Hi Alex – on your long dollar call: 1. What position is the pendulum at in this cycle 2. What signal/catalyst are you watching for to indicate the end of the cycle 3. If the Fed doesn’t hike will this end the strengthening or merely delay it?

1. If I had to guess: it is just at the bottom – maximum momentum. 

2. I would look for shifts in the thinking of Central Banks. When ECB and BOJ start feeling they are getting traction, and the Fed is concerned about new slowdown more than about inflation – I would look for the momentum to turn.

3. If think delaying the hike will only delay the dollar rally and not by much, unless the perception of a fundamental shift develops. However, the longer they delay, the higher is the chance of unforeseen economic or geopolitical events interfering and changing the policy course.

Fault Lines in the Global Bond Market

Or, more importantly, in my portfolio.

My readers know where I stand: long Treasury Bonds, long dollar.

I am not perturbed by strong employment report. In fact, on February 8th, after the previous report, I wrote a piece advocating that the Fed was on the tightening track. 

True, even this Friday’s report can be interpreted in more than one way. Some prefer to focus on weak growth in hourly earnings, rather than on the headline. 

I will stick to the facts I know. The market is pricing tightening and the Fed is not saying otherwise. The last two unemployment reports are certainly not derailing the tightening train.

I welcomed the violent sell-off that occurred on Friday. I was waiting for such an opportunity to double-down on bonds. 

My logic is: 

For now the dollar rally will compensate me for any losses from rising rates. But as the Fed hikes, the curve will continue to flatten and sooner or later we will be pushed into a recession. When the economy rolls over the bonds will rally again.

Meanwhile, I also rely on the fact that Europe and Japan are boxed in the QE-induced environment of zero to negative interest rates. A hiking cycle will widen the rate divergence, fuel further dollar  rally and cause deflation. Right?

Contemplating the recent price action, I have become concerned. We have grown accustomed to negative inflation surprises from Europe and to the idea that whatever QE they will schedule, even more will have to be done.

But bond markets always act like they can’t go down. Until they do. And then they really do.

Euro has corrected by over25% and EuroStoxx 50 certainly thinks that the economy is getting traction.

What if the market suddenly decides that Euroland is on the path to reinflation? And Bunds decide to back up say 200 basis points? What would provide a cap on US yields? And if the global bond rout is Europe-driven, will the dollar hold up?

I actually don’t think this will be case. The Emerging Markets are too fragile now. In particular, I think that a significant rise in Developed Markets yields would push China over the brink.

So China slowdown is a safety net against bond collapse and dollar trend reversal. But China has been bucking economic doomsayers for over the decade. Could the net prove to be flimsy?

To summarize: I suspect that market participants, including myself, are not prepared for a dramatic change of rate sentiment in Europe. Therein lies the fault line in the global bond markets.

Alex, in your RTV interview you touched on so-called risk parity models. If we go into a period of high bond volatility with relatively low equity volatility, it strikes me that risk-parity models could be caught the wrong way. Any thoughts?

When you try to hedge one asset class exposure with another, you are definitely running a risk of correlations breaking down and volatility profiles changing.

I prefer to focus on large-scale moves rather than on daily volatility and make sure that if my trade has several legs, I like each of them individually.

Having said that, there is no recipe against incurring a loss if the assets classes do not interact with each other the way you expected. 

Mr. Gurevich: I recently watched your interview on real vision TV and found it really great. I’m a full time trader and my question to you is using your analogy of the ‘pendulum’ that you spoke of in relation to trades and sizing where do you think we are in the move in US bonds? I’m not a longer horizon macro guy per say but it seems to me that bonds could have quite a bit longer to go, and being that we’ve been having a correction what area do you like best long or short end of the curve?

This is a great question. As I will elaborate in my book, the “pendulum” principle applies much better to currency market, than to interest rates and equities. The latter two markets are more driven by secular trends than by cyclical pendulum swings.

Negative Sovereign Rates Clarified

I must. I must say something. 

There is a raging debate going on about what negative rates signify and how far they can go. I have weighed into the discussion with my post from January 19th, but I feel compelled to get back to it.

Too many people speak of the conundrum of being “paid to borrow” and discussing lower bound on interest rates as the cost of “storage” of cash.

I have bad news and bad news for an individual investor.

1. No one will pay you to borrow money in any country. Unless…see below.

2. You might have to pay for the privilege of having safe and liquid cash, immediately available for investment.

Sovereign bonds trading at negative yield doesn’t mean that “people” are getting paid to borrow. It means governments are paying themselves to borrow with printed cash and are stringing all the investors along.

Negative borrowing rates exist for entities which HAVE SOVEREIGN DEBT AS COLLATERAL TO OFFER.

Now imagine that the “overnight” rate is -2% (negative). This is the price for quick and save liquidity. Then it might make sense for leveraged investors to own 5yr notes at -1% yield for two reasons.

1. They can lend the note overnight to earn 1% carry

2. You need fast and safe money and would rather pay 1% than 2% to keep it.

Some people will put cash under the mattress. But high turnaround business from banks to grocery story need fast cash. As long as the central bank can keep overnight rate negative enough and buy enough longer term sovereign debt, the rest will be bought by the leveraged speculators, no matter what the allocators think.

What investment advice is “for real”?

I was recently justly rebuked after I made a disparaging comment about financial  advisors  as a profession.

I said something like, “what could a financial advisor know about asset allocation?” My friend answered, “regardless whether they can find an optimal asset allocation for a client, the advisors add value: they get people, who might otherwise be keeping their money under the mattress, to invest, which benefits both the clients and the entire economy”.

A stock broker called me once when I was a graduate student (it was the 90’s, remember the cold-calling brokers)? I have invested a small sum into a mutual fund and then proceeded to buy and (unfortunately) sell some stocks.

My brokers were so incompetent and the commissions were egregious that I somehow avoided making money in the subsequent 3 years of booming markets.

This first broker did me a great service. He got me involved in the market and making mistakes while it was cheap.

When, as a freshly-minted Math Ph.D., I took my first Wall Street job in 1997, I had at least some smattering of experience.

So let’s evaluate investment advice not based on whether it is correct, but on whether it has value to us. 

History shows economists’ forecasts to be of little value, but it does not say that the economists themselves are of no value. As a macro trader, I form my own directional views, but I rely on economic research to understand the paradigms of growth, employment, inflation, trade balance and so on. 

Similarly, a stock analyst might write “XYZ company is rolling out a new product, I recommend buying”. You might disagree – this product could a disaster – but at least they alerted you to the timing of the roll-out.

After I post on twitter that I am buying or selling bonds or Euro, you will often see the market moving against my position right away. But it says nothing about how my overall portfolio is performing or what my long term strategy is.

The jury is out on everyone who is active in the investment business. I could claim that I am the best trader in the world and then blow up the next day.

All I can say is that I am “for real”: I have years of experience, I have traded many different products in decent size, and I have made some money.

So when listening to an advice or opinion, don’t just focus on whether the person offering it is correct this time. Try to decide if this person is “for real” and (and even if they are not!) whether there is something useful in what they are saying.

Besides mere information, you might be acquiring understanding of other people’s process and strategy, or even simply getting engaged.