Summary: Macro Dragon Reflections - In the latest reflections think piece, KVP takes a look at a few potential pathways & scenarios around the Fed's Jackson Hole event. Including the base case consensus scenario of a conservative & docile Powell, alongside the more interesting tail-side risks to the upside, as well as downside. Which pathways may see the VIX 18.84 jump by +50% to 30, or Gold $1795 crater lower by $100 to retest the recent $1690 lows. Plus there is also a pathway that could set us up for the S&P 500 rising +12% to finish the year above 5,000.
(These are solely the views & opinions of KVP, & do not constitute any trade or investment recommendations. By the time you synthesize this, things may have changed.)
Macro Dragon Reflections: Jackson Hole - Potential Trading Pathways
This week's symposium could offer hints on how the Federal Reserve is looking to start tapering its bond purchase programme. But it is unlikely Fed Chair Jerome Powell will give much details on exact taper timing and composition. There is still a debate among officials regarding the macroeconomic impact of the Delta variant and how it could temporarily postpone the start of the taper. Our baseline is that taper could start from November onwards if the pandemic situation evolves favourably in the United States.
What is the Consensus View & Feel Around Jackson Hole?
- Always tough to say, as consensus view & feel in essence should tell us what is “priced in” going into the event. And you only whether things are priced in correctly, post the event. Consensus view is also a function of data points, some of which may be very anecdotal or biased given on location (for instance SG crypto holders favour ETH over BTC) & view is not equal to positioning.
- When KVP Is bullish, he is long. When he is bearish, he is short. Most of the world will give you 99 views but not one position. So there is views & there is positioning, they are not the same thing. With all that said…
- KVP gets the sense that there is 70% chance, we get a conservative to dovish tone from Powell’s Jackson Hole speech later today. Where he will talk up recent delta & growth concerns, likely urging for more time before adjusting monetary policy.
- It also seems to be the case that most folks are expecting Taper to be either a Nov or Dec affair. This leaves us with two broad tail-risk pathways, to the upside & downside for risk-assets.
- With the VIX at 18.84, with a +12% uplift from last night’s sessions – no doubt linked to the blasts in Afghanistan’s Kabul Airport, see our early Fri Asia morning piece: Macro Strike: Afghanistan Airport blast kills over 70 people, including 12 US Service Members, Biden on the tape...
- So in the base case consensus pathway - We’d likely see yields fall back in, the USD lower, real yields lower, volatility lower, equities & commodities higher.
Upside Tail Risk?
- Lets call its 20% chance, that we get Powell not even mentioning tapering or even better for those with risk-on expressions, he flat-out pushes taper to 2022.
- Powell could cite concerns around the delta variant, uncertainty around the economy with Winter in the Northern Hemisphere being in 3-4m (which will be challenging for fighting the virus), not to mention things still being murky around the $3.5T infra bill, debt ceiling & of course the gov budget for the new fiscal year.
- He may also want to cite the need to see even more inflation prints & jobs data, citing the fall in retail sales, as well as consumer sentiment.
- This “Taper pushed to 2022” pathway would be super bullish for risk – we’d see equities fly, potentially clocking +3% to +5% on US main indices over the next 1-2wks.
- In the scenario where we also later get the $3.5T passed, the S&P 500 would almost certainly be closing above 5,000 from these 4,470 lvls. I.e. +12% uplift.
- US dollar would be sold & the DXY could break from these 93.08 lvls through 92.50 to probably test the 92.00 lvl.
- Which would almost certainly mean EURUSD 1.1749 getting back above 1.1800, GBPUSD 1.3691 getting to +1.3800 & USDJPY 110.01 to test 109.40 before trying for the 109 lvls.
- EM FX complex would rally strongly, as US yields would probably also tighten big time off of this. UST 1.34 getting back to sub 1.25/1.20, 2s at 24bp getting back to sub 20bp, etc. Probably biggest pop potential on FX side are the CMD currencies, in particular NOK, RUB & BRL.
- CMDs would have a field day if we got the double fall of the US Dollar & yields, with the likes of Oil & Copper likely leading the pack. Gold will likely be a function of real rates, which should fall.
Downside Tail Risk?
- Let’s call this 10%, this is the KVP favoured skew despite it being the lower probability path, it likely has the biggest magnitude of potential near-term moves & surprises. There are people who fanatically swear over their dead body, that there is no way in Hell Powell could surprise to the hawkish side. Lets see…
- In this Pathway Powell kicks up that Jackson Hole Zoom session guns blazing… in the left hand he’s got inflation, in the right hand jobs growth…
- …it’s the path of least embarrassment, given that he has been forced to pivot (Jun 5th) from being King Dove to wearing a few hawk feathers. He will not flip flop back at the risk of making it that much harder when they have to start to really tighten things .
- Powell’s stance is tapering is an operational exercise, that should have no impact on the underlying liquidity out there (Reverse Repo is sitting at +$1T) & its not monetary tightening. So lets get this party started with Sep 22 being a live meeting for the Taper to kick off!
- He is tired of being underestimated so rather than the $10-15B that folks are expecting the tapering to be, he drops the deuces… doubling us to $20-30B… “How you like JP now baby?”
- He’ll cite inflation being real & here to stay, jobs are coming back as structural subsidies have dissipated, plus house prices & asset inflation is at ATHs….
- We need to start letting some air out of this synthetically prices economy that we have inflated since the 2008 GFC. Afterall, the G4 Central Bank balance sheet growth has been growing at a CAGR of +15% since 2008.
- For context $1m in 2007 at +15% CAGR is $7m today… or you know how VCs & start-up founders are going on about their company is a unicorn (+1bn), well $1B today, discounted back 14yrs at 15% CAGR is $141M. Or to put it differently, if you were a $1B unicorn in 2007, the equivalent today at +15% CAGR is $7B… a unicorn just ain’t a unicorn anymore man!
- In this ‘Downside Tail Risk’ pathway, the market will hit the bathroom fast & it ain’t for number one.
- The US dollar will be Celestial, as its bid up in the risk-off, with DXY jumping from these 93.08 lvls to taking out the recent 93.73 highs & breaking out past the 94 goal posts, to new highs for the year.
- This throws EURUSD 1.1750 to well sub of 1.1600 with a screaming test of 1.1500. All currencies will fall against the USD, with the likely exceptions of the CHF & JPY. The likes of AUDJPY, NZDJPY & USDJPY could see -2% to -5% moves in just a handful of trading sessions.
- EM FX would be spanked even harder, making for some beautiful carry basket set-ups post the event, say long BRL, RUB, NOK, MXN, USD vs. SEK, CNY, CHF, EUR.
- Yields would spike so hard, folks would be hitting refresh on their charts thinking it’s a glitch… so USTs getting to +1.50-1.75%% from these 1.35% lvls. 2S going from current 24bp, taking out the c. 28-29bp YTD highs before breaking into 35-45bp – massive jump for that part of the curve. The interpretation would be, this is a Fed that is now likely to hike in 2022, instead of say 2023 or 2024 – they are done messing around.
- Real yields would likely scream higher, meaning gold $1793 would be thrown of the Burj Khalifa & shot all the way down to the sidewalk taking out the recent $1690 low. Bitcoin would be beat back through the $40K lvl from these $48-50K range, likely taking us back to the previous $28-40K trading range.
- Volatility would spike with the VIX 18.84, eclipsing the previous wk’s high of c. 25 (yes, do not mistake the mean with variances) with a +50% move to over 30. The volatility in the bond + credit market would be on a whole different stratosphere - it would get REAL.
- The weak points in the markets would be at particular risk, with KVP’s key concerns (if he was long) being around China & Hong Kong equities (which technically still look very bad & fragile), small & midcap stocks, selective EM markets. The Hang Seng in particular needs to hold above last wk’s lower low of 24,581.
- The S&P & Nasdaq could easily come off by -3% to -5% initially before undertaking a full -10% drawdown, which to be frank is nothing considering they are up c. 20% YTD & sitting at ATHs.
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