Yieldjunkie's Short-term Sentiment: Indices, Macro Risk Env

This thread has become a place to track changes to my macro outlook and the drivers behind those changes. It's against this backdrop that I'll trade on shorter time-frames, adjust asset allocations, and attempt to find weak spots in the market before the herd. The goal is to improve at deciphering macro conditions along the way.

Relevant:
(8/2021) Transitory
(3/2022) Supply chains, lasting impacts on trade, inflation
(4/2022) Consumer demand, revolving credit, more inflation
(10/2022) Tightening
(05/2023) Resiliency, and more inflation


Going to be using this space to map out my short-term sentiment and plan trades. My methods lean heavily on marginal capital flows, marginal changes in economic data, institutional risk management behavior, and yields. My sentiment is short-term in nature - every thought listed here has an expiration date, counted in US market trading days. I always keep dry powder.

Under 10-days:
Positive sentiment for risk assets leading up to the 5- and 7-year UST auctions (Mar 24, 25), primarily driven by the US stimulus (which has increasingly landed in financial assets and has been performance-chasing in nature) and improved covid outlook.
- Upward pressure on Nasdaq. (Conviction: Very Low, this is based on how much of the US stim bump has already been priced in)

10-25 days:
Negative sentiment for risk assets post-UST auction. I expect auction high yields to reflect an increased premium requirement on behalf of institutions to own USTs. Higher UST yields relative to SP500 dividend yield is going to attract capital flows if frothiness in equities continues, as the volatility is costly and TTM gains in equities are substantial. I expect realization of those gains at the margin. Higher UST yields (lower prices) will also incentivize traditional hedged corporate bond managers to reduce bond positions as they realize net gains owing to the short-UST leg of their credit positions.
- Downward pressure on Nasdaq. (Conviction: High, contingent upon high UST auction yields)
- Downward pressure on IG corporate credit. (Conviction: High, contingent upon high UST auction yields)

Ten minutes after I post, I'm long SQQQ @ $13.935.

My conviction on the 10-25 day trades is high, so rather than risk paying up for entry I'm starting to accumulate positions now. If my expectations for under 10-days come to fruition I will keep adding to my position, presumably at a discount.

Also just went long PST @ $17.020. Not exactly the level I'd like to pay for this, but unless we see the emergence of a COVID-20 It's not very likely that we see UST prices in this ballpark for quite some time. If the US stim turns out to be a dud (already totally priced in), my opportunity to open this trade is fleeting.

Beginning with last night's Australia session, equity and bond futures have failed to hold a gain versus where we closed Friday. I'm comfortable with my positions and have an order in to add to SQQQ @ $12 if I get the chance, but I'm doubtful.

I'm not looking to add to my PST position, rather find a way to play IG credit hopefully more-directly.

Closed out PST @ $16.960 on this news. This will undoubtedly bring UST prices higher, yields lower, at least in the very short term. In any event, I'm not married to this position and wasn't pleased with my entry level anyways.

My SQQQ trade is still valid because it is likely to benefit from both 1) rising UST yields and 2) increasing covid uncertainty. There is a chance that nasdaq could catch a bid on the whole "wfh" trade, but I'm pretty doubtful given where current levels are sitting and particularly now that the market is attuned and sensitive to yields. That trade isn't as likely to be shaken by a headline as there are many, much larger and slower-moving, implications for institutional managers.

I want to clean this up a bit for those who aren't bond-savvy. And keep in mind, rising yields = lower prices and visa versa.

Generally speaking, UST's have been well bid throughout the pandemic owing to the traditional sense of parking dollars in risk-averse assets during a time of uncertainty, paired with the US Fed's bond purchasing program. These yield levels alone were enough to hold real-money's feet to the fire for the better part of a year, as firms like insurance companies and pensions who rely on stable short term yields as a function of their business had alot less return to work with (think about the actuarial componentry required for these firms to operate.)

As we are exiting the covid-uncertainty period, and with USDs continuing to flood the market into risk-assets (catching the eye of every performance chaser and benchmark investor), UST yields now, one month, and two months ago were far from sufficient to attract the marginal capital. In short - the market is beginning to demand a higher return. Everything here happens at the margin - when the marginal buyer stops, price slips and yields rise on USTs and that's what we are starting to see happen. Would you want to lock up $1mm for thirty years for a 1.625% return?

Now lets add some gasoline to this fire and think about the traditional bond manager who is hedged for interest rate risk (this is a mega-sized market, I will add figures when I get the chance). This traditional fund manager may be 60-90% hedged meaning a $10MM long position in a corporate bond will be held alongside a $6-9MM UST short of the appropriate duration treasury. Currently, for the reasons in the first paragraph, bond prices across the rating spectrum are at very high levels historically (equivalent to yields at historically low levels). So as you are looking at your PnL: your long positions are running out of room to run while your UST shorts are starting to pay-off. The easy move here is to reduce those long corporate credit positions and realize the PnL. This is a major shift in asset allocations and as the move takes hold, you're much more likely to find a fund manager running towards the exit than you are to find one adding US Corp bond risk at these prices. This creates the ability to trade the downside of US Corporate credit.

Now lets snap back to simplicity here. As that movement is taking place, and the market is demanding an increasingly higher yield to own USTs, we aren't seeing an increase in equity dividend payouts. In fact, we are seeing recent historic lows. What that means is, equity strength is only being paid out in price appreciation - not payment for ownership. You have to sell to realize any gain on top of the 1.58% dividend payout if you own the S&P500.

SO... towards the conclusion. At the margin, the gains you would have realized for holding nasdaq for the past year have been astronomical - nasdaq captured the most benefit from the "covid-jpow-govt-support" trade. As we hover around and push new ATHs on US equity indices, volatility is starting to ramp up. You have alot of people starting to wonder how we are pushing all time highs with the US govt discussing double digit real unemployment numbers. If you take price appreciation out of the mix for a minute and look at gains resulting from just owning those equities (1.58% on dividends) and compare it to the yield on relatively "risk-free" USTs (currently 1.60% on the 10-year, which is a traditional comparison duration for this purpose) it is beginning to look very attractive to close out your incredible equity gains (>95% on Nasdaq from exactly 1 year ago, if you timed it perfectly) and roll your assets into something less risky to preserve capital while the market volatility hashes out.

What I'm not doing here is presenting some doomsday view - I think the world did an incredible job of weathering a pandemic, and I don't forsee some total meltdown happening. What I am doing here is presenting my view on how to use marginal changes in key areas of the market to perceive the path of least resistance for large money managers, and use that information to trade volatility and macro risk sentiment alongside capital flows.

Cheers!

Nice write up! So what do you think will happen if the Fed doesn't extend the SLR relief program? If they don't, there's going to be pent-up sales of about 700B in US treasuries.

Thanks! You bring up a hell of a point here. I think if the Fed doesn't extend the SLR program... the situation I described above in rising yields and corporate credit will slip much faster than it already would otherwise. We'd see forced liquidations of those long-UST positions on top of the positive feedback loop of long-corp/short-UST profit realization. That would make things way uglier and fast - one of the main drivers fueling the current market position has been cheap capital/cheap funding/cheap leverage. As far as equities go.. no SLR program would handicap that UST yield/ownership when comparing it to S&P500 in terms of asset allocations - that one is harder for me to pin down.

Where did you get that 700B number, by the way?

What I'm taking away is that the Fed is going to extend it. They don't like to stir the pot too much. I got the 700B number here:

Thanks!

And I agree - I would expect that the fed members are well aware of the implications removal would have... but with that said, I would expect it remains the elephant in the room and will have to be dealt with at some point in the future.

Big day today with FOMC statement and economic projections.

Heading into the day, US equity futures are rather weak and a bit choppy after lackluster moves, largely flat, overnight. I was hoping to see enough of a bump yesterday to add to my position around the $12 or $12.50 area but it didn't come to fruition and I'm not going to force a trade.

UST futures are continuing to slip, with most of the volatility seeming to be in the belly of the curve. Slightly lower overnight and sold early morning.

Something to keep in mind here, away from the Fed, is the calendar (always). With earnings season past us and with the US stimulus seemingly totally priced in, we really only have economic data to focus on until mid-April, when the major US Banks start to report earnings and kick off the next season. We won't see tech for ~2 weeks to a month after US Banks, with foreign banks skewed towards the end of the ~2 month earnings season. All that time between now and then with only economic data to focus on lends to market choppiness and usually a persistent lack of conviction.

Markets are probably going to move quite a bit. Wrote a little preview here: https://www.metalsmine.com/thread/po...8#post13454758

Excellent preview! I may take a few shots at trading USDJPY around this event.

And for anybody watching the economic projections, here is the Dec '20 document for comparison.

Couldn't help myself alongside the curve steepening - added SQQQ @ $13.28 on that spike. Still have an order in @ $12 if we ever get there - I'm starting to think that level isn't reasonable anymore since yields have already begun to slip.

My conviction on this trade remains strong, particularly after seeing UST yield activity heading into the London session - I have also wrapped in a few long USD/JPY positions as higher yields on USTs translate to a stronger dollar. I could've definitely waited on entry though, I got in right before the FOMC releases yesterday and JPOW didn't do me any favors.

As we sit, I'm still keeping a keen eye on the upcoming auctions. Nasdaq futures were lower overnight and are volatile thus far during the US session - this will become more relevant, causing some mounting pain as the vol creeps into risk metrics.

I'd also like to point out a circumstantial feature of this trade. It's not exactly the most professional trade, as I currently have no exit levels and could easily focus this somewhere other than a triple-levered inverse ETF.

My rational behind this is due to the current price level of SQQQ relative to 52-week and life-of-fund price range paired with the 3x levered aspect. At the time of writing, the ETF is bid at $13.57. It's 52-week range is $11.76 - $161.25 which puts the current price well within 2.5% of it's low based on size of trading range.

Because it's constructed to move relative to percent changes in nasdaq and not absolute value, paired with the current near-ATH level of the nasdaq, movements on the downside will get smaller as nasdaq rises, while movements on the upside will get larger as nasdaq falls and the percentage change is applied to a larger base value. This isn't groundbreaking or anything, and it means that it'll take a fairly large move in nasdaq to push SQQQ anywhere near it's higher range - but where this leaves me is that my largest risk (from where I sit) is the opportunity cost of locking up the assets waiting for a move.

In the meantime, I may write some short-dated call options on the position to bring in some of that juicy yield. It would limit my upside so I'd have to be careful about what strike price to choose, but SQQQ is consistently a most active ticker so demand shouldn't be hard to find.

Great timing on this discussion, EventsTrader!!

It's looking like there are no position changes to be made here today. Sitting tight with eyes on the upcoming auctions - if nasdaq pushes up another ~2% tomorrow I may add, but for now I'm comfortable.

I'm looking to get long USD on the same basis - DXY may be the way to go here.

I moved my last limit order up to $13.00 from $12.00 and was filled - $12.00 was starting to seem unrealistic and at this level I'm adding at less than 1% (based on size of trading range) higher than the 52-week low. Cost average for my entire position is $13.55 which is under 1.5% from the 52-week low.

The Fed members are aware of what direction we are heading in yields. There's little argument that the market is demanding a higher yield, it just has to work it's way out. As I think about it, the timing of the SLR program expiration announcement was an eloquent move. Falling on quad witching allowed for much higher liquidity for those who wanted to begin to make allocation adjustments - question is, how many would've made allocation adjustments that quickly.

I'm interested to watch the action on 3/31, when the program expires, as it's also the last day of the quarter which lends to unusual behavior. Typically for fixed income managers, unless they have waited until the last minute to make adjustments in-line with index holdings, most are sitting on their hands.

As expected, 5-year auction results helped to cement the upward shift in yields. Tough to figure where tomorrow's auction will come in - if we take the steepness of last month's auctions we would be looking at something around 1.54 which would be tough to digest following this month's 1.523 high yield on the 10-year. We shall see.

Today's auction has briefly pushed the nasdaq lower, currently down 80 basis points on the day, leaving my position in the green though nothing to write home about.

Events:
3/25 - 7yr auction
3/31 - expiration of SLR program

~4/15 - Earnings season begins with the major US banks, large cap tech will come in ~5/1

I'll likely extend my current sentiment as we near the 25 day mark.