when we get more hikes. 

What's The Trade? 

I've been advocating a short GBP trade for the last couple of weeks, but I do think it's time to exit that one. The market has moved pretty quickly as in the chart below, so I think the surprise now is more likely to be hawkish than dovish. 

Source: MT5 FXPro 

If anything, I'd say the only pair I'd trade with is a EURGBP - there's just too much USD risk with the Fed ahead. But I don't really have a huge amount of conviction one way or the other, and with the ECB on the same day, I just don't want to be resting on a big position. 

So that's not particularly useful from a trading perspective, but hopefully useful for forming opinions about the BoE in general. 

As always, do reach out with your questions. 

Even a Stopped Clock is Right Twice a Day - The Equity View

A couple of weeks ago, I wrote a piece I called: "The Bears who Cried Wolf". In this piece I outlined why it was the right time to take some chips off the table and focus more on preparing for a possible downturn in equities which are priced to perfection. 

While one doesn't like to blow one's own trumpet, this now appears prescient. In this piece, I am going to add to a couple of the comments I made there, and also provide some confirmation bias to those who are seeking bearish ideas. (One of those people is Ouens Maksvitz, who very kindly gave me the inspiration for the title today - so thank you Ouens). 

We know that the perma-bears have been bearish and wrong for the last 10 years. However, my current argument is that even a stopped clock is right twice a day, and that is the point we are currently facing. With a raft of issues coming up, like the Omicron virus, a Fed taper and a possible disruption to the status quo at US midterm elections (where, no doubt, the Dems will be hammered for lack of clarity on policy, and also... it's the economy stupid). 

So, without sounding too much like David Bowie... let's ask Where Are We Now? 

Source: FxPro MT5

Well, we've taken a significant drop down, and we landed basically exactly on the 55-day SMA. This might seem like an arbitrary choice of moving average, but it has served pretty well in the past. It has generally been the point of support, and we can see this again now, landing perfectly on the 55d. The next couple of days will be extremely important. If this level holds, and we get the usual return to uptrend we've seen before, then I am sure we will continue with this relentless march higher for equities. 

To be fair, this chart above doesn't tell the whole picture, if we look at the pandemic darlings, we can see that this recent downturn has been pretty brutal: 

Source: Bloomberg 

However, with the Fed coming up... is this a time for caution? While I do not expect the Fed to increase the pace of the taper at the next meeting (unlike market consensus), this could still be bearish for markets as we see an increasing negative response from the market toward higher inflation and margins will eventually be squeezed. In fact, if we look at something like Chinese Producer Prices, we can see stunning inflation and this will eventually be passed on to US producers - I am certainly not saying that this will lead to persistently higher inflation in the United States! I am still a team transitory and do expect most of the current pressures to fade (especially in Europe), but there could continue to be transitory pressures for some time. 

Source: Refinitiv 

But isn't this what the perma-bears have argued forever? 

Basically yes. The perma-bears are always saying that for reasons x,y,z the economy is going to crash and burn and everyone in markets will want to run for the exits. In reality, I do not believe in these doomsday scenarios, but rather continue to advocate looking for value in these markets! I can see the S&P easily falling below 4200 before we set another all-time high. This would be a 10% drop and we'd enter into correction territory. 

One of my favourite charts is this one below - it shows the intra-year drawdown compared to the index return, you'll see that its incredibly rare to see a drawdown intra-year of below 10% in recent years, and crunching the data shows that drawdowns of more than 10% are extremely common. What's also pretty clear is the massive volatility increases we have seen since the financial crisis. Look at those big numbers in the drawdowns compared to the 5s,6s,7s of the 80s and 90s. 

Source: Calamos

Shall we blame QE? 

This has been something which many perma-bears love to point out... drops have got bigger post financial crisis as central bank balance sheets have got bigger, therefore QE caused more volatility. The argument goes lower rates, so incentivised to take more stock market risk, so when the drops come they're bigger as a) there is more money in stock and b) there is more leverage because leverage is cheap. I don't buy this at all. I think it's more just a product of increasing financialisation, and we have also seen recently big increases in technology of financial markets - naturally this makes markets more accessible and thus more tradable. 

When you had to wait 20 minutes to get live prices since you lived in Omaha and everyone else was in New York, naturally there were longer lags. But there we go, it's easy to spin a narrative to suit your mood. 

Source: Federal Reserve - yes that's 8MM or in other words, USD8trn

Where's the value? 

Look at the financial stocks for instance, they are seriously cheap! Well, compared to tech anyway - up just about 20% since before the COVID-19 pandemic, and some stocks look ridiculously cheap on their earnings multiples - GS, Citi, HSBC, Lloyds (in UK commercial) are my favourites in the sector. 

Source: S&P

Look Regionally: 

Then, as I flagged in the previous report on the equity market, look for value geographically. The UK at the moment is insanely cheap! Coupled with my view for financials as we look to get a steeper Treasury curve in the coming month, this looks quite enticing as a play. Europe isn't bad either, and if you insist on having tech, look to Europe and ASML. 

Source: Refinitiv 

Finally, I know many of you think I have some great grudge against EM, but this isn't true. Given the USD has been on an absolute mad run in the last few weeks, I do think there is a case to say let's start to add a little to EM equities. I particularly like the look of South Africa. OH-micron I hear you cry! However, I feel like this is already baked into the price of the ZAR, so it could be time for a bit of a retracement, although this would be highly risky. 

As a general rule though, EM is starting to look ok again, not too expensive if we look at some indices - below is the iShares Core MSCI EM Index: 

Source: Refinitiv

You can see we're down a decent 15% at the moment, and it could be time for something of a correction. That said, I remain extremely hesitant toward China, so if you can find an EM ETF ex-China, that would probably be the one I'd buy given all the regulatory risk. I suppose I could dig out a random ETF, but that wouldn't be great advice given I'd know nothing about it... I have to leave some work for the readers :) 

Conclusions:

Well that's basically the end of this tour of stuff, I am bearish, tactically, for the time being. I look for opportunities in Europe, the really hard-hit sectors, and also in some tactical shorts of those which continue to be resilient. 

Please do reach out with questions, or comment in the box below if you disagree. Let's hopefully get a good debate going for this one :) 

The Week Ahead

Hi All, Apologies but there will be no No Rest for FX this week. I have a busy week ahead and won't be trading much (if at all) myself. So just sticking with The Week Ahead. It should also be a quiet one with me re emails... preparing myself up for the chaotic subsequent week, is I'm trying to avoid getting Hung Up in any trades which might go stale after a few central bank meetings here and there and then get ready to Get Into the Groove for the Fed on the 15th. 

Big crypto moves this weekend... my long-term view on crypto is not great if I'm honest, but I'm only an amateur in the space so please do challenge me in the comments and I guess it should really be a papa don't preach :) 

The Weekend in One Image: 

Energy prices have surged completely recently in Europe. Day ahead prices above EUR250/hour. 

Central Banks: 

Highlights for The Week Ahead: 

No doubt the RBA will garner a lot of attention on Tuesday - this has been the central bank which has seemed very willing recently to abandon any forward guidance. I.e. When we had the abandonment of the yield curve control target and a seeming more hawkish shift from the board. Then we also have the BOC Wednesday, which has also been party to the occasional mixing up of the rhetoric. 

I will try and get you a primer for both, but at the very least I will get you the BOC - I'm starting to feel USDCAD looks very overvalued, and I very much like the idea of a USDCAD short - especially when we add in my view for probably higher oil prices. 

Economic Data: 

It's looking pretty busy for data. The US and China both publish inflation data this week. Latest CPI report expected to show inflation at 6.7% in November... the highest since 1982!!!! Wow. 

Personally, I expect this is probably about right, but this should be overlooked. Inflation for December should be markedly lower with this slump in oil (and subsequently gas) prices. We also get UK GDP figures, IP, and more. A few other data pieces from Europe but nothing I expect will seriously move the market. 

No Rest for FX 4: Briefly...

EURUSD: Expect little movement this week as investors choose to hold fire before the Central Bank meetings in the subsequent week. 

GBPUSD: Also expecting little movement, generally think this will be a pretty mundane week. 

EURCHF: Well, obviously here I'm bullish :) - Just going to have to keep thinking Like a Prayer with this one. 

USDJPY: Happy to continue to be short here as it does seem USDJPY is correcting. I have flagged this divergence between the US yields and JPY for a while, and see no reason for this to change. 

Equities: I continue to hold my shorts. I feel this may be a mistake for the first day or two of the week, but I think by the end the market will be little changed, perhaps a % or 2 higher. 

Treasuries: Again see no reason for massive changes this week, especially with Fed and ECB the week after. CPI will be the one to watch, but as I've said, this will drop in the next month no doubt with the fall in oil prices. 

That's all for this week, apologies for my brevity, but "why waste time say lot words when few words do trick".

Non-Sequitur: Madonna 

Again, no prizes for guessing this week's artist. It's Madonna. Madonna holds the record as the most successful female artist of all time. Wowza. Many facts I could draw from here, but let's stick with the easy ones... she's sold over 300 million records worldwide, is the highest grossing solo touring artist of all time, and once dated Vanilla Ice. 

November Nonfarm Payrolls Primer

Tomorrow is Payrolls Friday and once again it's going to be a critical payrolls report. In the last few days, we have heard increasingly hawkish noises from various speakers of the FOMC. The most notable has been from Powell, who has been quick (since his reappointment was confirmed) to turn up the hawkish noise - suggesting a discussion on a faster taper will be relevant at the next meeting. 

Thus, the pace of job gains in the economy will be critical to determine whether or not a faster taper is a good idea. A weak number on Friday will likely be enough to keep the Fed on its current taper timeline for another month at least. Conversely, a strong number will almost certainly give the Fed the confidence to increase its pace of tapering. 

Source: US BLS, FRED

A quick primer on the payrolls report: 

The Nonfarm Payrolls report is released monthly and contains a whole host of data about the labour market in the US. Through the pandemic for a time it was less important, but generally it is a critical and highly watched piece of data. The employment report is likely to shape the Fed's reaction function from now on, unless inflation becomes even more persistent. The report is release on the first Friday of the month at 08:30 ET (that's 13:30 UKT). 

What's expected from the report?

In the previous report, we had very strong monthly gains at over 500,000, and the market took this as a sign that labour market pressures were easing. It is interesting to see that the JOLTS number (that is, the number of jobs market vacancies in the US), has ticked down slightly, although it should be noted this data is delayed (latest is for September). 

Source: Refinitiv 

That said, there's no doubt that openings remain at very elevated levels compared to pre-pandemic. This means that there is still significant labour market tightness, despite the gradual grind lower in the unemployment rate. Thus, I would not be surprised to see the number on Friday to be a supply side indicator once more. The October report was difficult to digest because on the one hand a big beat means the Fed can hike quicker, but on the other it means supply side pressures are easing so there should be less upward pressure on wages, reducing inflation. 

I suspect a similar dynamic could be at work in this next report unless there is a very significant beat to the number. 

Consensus Estimates: 

In a Reuters survey for Friday, the median estimate currently sits at 550k jobs. This seems reasonable to me, perhaps a little low but still reasonable. The ADP number (which is essentially a private payrolls preview for the NFP number) came in at 534k today, although there is usually very little correlation between the two numbers, so read what you will into that :) 

We're in the run up to Christmas, and obviously last Christmas the pandemic was still having a pretty significant effect, so even with seasonal adjustments I think this could be a pretty strong report. 550k seems about right, maybe we'll get a little higher or a little lower, but I'd be surprised to see a big miss. 

What's the trade? 

For me, I want to be long USDs into the report. I think the supply side element is less of a factor now the Fed is being more aggressive in its hawkishness, email subscribers will receive some more short-term ideas on the day, so please fill out the form if you would like to be on the distribution list. 

With that said, I am longer-term expecting a bit of EUR strength into year-end, and also more GBP weakness, so my preferred option for the next month or so is to be long EURGBP. 

Good Luck to All. 

The November Reading List

Good Morning All and welcome to December. Can scarcely believe the time has come for me to write yet another reading list. Since starting The Reading List in February 2021 I've read over 40 books! Not bad going at all in my opinion! 

In November, I read very broadly, with fiction, history, philosophy and a collection of short stories. As always, please do reach out with all your suggestions. I'd like to say a special thanks for the recommendations of The Righteous Mind and also On Tyranny, both were excellent reads. 

Without further ado, I present the November Reading List. 

Why Visit America - Matthew Baker 

I'm not particularly sure why this book caught my eye on the stands at Waterstones, perhaps it was the punchy title but I grabbed it from the shelves and dived straight in. This book is actually a collection of short stories, and in many ways it reminded me of Tom Hanks' "Uncommon Type", just rather than being full of happy stories some of these are much more dystopian in nature. 

I particularly enjoyed the tale of the chap who decided he wanted to upload himself into a computer and live forever, sure... this isn't particularly original but it did look at some of the moral questions surrounding such a decision. By far the most disturbing story was the one of the "Lost Souls", where newborn babies were born as lifeless beings as the number of available "souls" for earth had been exceeded, leading to all kinds of crazed attempts by wannabe parents to secure their child's soul. 

Not all the stories are quite so dark, the story to give its title to the book "Why Visit America" was about a town which decided to secede from the rest of the USA. In reality, everybody ignored this small town since it didn't change any of the rules so it had "seceded" in name only, and actually had no legal right to do so. It was more just like a commune of people who had decided to live alone. 

On the whole, I highly enjoyed this book, it's quite witty and some of the stories are very poignant and can prompt some serious thinking about what would happen in these rather perverse situations. It's definitely a good read, and if you don't like long books, this is for you since they are all short stories. 

The Righteous Mind - Jonathan Haidt

Thanks again for the recommendation here. This book definitely did seem like a natural extension to Kahneman's Thinking Fast and Slow, and stepped deeply into some explanations of why people do tend to disagree so severely on some issues, and explains the role of intuitions and biases that shape people's political beliefs. 

What I particularly like about The Righteous Mind is the author's complete honesty about his own wrestlings with his political views - starting off as a typical university liberal, and then having to cede some ground to conservative viewpoints in certain areas. My favourite quote from the book is below: 

"I find it ironic that liberals generally embrace Darwin and reject "intelligent design" as the explanation for design and adaption in the natural world, but they don't embrace Adam Smith as the explanation for design and adaption in the economic world. They sometimes prefer the "intelligent design" of socialist economies, which often ends in disaster..." 

The key takeaway from the book for me is that I now at least have some understanding of why Republican voters in the USA (and increasingly the "New" Conservative voters in the UK) continuously  vote for politicians who pursue policies which hurt them. It's not because they are failing to reason, it's because they are a) prioritising more than just economic welfare and b) their views of "morality" and "righteousness" are probably different to yours. 

Haidt delights in dilemmas like whether it is morally wrong for a woman to cut up an American flag nobody sees or flies and use it as toilet paper. This is where we find the difference between the liberals and conservatives.

All-in-all, this is wlel worth a read. Buy the Kahneman, then read this. The two link beautifully together. 

On Tyranny - Timothy Snyder

I bought this book almost a year ago and I've only just got around to reading it now... and it's well worth a read. Snyder draws extensively on the tyrannical rules of the twentieth century - namely under Hitler and Stalin - to illustrate the key places where we can help to stop the rise of future tyrants. 

For me the biggest lesson was on institutions. There was often a false belief in these societies that because institutions had been the way Hitler climbed to power, they could also be the way that power was taken away. Obviously, when institutions are weak and subject to reform, this can be a very dangerous society indeed. Likewise, when leaders try to use "extreme circumstances" to justify "temporary" extreme measures, these should be treated with great suspicion. The COVID-19 pandemic leaps to mind as an area where we have had an unprecedented expansion of powers of the state. The key is to ensure these measures are simply temporary. 

This one is short and well worth a read. It's also going on my regular reader list (the only other book to get that honour is Galbraith's The Great Crash). 

The Anarchy - The Relentless Rise of the East India Company - William Dalrymple

Prior to reading this, my knowledge of the EIC was pretty limited, I knew they were almost universally hated for crimes in India, but that was about it. 

Regular readers will remember that in the September Reading List I read "The Return of a King" by the same author, and I lauded huge praise on it as a fantastic work of non-fiction. I am going to say that this book on the EIC is even better. This is simply fantastically written, it's gripping, and the characters of this rather complex story are always portrayed with great fairness and clarity. Often, I have found it difficult to keep track of key "characters" in history literature, but this is clear-cut and understandable.

Dalrymple's narrative of the EIC is simply addictive and riveting and he takes us through all aspects of the story, from the initial conquesting, to battles with the French, and later to the atrocities such as at the catastrophic famines which occurred under EIC supervision. For anyone remotely interested in this period of history, or the making and breaking of the British Empire, this is critical reading. 

The Passenger - Ulrich Alexander Boschwitz

We return to fiction for the final book, but in reality this probably describes the terrifying reality of many German Jews in the aftermath of Kristallnacht in 1938. Boschwitz published this book originally in 1939, and since then it remained largely under wraps, but has since been recovered to become a major bestseller in recent years. 

The story is simple, a man flees from his home after Kristallnacht and takes train after train trying to hide his Jewish identity and flee Germany. This book is absolutely gripping and equally terrifying. All of his previous friends and colleagues abandon Otto in the central story, and he is left to fend for himself with only a few marks in his pocket, I won't give any spoilers, but I ploughed through this book in no time at all. 

I highly recommend this to anyone, and if you read On Tyranny before reading, it becomes all the more prescient and frightening. For anyone interested, the actual story of Boschwitz himself is rather interesting too, and although he was lucky enough to get out of Germany in 1936, he was unlucky enough to be on a ship which was torpedoed by Germans in 1942. Nonetheless, the story of Otto in The Passenger is compelling, and please don't fall into the trap that this is no longer relevant, because I assure you, it is. Definitely in my top 5 fiction reads of the year! 

---

And so we reach the end of this month's reading list. In December, I am going to be reading very widely once more. It is Christmas, so there will be a few less serious books in there (like the latest Jack Reacher book) and also the usual array of history and academia. 

I'll be reading Barack Obama's The Audacity of Hope, the latest Jack Reacher, The Human Swarm by Mark Moffett, The British are Coming by Rick Atkinson, and, perhaps the most nerdy of the month, The Federation Papers by Alexander Hamilton, James Madison and John Jay. 

Please do keep your recommendations coming, I know I'm a bit behind on them, but I promise I will get to them all in the end :)