Summary
Amid general risk aversion in markets last week, US bond yields have continued to move lower. That move was across the curve and reflects a number of factors, including: escalating US-China trade tensions; dovish language in last week’s Fed minutes; and disappointing US macro data (e.g. with the Markit manufacturing PMI falling to its lowest level in 3 years).
With that, positioning at the short end of the curve has become increasingly net LONG (i.e. with participants pricing in more Fed easing). As such, LONG positions in US 2 year futures have increased and now account for 51% of speculative contracts (the highest percentage since 2016, FIG A). Unsurprisingly, that’s been accompanied by a move higher in Fed funds futures, which now imply 44bps of cuts over the next 12 months (FIG A). Similarly, net LONG positioning in Eurodollar futures has also increased further (to its highest level since 2015, FIG 6).
FIG A: Speculative LONGs in US 2 year futures as a % of open interest vs. implied Fed hikes/cuts over the next 12 months (bps, INVERTED)
With lower bond yields, cyclical sectors have continued to perform poorly vs. defensive sectors*. Somewhat surprisingly, though, the cyclicals vs. defensives ETF flows model is now mid-range, i.e. as investor appetite for cyclical sectors has recently increased (on a relative basis, FIG B). In our simulated macro fund, we remain LONG financials vs. utilities, reflecting our view that the move lower in bond yields has likely mostly played out, and that a mini-reacceleration in the US economy in the second half of this year is likely (for detail see Macro Trade Recommendation No. 99, 10th Apr 2019: “Move LONG US Financials Relative to Utilities”).
FIG B: S&P500 cyclicals vs. defensive sectors relative performance vs. relative ETF flows
*Although the sell-off in oil last week has also weighed on the energy sector, which is the worst performing sector over the past 10 trading days.
In the oil market, most of the weakness last week occurred on Wednesday and Thursday, i.e. after the positioning data was collected (on Tuesday). Despite that, net speculative LONG positioning in WTI decreased again for the fourth week in a row. LONG oil remains a crowded trade, though, with LONG positions accounting for 79% of speculative open interest (vs. 80% at the time of the oil price peak in 2014, FIG C). Given oil’s strong gains this year, the stage is set for a supply response (probably with stronger production from OPEC+ and the US, probably later this year). If correct, that’s likely to push the oil market back into surplus (in late 2019/early 2020). While a near term bounce in oil prices is plausible, the risk reward to running LONG oil positions in the medium term has therefore diminished (for more detail see Commodity Fundamentals Report, 23rd April 2019: “US sanctions on Iran: How much do they matter?”).
FIG C: Percentage of WTI speculative open interest that is LONG vs. futures price (USD/bbl)
Points of note
Currencies: Speculators continued to build SHORTs in the BRL last week (with net SHORT positioning now elevated, fig 18). The real has been under pressure recently, having broken through a key psychological level (i.e. 4.00 BRL per USD). With inflation picking up on the back of a weakening currency, the BCB is somewhat constrained in its ability to cut rates. Adding to Brazil’s economic troubles, the bold pension reform programme set out by Bolsonaro prior to the 2018 presidential election is facing challenges in passing through congress. That is, no doubt, further dampening investor appetite and adding to the general outflow of capital from Brazil. Also of interest was the pick-up in net SHORT positioning in the GBP. Sterling has weakened notably since the news of Theresa May’s departure, largely due to fears of a new PM who would support a no-deal Brexit. Further sterling weakness, if significant, would squeeze real income growth and serve as a key headwind for UK economic growth.
Commodities: In silver, net LONG positioning has unwound notably since its peak earlier this year, and is now almost flat (having decreased in 7 out of the past 10 weeks, FIG D). While silver is oversold and the positioning indicates that it could bounce, the fundamental outlook is relatively poor, in our view. In particular, significant Fed easing is already priced into the market (e.g. FIG A), and is unlikely to increase further (for this reason we reduced our gold exposure earlier this year – for detail see Quarterly Global Asset Allocation Alert, 16th April 2019: “Reduce OIL & GOLD Exposure in Strategic Portfolios”). In the copper market, speculators continue to add to net SHORT positions as the price continues to weaken. Of late, copper has correlated well with the renminbi and other Chinese assets (e.g. equities).
Bonds/rates: Expectations of lower interest rates are not confined to the US. In the Eurozone, implied EURIBOR has shifted significantly over the past 3 months reflecting poor economic data (FIG D) while German bund yields continue to make new lows.
FIG D: Implied EURIBOR term structure (using futures contracts)
For full charts appendix click HERE.