Powell the Volatility Dampener...But for How Long?
Covering risk-off bets was the right idea ahead of Powell but now that he's finished, and financial conditions have eased, he will soon have to hawk it up again to bring inflation down. But when?
I had taken back a bit of my bearish positioning into today’s Fed meeting as some of my risk-off capitulation signals were shouting loud (mentioned in a prior post) and also because I know that the Fed prefers to be a volatility dampener and not a volatility accelerator if given the opportunity at their meetings (especially since the December 2018 hawkish move that led to market crash and ultimately the Powell pivot). The Fed is in the business of “buying time,” seeking to smooth volatility in both directions in order to achieve its desired monetary goals, which in this case are tightening financial conditions to prevent inflation expectations from running away. It is also trying to walk the fine line of not over-tightening too aggressively, causing a significant market crash which would back up into the real economy and lead to loss of labor gain momentum. As a result, the environment of elevated VIX and MOVE index leading up to the Fed meeting where financial conditions had tightened since the March meeting meant that even though the Fed had not completed its mission on inflation, it could not afford to push too aggressively hawkish at this moment. The setup to being negative on risk assets into this meeting simply was not as good as it had been and as such, I lowered exposures. While Powell largely delivered on the market’s expectations at the meeting, his acknowledgment that 75bps hikes were not on the table was enough for the market to breathe a short-term sigh of relief and rally risk assets aggressively. I added to gold, bitcoin, and crude after the release to help my book out.
So where does that leave us now? Once again, we are left with a Fed that is trying to tighten financial conditions to arrest inflationary fears but instead, after today, we have a market reaction that has loosened financial conditions (vol fall, $ weakens, credit tightens, equities rise), which has allowed inflation breakeven yields (the Fed’s scorecard) to move higher on the day (5y5y up 2bps, breakevens up 4-5bps, etc). As a result, we have once again moved further away from the Fed’s goal, something that the Fed ultimately will be forced to push back against again as the data continues to move against them.
Which data points am I looking at to allow me to re-size up my risk-off exposures? The first chance will be with Friday’s release of payroll information. If we were to get a hot wages print, I suspect the market would quickly reverse gains from today, tightening financial conditions aggressively again to help ensure the wage/price spiral doesn’t get further out of control. If this payroll print is instead more benign, the risk-on rally likely continues through the weekend but then I would look to next week’s CPI release as the next opportunity to put on my risk-off exposures. Many in the market believe CPI has peaked. I am not so sure that is the case, especially as oil prices continue to march higher. I will be watching the data closely and will be looking to add back index puts as volatility declines into these data releases to play for the larger risk-off swoon that I have been writing about for months.
Current Positioning:
Macro Ideas
Long gold and gold miners via GDX
Long crude calls
Long Bitcoin
Short 30 year bonds
Short IWM/QQQ/EEM/EZU/EWZ/EWW via puts
Single Name Exposures
Long DISH (upcoming early May investor day catalyst)
Long MP/LNG/NOG/CCJ/MOS/AGRO/FCX (various long commodity-related names/inflation hedges)
Long FRO/STNG (tankers that will benefit as storage plays in the oil storage world)
Long DBA (agriculture commodity ETF)
Long KEUA (European carbon credit exposure)
Positions removed since Monday:
Short bank ETFs
Short RIO/BHP/VALE (mining hedges)
*Important Disclaimer: This blog is for educational purposes only. I am not a financial advisor and nothing I post is investment advice. The securities I discuss are considered highly risky so do your own due diligence.