H is for Hawk

If the appropriate literary allusion for last week's ECB was "How do I dove thee?", then the equivalent for yesterday's FOMC announcement was H is for Hawk.  To be sure, by the standards of previous tightening cycles the fare on offer from the statement and the press conference were pretty anodyne; given what we've heard from Yellen since her ascendancy to the head of the FOMC, however, it was fairly stirring stuff.

Contrary to expectations, the median Fed funds plots for the next couple of years were ratcheted up despite little net movement in key macroeconomic variables.  Of course, it subsequently emerged that some forecasts were made with the assumption of looser fiscal policy and some were not, which sort of renders the whole exercise somewhat meaningless.  And in fairness, in one of her less-hawkish moments, Yellen couldn't resist pooh-poohing the shift in the Fed funds projection, calling it minor.

This, of course, raises the larger issue that if the Fed doesn't want the market to fixate on the dots, why include the bloody things in the projections to begin with?  When the FOMC was trying to promise perma-ZIRP, they were a useful tool with which to illustrate their intent for the visual learner.  These days, however, the most notable effects of the dot plots is to increase uncertainty and reduce Fed credibility.

Speaking of which, Yellen also walked back on the "high-pressure economy" language that she seemed happy to flirt with a few months back.   Given that that idea provided cover to err on the side of inaction despite improvement in the economic fundamentals, her dismissal of the concept suggests a somewhat more activist reaction function than had previously been the case.

Similarly, she also dismissed the necessity of easier fiscal policy, a prescription she was happy to provide earlier in the year.   To be sure, she had already started the retreat from this posture a few weeks ago, so this wasn't quite as new as the rejection of the high-pressure economy stuff.   Still, it does suggest that an injection of fiscal stimulus would present at least token risks of over-heating.

These are what you might call more mainstream views, rather than the overly-cautious dovishness that has characterized Yellen's approach to policy for the last several years.   What's changed?   Well, an obvious factor has been an abrupt shift in the (expected) political trajectory.   While Yellen once more took pains to stress the apolitical nature of the Fed, a cynic might reasonably question why what was apparently good for the goose is not, in fact, good for the gander.

Equally, a cynic might raise the question of why anyone should believe a dot plot projection calling for 3 hikes next year.  After all, this time last year the Fed was calling for 4 in 2016 yet delivered only the one.  "But there were extenuating circumstances!" you cry.  Fine.  Still, at the time of the last Fed meeting would you have bet on only one rate hike this year knowing that the ensuing 12 months would bring:

*  9.2% total return for the SPX
* 0.18% increase in 10y yields
* 14.5% total return in high yield corporate debt
* 40% rise in oil prices
* 188k per month rise in payrolls and the unemployment rate at 4.6%
* Core PCE price index rising from 1.3% y/y to 1.7% y/y

Macro Man wouldn't have, and yet it happened.  That being said, the market can go a long way in pricing more rate hikes.   If we look at the 13th vs the 1st Fed funds contract, we can see that the market is currently pricing in only about half of the rate hikes over the next year that it was in the middle of 2015, and some 30 bps less than was priced at the beginning of this year.


Macro Man ditched his recent bond purchase as Yellen was talking.   Just because something is a nice set-up for a trade doesn't mean that the trade has to work, and in this case it didn't.   Looking at the chart of EDZ8, yesterday's price action doesn't exactly look like a market heading for an imminent reversal.

Nor indeed does USD/JPY, which has unsurprisingly ripped on the prospect of tighter monetary policy and is currently threatening to hold a break above the big neckline.

EUR/USD is also threatening the lows of the entire down trade, and the divergent policy orientations of the Fed and ECB makes a parity party look likely once again.

Macro Man had a little chuckle in the press conference when one of the journos asked about equities, noting that Dow 20,000 is a foregone conclusion.   While it would certainly seem like it statistically, given the rising prevalence of SPX RULZ! SHORTZ R FULZ!  spam in the comments section, it would be a sort of karmic justice if this presumption were to prove misguided.

More prosaically, the impact on equities from a tightening of monetary conditions caused by a shift in the perceived Fed reaction function could be vastly different from that caused by a presumptive shift in fiscal policy.  The latter is arguably growth positive on net, while the former clearly is not.  Given the degree to which financial conditions have explained equity performance over the last half-decade, a tightening should be viewed with some degree of trepidation.

At least until you see Yellen's face break out; the  you'll know she's started eating too much of this.


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Nico G
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December 15, 2016 at 7:57 AM ×

Yellen's personal duty was to maintain Obama era' stellar market returns hence preserving markets calm until election. So no rate hike, calm markets indeed, the Dems lost because 93% of the US population did not own equities.

Trump said the Fed ain't doing its job. Trump is the president now, and the Fed will FINALLY do its job of rate normalisation. I say 4% yield very fast next year on the 10Y

let's remember former bubbles and their respective axioms:

1998 LTCM - "the risk free rate is fixed for all complex derivatives pricing. The risk free rate shall not move"

1999/2000 - "this is the new economy Citrix or Akamai earnings don't matter they are just changing the way we'll work and live"

2005/2007 - "house prices will always go up. Demographics, millenials, mobility, divorces, immigration blablah all that is supportive of higher house prices"

Annex: "by the way if your credit sucks, just rent a good one"

2014-2016 - "rates will stay low forever for reasons A to Z"

Rates are shooting up. Whoever is now blogging than higher rates are good for the economy wins a one way trip to Venezuela or Zimbabwe. Enjoy

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Anonymous
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December 15, 2016 at 9:00 AM ×

@Nico G
"I say 4% yield very fast next year on the 10Y"
If the FED raises rates fast, I would say we are more likely to see yield inversion....
Touché!

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CV
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December 15, 2016 at 11:21 AM ×

Hmm ... sh't just got real in bond and FX land. Someone is being carried out here, feet first. Funeral bells are chiming.

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abee crombie
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December 15, 2016 at 11:31 AM ×

The game is on. How far can equities go before higher rates start pinching everything from housing, interest costs,foreign econmoic activity, etc This is setting up for a nice move if cyclical growth disappoints under the current fed mantra. Not sure when thst happens but id like to take a larger bet that higher rates DO impact economy more than trump prospective policies. Could i be wrong, sure and equities keep rallying to even higher levels on much improved economic growth, yes its possible ...but for the past 20-30 years the economy is addicted to monetary policy. It works with a lag. Dont see anything different, in fact its probably more addicted. Lets see by q2 next year how things are playing out.

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abee crombie
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December 15, 2016 at 11:32 AM ×

The game is on. How far can equities go before higher rates start pinching everything from housing, interest costs,foreign econmoic activity, etc This is setting up for a nice move if cyclical growth disappoints under the current fed mantra. Not sure when thst happens but id like to take a larger bet that higher rates DO impact economy more than trump prospective policies. Could i be wrong, sure and equities keep rallying to even higher levels on much improved economic growth, yes its possible ...but for the past 20-30 years the economy is addicted to monetary policy. It works with a lag. Dont see anything different, in fact its probably more addicted. Lets see by q2 next year how things are playing out.

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CV
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December 15, 2016 at 11:32 AM ×

I am really interested in the U.S. belly here ... if the U.S. is late cycle, a 5y above 2.2% is really interesting. 2s5s to invert long before the 2s10s. Of course that all assumes the Fed actually delivers and kills growth.

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Bruce in Tennessee
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December 15, 2016 at 11:51 AM ×

Yet the long tail of too much credit has to, and is being, addressed. The last 8 years of maintaining the patient with too much debt was folly. To think there wouldn't be bad-tasting medicine for this was never in the cards. The congressional response to Trump's fiscal ideas has been interesting....

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Anonymous
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December 15, 2016 at 12:17 PM ×

Nico is right. For most of the year Fed was a tool intended to keep Obama regimes illusion of a benevolent, stable zombie market in the air to ensure continuation in elections. No need for that now, all signs point to chaos ahead. The curve is risking inversion after years of artificial depressing. It will kill auto loans (were already in trouble due to surging inventories) and mortgages. Corporate credit get smacked, buybacks will die, EM killed and indirectly sow more chaos in already unstable EU. All integral parts of status quo illusion. In terms of macro interesting times ahead.

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washedup
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December 15, 2016 at 2:12 PM ×

yup Nico with you on the yield curve inversion - 4 bps again today - its 99/00 and IWM is JDS Uniphase.

good news and bad news for the TLT bulls - the positive is that a further selloff in treasuries seems to be pushing further and further into the front end, so the downside seems limited - the negative is that aside from direct steepening actions by the BoJ (which may frankly be cancelled somewhat by PBoC), the yen basis is in a clear trend higher, so the spread may not be as easy to arbitrage as some think.

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NonAnon
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December 15, 2016 at 3:06 PM ×

The dots say the Fed - bang on the 8 year timeline - deadly embraces the Ghost of 1937. Cannot be that stoopid - can they? Cue backtracking, surely.

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Anonymous
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December 15, 2016 at 3:07 PM ×

I think JDS at least had a p/e, which, if you take out the regional banks, is more than you can say for iwm!

higher short end vol -> lower long end prices.

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abee crombie
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December 15, 2016 at 3:09 PM ×

washed, what yield curve inversion are you referring to? (tenors) Sorry I am not seeing any

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Leftback
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December 15, 2016 at 3:21 PM ×

The Dot Plots (aka so-called forward guidance) should be abandoned as a communications tool. The market does a far better job of setting (and anticipating) rates than the Fed, and the ludicrous dot plot just causes market distortion.

Wage growth (real data relevant to the US consumer) remains very slow. Inflation-adjusted wages fell 0.4% in November. This is probably more important than the soft data (Philly Fed and Empire State survey data) or even the CPI (0.2% m/m, 1.7% y/y). We would all be well advised to look at hard data this winter rather than soft survey and sentiment indices.

Don't look now, but there is a significant yield curve flattener going on today. The long bond was spared the pain this morning and seems to be catching a bid today, even as the 2y was selling off. The 10y was higher by almost 10bps at one point today, but has come in considerably since then. We saw something very similar to this happen after the last rate hike in December 2015, which was accompanied by a prediction of four rate hikes in 2016 (we just got one, remember, and it came at the end of the year). That is the bond market is now saying, OK, we have adjusted to the rate hike and maybe one or two more at the front end, but we're kind of skeptical about the longer term terminal rate projections.

Not sure if we can still generate YC inversions, guys, just cannot see that happening with FFR still this low, but YC flattening has happened many times in Japan, whenever it came to the end of one its many weak business cycles during the long years of ZIRP.

The Dow is playing tag with 20,000. Ridiculous pre-expiration activity continues….

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Anonymous
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December 15, 2016 at 3:25 PM ×

Hmm can look at it in forward space for seeing how close to inversion, eg 3y fwd 2y vs 3y10y

Does this mean that the neo-Fisherites were right??

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JMT
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December 15, 2016 at 3:35 PM ×

I agree with Nico and that the yield climb should continue well into the Q2 next year. Those who think that the economy cannot handle a 4.00% 10yr are probably the same who are buying equities where Shiller's p/e CAPE ratio is at a euphoric 28.

Imho, the risk to the bond bear trade is a stock market correction not the economy slowing down. Wouldn't be surprised if stocks roll over come Jan 20th! ('TINA' is not interminable.)

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johno
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December 15, 2016 at 3:36 PM ×

Two observations. Re the dots, I concluded some time ago that Yellen is about the 5th lowest dot. So she hasn't moved and she's still expecting only two hikes next year. Perhaps explains her dismissive comments about the movement in the dots yesterday.

Second observation regards xccy basis in JPY which washed mentioned. Funny thing is the basis is tightening in the short end and widening in the 5y and longer end. Anyone who can shed light on that?

My remarks the other day about there being no "levels" notwithstanding, EURUSD just broke the low of its range ...

People see DB arguing that higher rates will be good as people don't have to save as hard? Unorthodox position .. maybe makes more sense in a country where people save in the first place, like Japan. Views on that?

If Trump wants to get re-elected, he should regulate tech, starting with driverless cars. Think of all the employment in driving cars/trucks, not to mention middle class American manhood's deep affinity for driving. Some kids in California want to tell Joe average that computers can driver better than him, and that he should get off the road for everyone's sake (while making billions off this)? And bye-bye all those high-paying truck driver jobs? Forget it. Trump should iron fist this, very publicly. "Too much change too fast." The middle class would love it. They'd go bananas for it. Boost their male egos and boost their sense of economic security. And higher interest rates would make retirement seemingly viable again for people outside of the public sector. Again, plays to economic security, which is the issue on which the Democrats really lost (though they're too close-minded to see it, still looking for Russian hacking explanations, blaming Comey, blaming fake news, etc.).

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BuYsToCkS
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December 15, 2016 at 3:48 PM ×

Equities moving higher again today (just as we said yesterday), bit of a no-brainer really. Shame most of you missed it - you can bring a horse to water...

Fully agree with the comments above about the Fed being a political animal (pro-democrat). Also agree with the bonds down, stocks up view. Saying that, if bonds do recover, stocks will go up anyway haha.

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washedup
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December 15, 2016 at 4:03 PM ×

@abee was referring to the trend not the level - they've all flattened quite a bit last 6 weeks, and the move has accelerated somewhat last few days - 10/30 is in 27 bps (from 86 to 59) since 10/31 - given the 2 year is around 1.3, the market is pricing in around 3 hikes when the fed is promising 6 - there is no way that happens, but if the long end selloff keeps de-celarating and the front decides to price in a couple more hikes we will start cutting it close - frankly I think if it weren't for BoJ and ECB the yield curve would absolutely be inverted by now - of course one of those things I can say but can't prove.
Given that move in slope, its a little odd that financials are leading us - NIMs (as simplistic as that measure is) are coming in but buy banks because they've recaptured Washington DC? Hmmm… I must have missed the part where they'd ever gone away!
and @anon 3:07 - touche!

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BuYsToCkS
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December 15, 2016 at 4:07 PM ×

Nico, Dow is up over 100pts since the open. Why not size sell it with ur friends? We could do with a nice short squeeze to smash up thru 20k ;)

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abee crombie
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December 15, 2016 at 4:11 PM ×

Buy financials and sell STUD was the trade of the year, but you needed some patience and balls to pull it off. Selling equities up here feels like same thing, you know it makes sense, but everyone is unsure of timing, and if you got into the trade too early, you get beaten up mentally by the grind offside.

So how to trade it. Nico you love the short side, any thoughts?

S&P high beta index is probably the one to watch. Look for a reversal signal, similar to what we got in Jan/Feb with the "Short Momentum" this year, IMO

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BuYsToCk
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December 15, 2016 at 4:32 PM ×

Funny how all the short-sellers who were crowing so loudly yesterday have now disappeared and gone quiet. Such is the world of retail trading, where 99% of guys like nico & pals blow their account.

Much as I'd love to show you lads how it's done in the real world, my advice to the perma-bears is best summed up in the quote from Glengarry Glen Ross: "follow my advice and fire your fucking ass because a loser is a loser."

Ciao.

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Anonymous
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December 15, 2016 at 4:42 PM ×

stevie, is that you?

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AB
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December 15, 2016 at 6:35 PM ×

Check out the Atlanta Fed Wage Growth Tracker to find a sign of wage pressure.

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Nico G
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December 15, 2016 at 8:13 PM ×

Do you know what is the most remarkable thing that was said yesterday? That Yellen would be forced to raise rates even higher than announced if Trump insisted on fiscal stimulus. 'You move, I move". In one's reasonable mind, you would think that Yellen killed the Trump rally right there.

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Nico G
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December 15, 2016 at 8:13 PM ×

Abee

a bit of thoughs about markets and shorting, sorry for the long post. Im already short here as you may know 2210/2225/2250 clips for 2228 average. To me the FOMC change to agressive regime was a no brainer and i wanted to be positioned before - even if expiry combined with Santa is the most supportive environment at work evert year against bears

Last year i waited prudently that December pass and January gapped and traded hard down. I had no position and it was the most miserable time of my life. It might surprise you that one only suffers mentally if an identified trade setup has been missed because of hesitation in other words when one's caution keeps one from making money.

I do not suffer mentally when i'm in a position and losing, because i follow a hard conviction. It has been repeatedly written here that you are either short too soon, or not short at all. This beast of a Spoo market is making sure of one thing: that the lift will go down empty, just like it did on last January 4th gap down. There is no way in hell one could comfortably 'short the hole' on January 4th, it looked like equity flows would fill that gap. We froze and waited for a higher entry and missed a formidable leg.

You can be sure not many bears will be positioned this time again. Fed goes full hawk, you short and market stops you the next day? You might not try again, especially when the whole industry of leeches is celebrating printing DowJones 20000 Tshirts. I want to look back and say 'it was hard but i did the right thing'. To be short at a all time high, just when Fed confirms that it is agressively reversing the monetary policy that saved the equity markets and helped it more than triple in 7 years. Equities went up on POMO/QE only, this was the game. So what now? The Trump trade has become a cult, so powerful that followers think the Trump economy can overcome rising rates and a bond meltdown.

1) It has been mentioned that rising rates nuke auto loans, then student loans, mortgages and more importantly, leveraged balance sheets. You need to remember US corporations have leveraged their balance sheets up to their eyeballs to keep up with earning growth expectation.

2) the bond meltdown itself jeopardises financial stability, i've written at lengths that the bond market became a game for speculators who will stop sell on the way down. Their leverage is the same European banks had on Greek bonds, to the tune of x30. There are a lot of people incurring horrible losses as we speak and while bond holders wait until expiry, the speculators will be stopped out and exacerbate the bout.

Do you know what is the most remarkable thing that was said yesterday? That Yellen would be forced to raise rates even higher if Trump insisted on fiscal stimulus. 'You move, I move". In one's reasonable mind, you would think that Yellen killed the Trump rally right there.


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Vasastan
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December 15, 2016 at 8:27 PM ×

Anomymous at 3.07, just to be that guy: the only years in the past twenty (!) when JDSU have shown profit are 1996, 2011 and 2013. Otherwise I agree.

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Anonymous
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December 15, 2016 at 8:38 PM ×

Nico, why are you befriending your positions? it's about making money, profiting, not being a prophet.

you'd have done far better with some puts, even if the vol was high, would have taken you out gently (just like how in macro hedge funds how drawdowns are supposed to be used ... tangent ... this makes the average macro/CTA category look like a long straddle position to allocators btw, ie long vol, and at a philosophical level, starts to explain some of the horrendous average macro hf performance in the qe era)

humbly I think you could do trade construction much better, eg 95-90% of moneyness put spreads, puts on the low vol etfs, etc ... maybe your next posts can be more questions instead of thinly-veiled anxiety

liquidity dynamics matter, but so does newsflow and the common knowledge game (ie read ben hunt at salient), positioning, seasonals, and long term valuation

some of those things are improving for equities or still positive for equities, even if the second derivative has turned in others

are you sure about european banks for instance? sx7e futures might be a nice (consensus -- maybe macro hf but not yet real-money consensus) long against the us if you are so pessimistic, rv often a bit more cleaner than punting

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johno
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December 15, 2016 at 8:55 PM ×

Interesting to hear your take on trading, Nico. It works for you, perhaps because you have such conviction. I never have that conviction, so if I try betting on a reversal before it's begun, I get stopped. I try again, stopped. And again, stopped. By then, my stops have added up and I sideline myself (two days later, the Bank of Canada surprises hawkishly, oil bottoms and USDCAD nicely trends from 1.46 to 1.25 in 3 months and I miss it all, to give you one example this year of me making that mistake). My own answer is to wait for the market to crack first, and then press it. Accepting that I'll miss that first gap, but not letting that keep me from getting involved. For anyone who trades without Nico's conviction (which is me, at least), "building" a position against trend is psychologically deadly. All my biggest drawdowns trading macro are where I didn't wait wait for the catalyst/crack in the market, but fought the trend, thinking I could pick the spot where the market would reverse.
So, unless you can have Nico's conviction and his method to risk manage that conviction, be careful.

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Nico G
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December 15, 2016 at 9:07 PM ×

anon 8:38

put options? please. Read yesterday's posts.

i am not touching European banks, it was a formidable campaign on the short side, now the momentum is strongly on rebuilding valuations but im not comfortable picking up that kind of zombies especially knowing that Greece will be Greece forever. Last July Europe started to outperform the US (so your rv would work). Try to read July posts, i said there was no more point shorting EZ banks at EM compressed valuations. If you're trading EZ banks don't get greedy, next year will be more of the same, Europe crisis etc at least the FX people see that clearly, the EUR is toast.

a better example for picking up jettisoned zombies would be miners last January. Miners do a tangible job with tangible assets, not the fantasy world with no accounting whatsoever and unlimited license to cheat and rely on political liaisons, that are banks worldwide.


johno

if you miss the first leg down, it might be excrutiatingly uncomfortable to engage knowing the history of signature V shaped bounces on Spoos. So far if you miss the first leg, you have just missed it all! To elaborate further on last January, how exactly would you short AFTER the crack, after the first gap. The market trades down extremely fast, as you know.

It is terribly tough to short against trend, before cracks. I am not suggesting this to anyone unless you are glued to a screen. You'd have to follow the Spoos almost around the clock for dips may happen overnight, this is not healthy living.

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Anonymous
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December 15, 2016 at 9:13 PM ×

One question on trading strategy: IWM has outperform QQQ since the election. If I believe that it is going to reverse to historical norm and QQQ will outperform IWM for the next few weeks. What is the best trading strategy here? Call QQQ and put IWM at the same time?

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Nico G
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December 15, 2016 at 9:14 PM ×

johno

USDCAD last January is a good example to debrief, i didn't remember you were part of it too, i would have told you to stay put! I shorted 1.39, 1.40 and 1.41 and still did not look brilliant when it hit 1.46 and MM was calling further up. But it was a strong conviction on both a 'philosophical' take on Canada (the country, the security, the infrastructures, the investment possibilies etc) after a fairytale Christmas holiday there, and a very technical view on oversold oil complex that stretched to oversold currencies for oil producers. It worked.

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Anonymous
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December 15, 2016 at 9:17 PM ×

Since Sep 30, GS is up 50%, BAC also - 100bn mkt cap added there.





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Anonymous
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December 16, 2016 at 2:06 AM ×

Does it seem more likely that the US macroeconomy is running so much hotter than hot, as compared to earlier this year? Or that Yellen has a personal grudge against Trump for saying mean things and basically saying her job as chairman is over when her tenure is up.

The simplest answer is more often correct than not. Nothing has changed, and she is raising rates and future rate expectations in the hope that she can crash the economy shortly after Trump inherits credit/responsibility for it.

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Nico G
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December 16, 2016 at 2:24 AM ×

but something has changed over the last year, i've pointed at Libor many times for it was completely ignored

Libor rates have spiked an alarming 600%, moving from 16 basis points all the way up to 92 basis points - a seven-year high

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Anonymous
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December 16, 2016 at 3:06 AM ×

She is raising rates, because within the context of her liberal and scholarly moral and intellectual compass it is finally the right thing to do. I used to admire Greenspan, until I read his book. Bernanke may have saved the global economy, but he just couldn't quit saving it. Yellen is no better, nor worse.

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Nico G
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December 16, 2016 at 5:00 AM ×

China has dropped to #2 holder of UST behind Japan

next are Ireland, Cayman islands, Brazil, Switzerland, Luxembourg, UK, Taiwan and HK

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Anonymous
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December 16, 2016 at 9:30 AM ×

@anon 2:06 I agree. She's a stupid c*nt totally unfit for the position.

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