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August 5, 2017 | Trading Desk Notes – Aug 5

Senior Vice President and Derivatives Portfolio Manager. Victor began trading financial markets over 45 years ago and has held a number of senior executive positions during his career as a commodity and stockbroker. Over the years he has provided considerable market analysis via radio and television and at financial conferences. His primary brokerage business is providing corporate accounts with risk management services using exchange traded derivatives. He actively trades currencies, interest rates, precious metals, stock indices and commodities for his own accounts.

It’s an interesting combination: The major US stock indices keep making new All Time Highs, the USD has fallen ~11% since December with bearish sentiment at an extreme, credit quality spreads are narrow and volatility is extremely low across asset classes. In other words, the markets look to be set up for “change.”

US Dollar: The decline from the December 2016 highs seemed to accelerate the past 6 weeks or so as “Political Turmoil” in Washington became the lightning rod for extremely negative USD sentiment. Speculators built massive short futures positions against the USD even though interest rate spreads remained USD positive. We believe that momentum driven currency trends almost always go WAY further than seems “rational” then turn on a dime and go the other way…creating “V” shaped tops and bottoms.

The USD rallied sharply Friday, sparked by stronger than expected employment, renewed talk of tax reform, and (mostly) by traders rushing to cover short positions. We think the USD fell too far too fast the past several weeks and we expect at least a correction if not an important turn higher. If the USD is higher later this year we may look back and see the appointment of General Kelly as the turn-around point in the “Political Turmoil” narrative that weakened the USD so far this year, but the thing that would really give the USD a boost would be if the market senses that Washington will actually deliver tax cuts.

The Canadian Dollar: made a 14 month low May 5 and then turned higher in lockstep with crude oil. However when crude oil turned lower in late May (and fell nearly $10 by mid-June), CAD kept rising as the “Hawkish Bank of Canada” became the driving narrative (along with covering of massive CAD short positions that had been built by futures market speculators February through May.) It’s interesting to note that as CAD rose from around 73 cents to around 80 cents in the May to July period that the AUD also rose from around 73 cents to around 80 cents in the same period, even as the Reserve Bank of Australia repeatedly maintained a more dovish stance on interest rate policy. The takeaway? It’s mainly about the USD…not the local currency.

The Euro: Plunged from 1.40 to 1.05 between May 2014 and March 2015 as it was the “other side” of USD bullishness during that period. Negative sentiment persisted on the Euro over the next 2 years with many analysts expecting it to break below 1.00. It hit a 14 year low in December 2016 following Trump’s election (as the USD hit a 14 year high) even as negative positioning on the Euro was dissipating. Over the past 7 months the Euro rallied from around 1.05 to around 1.19 as sentiment turned against the USD and futures market speculators built a record sized massive long position in the Euro. We wonder if the Euro’s run from around 1.12 to 1.19 was inspired by the “Macron Miracle” much as the USD’s run from 97 to 1.04 in November and December 2016 was inspired by Trump’s “Make America Great Again” promise!

Stock values relative to currency values: US stocks have been making new All Time Highs as the USD falls. It’s interesting to see that 3 stocks with big foreign earnings (Boeing, Apple and MacDonald’s) account for nearly half of the 2000 point gain in the DJIA this year, or to put it another way, the DJIA is up around 11% YTD while the USD is down around 11%. In Europe the German DAX index hit All Time Highs June 20 and is now down around 6% since while the Euro is up about 6% in the same time period. In Canada the TSE hit its All Time High in mid-February and is now down around 4.5% while the CAD is up around 4.5% in that same time period.

If an American had bought the DAX un-hedged at the beginning of the year he’d be up over 22% in USD terms, more than double the return of buying the DJIA. If a German had bought the DJIA at the beginning of the year he’d be down about 2% in Euro terms whereas if he’d bought the DAX he’d be up around 8%.

Trades we’re watching: We think the USD is WAY oversold and that Friday’s sharp gains may have marked the turn, but we’ll wait for market action to confirm that. If the USD turns and rallies in the months ahead then the obvious trades will be the reverse of what markets have done in the first half of this year. A USD turn might also cause volatility to rise so we will consider buying volatility, for instance we might buy OTM puts on the S+P looking to benefit from a fall in the stock market and a rise in volatility.

We’re also looking at potential buying opportunities in JPYNZD and JPYEUR. The Yen is often a haven if markets go risk off, so if the markets get the jitters the Yen might rally. The bearish COT positioning in both of these pairs is at multi-year (if not All Time) extremes.

 

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August 5th, 2017

Posted In: Victor Adair Blog

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