June 2020 Macro Markets Blog Post

Recap

     Hi all, and thank you for tuning back in to the June update from MacroSquawk. Once again, I want to preface this month's blog by saying that I do not yet have access to a Bloomberg either from EIA or from NYU as I am currently away from the city. If you have been able to read the past blog post, it has been in many ways I feel indicative of the mood for the summer. We got the move in dollar weakening and commodities strengthening that I had described, albeit a bit later than I had expected. These I think are moves that will last for the remainder of the summer. This however, can derailed by any downward surprises in equity markets - which is what this blog post will mainly focus on.

Macro Thesis  

     I think right now the macro is caught in a tug of war between the technical pullback narrative, and a real reversal. Currently, I am of the opinion that we are likely only experiencing a pullback. However, I think the market might be inaccurately pricing the magnitude of the pullback, and what the path for assets might look like a few months out. 

     The reason I think that this is only a pullback is because this time around, generous fiscal and monetary policy have reduced many of the risks of a prolonged economic downturn, which is evidenced by the recent beat on expectations on the jobs report. More important is where the recovery in risk sentiment is exactly coming from - this time it's not from the US. Instead, this blow-off recovery we have seen of late seems to largely driven by the consequences of the Franco-German plan. In the last third of this rally we have seen that EU fiscal policy has been aimed primarily at beat-down countries and EU citizens. This is opposed to fiscal and monetary policy aimed primarily at businesses in the United States, and has been much more effective in reigniting risk sentiment. This is handily observed through the out-performance of EuroStoxx and DAX, as opposed to the SPX and Nasdaq. This is one explanation for the recent out performance of euros vs dollars. It has also been observed that the EURUSD appreciation has closely followed the appreciation in European Indices. This sentiment is what has led to a weakening of dollars and subsequently the appreciation of commodities via the exchange rate mechanism, and therefore EM risk assets. 

     Therefore, the right question to ask is whether that movement seems poised to stop? The answer for this seems to be a no. The reason for this is that the reduction and removal of austerity from the German economic program has long been on the wish list of many EU countries, notably France. Now that they have overcome this hurdle, it seems the precedent has been set for an abundant amount of fiscal stimulus as a part of their political culture, though that can change. Therefore, it doesn't seem that the dovish fiscal stimulus policies in the EU will stop. In the absence of their censure, the dollar weakening move is likely to continue.

This begs the question of why exactly markets have fallen over the past week? The best response to this so far seems that an abnormal spike in cases has led to worries about a second wave and shutdowns in the US and China. It might certainly be the case that case counts have increased after partial re-openings. However, it seems a political difficulty in the US to reimpose lock-downs after their initial unpopularity, as well as the recent Black Lives Matter protests stoking outrage amongst law-abiding citizens. It's also the case that the Federal Government and Federal Reserve have gotten smarter in preempting the economic consequences of a lock-down if it were to happen. This would have the effect of supporting US indices.

However, my disagreement with the general sentiment in the market is on price target. I don't think that the 3000 level holds on spoos. Rather, 2800 is the price target on spoos and 9000 on Qs. After that, I think spoos consolidate and have a slow ascent, and Qs a faster one. This is due to two reasons: (1) US indices have lagged European ones, and higher-performing European indices have more room before hitting critical supports, and (2) this week's quad-witching/option expiry might serve as a short-term catalyst to break 3000 on spoos. The thinking here is that since the US economy has been under-performing (as a result of less effective fiscal and monetary policy), it's likely we see more weakness. After getting to 2800, a possible path is a slow ascent because the real economy is not yet strongly improving. This might mean tech outperforms due to its growth premium. 

Summary of Macro Thesis

• Stock markets are likely in a pullback phase, followed by slow growth. This is because of generous fiscal and monetary policy in the US and more importantly EU holding global risk assets up.
• There doesn't seem to a high chance that EU stimulus will stop. If anything it's now more likely to be an endearing part of their political culture. 
• It might stop in the US in the end of July after the beat on the June jobs report which is a potential risk factor - not yet a big enough risk however
• Fears of case spikes and shutting down again are likely overblown. It would prove a political difficulty to shut down again. 
• However, price target on spoos is 2800 not 3000 due to US indices relative under-performance to EuroStoxx, DAX, and Nikkei. This is followed by a weak recovery due to weak economic growth
• After the completion of this pullback, we get back to the long risk (short dollars, long commodities) view we were in previously.

Long US Tech, Long DAX

As discussed above, I think there might be an opportunity to get long Qs at 9000. This is because it acts as a major round number resistance, as well as was a previous resistance that might now act as a support - in line with the constructive view for risk described above. I think tech outperforms because of the low growth environment in the real economy we are likely to find ourselves in. This is evidenced by the fact that Qs have reached all time highs but spoos have not.

I also like getting long DAX as the German economy is not only a benefactor of the fiscal stimulus as many of its export markets are in the Eurozone, it also has the strongest economy. This is because of the strength of their short-time paid work programs that have made the furlough much less economically difficult on its citizens. This is evidenced by its more vicious rally relative to EuroStoxx. I think an area at which to buy is around 11,000, which is where fiscal stimulus was first announced. Due to the strength of the fiscal stimulus in the EU, I think it's likely that it can retake its most recent high which could net a high risk/reward.

Short USD - Long AUD/USD, EUR/USD

I think getting long EUR/USD and AUD/USD are probably the best expressions of the short dollar view. Fundamentally, fiscal stimulus in the EU seems more effective at improving the economy. This is being reflected in expectations of future earnings on EuroStoxx and DAX. AUD/USD is a sensible trade because it benefits from the strengthening of its current account via higher commodities prices. The risk here is an escalation of of tariffs from China due to the investigation into the virus outbreak in China. Currently, this seems more symbolic as Australia's main export to China is iron ore. China is unlikely to crimp these imports due to their huge infrastructure programs.

Technically, I think they give great setups for a pullback. On AUD/USD, we might look at .66, which is the top boundary of the triangle. On EUR/USD we might look for 1.10, which is the top of the horizontal channel. Due to the strength in the EU, it might be difficult getting in at 1.10 so it might be prudent to start sizing in around 1.11. 

Opportunistically long commodities - WTI, Sugar, Copper

The reason I say opportunistically, rather than emphatically long, is because of the nature of the rally in commodities. The real gains in economic growth driving the commodities rally are unlikely to continue. That's because the China reopening story, which is the main driver of commodities, has been played out. The move in commodities we are likely to see from here on out is based more on monetary rather than real inflation. For this reason, any rally in commodities is at risk from a second wave in China, for which we are seeing early indications. This would derail any monetary inflationary effect on commodities prices. If this risk plays out the best we might see is a consolidation and at worst a reversal of fortunes.

Technically, I think WTI offers a better setup than Brent. This is because it is currently holding the 35 level that had previously acted as a double top. This might offer a tight stop with which to get in. Fundamentally, it is bolstered by cuts in production from OPEC+ which seem to be committed to getting prices above $40. Given a tight stop and a target of roughly around $45 (filling the gap), this might offer a risk/reward anywhere from 6:1 - 10:1

Sugar is interesting and it might be a long between 11 and 11.50. It currently benefits from two factors. The first is strengthening in oil, as well as the recent appreciation in BRL. This means that if the tenuous risk-on view I have here described is to materialize, sugar might be a way to gain a view on both the short dollar and long commodities view. Once we see a pullback, a likely target is at least 13 and perhaps 14, making this a longer term trend trade with an attractive risk/reward.

Copper is an interesting trade as it benefits solely from advances in the real economy. What's interesting is that it has witnessed nearly the same appreciation as European Indices. If the June Jobs report is an early indication of a reversal, copper might be set to outperform stocks after this pullback is completed. Technically it's also interesting as it seems a good level for it to pullback to would be between 2.4 and 2.5. If the real reflation view plays out, it has a chance of rallying to 2.9 over the next few weeks and months giving it an amazing risk/reward. 

A note on US Rates

Continuing with the theme from the last blog, I don't think that USTs offer many opportunities. This is especially the case after the Fed has committed to 0% rates until at least 2022. However, the possible introduction of YCC as early as July might have a material impact on inflation and show its effects in other markets such as gold and silver (more on this as we get closer to it). For the time being, USTs might act as a great signal for commodities, FX, and stocks.

After the June Fed meeting, we had seen a very pronounced bull flattening on a day that USDs weakened. This was the first indication that US markets were under-performing and that the risk rally was being led by Europe and abroad.

However, for the time being, 10s30s might give a good indication of real vs financial growth. The most recent rotation into value was presaged by a bear steepening in 10s30s. Therefore, USD rates might act as a signal into where the capitals will flow into in US stocks, and therefore whether they will flow into commodities at a faster or slower rate.