These Winning Positions Could Turn Into Market MigrainesBy
Record shorts in eurodollars, VXX, while peso shorts fold
Positioning in crude oil and the ruble growing more cautious
A new quarter raises new questions. At the top of the list, where might placid markets run into a spot of bother?
One way to approach the dilemma is to look for pain points by identifying positions that have become crowded across asset classes, the popular trades in foreign exchange, debt, equity, and commodity markets whose unwinding might trigger sharp moves in financial markets.
Watch the Reds
Federal Reserve policy continues to underpin the market and assessing the timing of tightening remains key. With the latest Commodity Futures Trading Commission data pointing to record short positions in eurodollars, which part of the curve that bets on the pace of tightening is the most vulnerable to a squeeze? Using daily open interest as a proxy, contracts maturing from June 2018 to March 2019, the so-called reds, have seen a bigger increase than the shorter-term whites and the longer-term greens and blues put together.
Sell Vol Till You Ball
The lowest quarterly average for the CBOE Volatility Index has left traders conditioned to expect subdued equity swings. That’s driven an explosion in short interest in the iPath S&P 500 VIX Short-Term Futures exchange-traded note, ticker VXX, as investors look to profit from the typical upward-sloping term structure of the VIX futures curve.
“Markets have become trained to expect VIX to recede,” writes Peter Tchir, head of macro strategy at Brean Capital LLC. “The Pavlovian response to higher VIX is to sell more.”
Trouble may be lurking, though, as a shrinking spread between the third and front-month futures contracts threatens to reduce the appeal of this trade.
Tech Titans (Too) Loved
Technology shares did the heavy lifting as the S&P 500 Index rallied to its best quarter in more than a year. Investors have added $1.4 billion in inflows this year to XLK, the SPDR technology exchange traded fund, more than any other sector ETF. The group is overvalued relative to history, with a current price-to-earnings ratio of 23.7, 33 percent higher than the five-year average.
The Mexican peso was the best-performing major currency in the first quarter, gaining more than 10 percent relative to the U.S. dollar. But there are signs the run might falter as short positions approach zero. Since 2014, whenever bearish bets reached that level, there was a major reversal with a significant re-build of peso shorts.
Another sign that the peso’s time in the sun may be nearing its end? Seasonality. The first quarter has tended to coincide with an advance in the currency, which generally experiences weakness through the rest of the year.
More Caution on Crude
Speculators have pared back from their record bullish position in oil over the past month as rising U.S. crude production and drilling activity counters OPEC’s efforts to extinguish an inventory glut, at least for now.
The combined net-long position in four types of Brent and WTI crude, including both futures and options held by money managers has fallen to 620,481 lots, from a peak of 929,985 on Feb. 24, according to weekly data from the CFTC and ICE Futures.
Few Bears on the Ruble
Bloomberg’s Fear-Greed indicator offers a look at whether bulls or bears are in control of an asset. For the U.S. dollar relative to the Russian ruble, it’s flashing a red signal -- that is, one that’s supportive of strength in the back half of the pair. As a caveat, the conviction associated with positioning in this cross is relatively weak compared to earlier in the first quarter, or near the end of 2016. The Russian currency is 9 percent stronger against the greenback so far this year, the second-best gain in emerging markets.
Emergent Tech in the Crosshairs
President Donald Trump’s crackdown on the H-1B visa program for skilled workers couldn’t have come at a worse time for emerging markets.
The Relative Rotation Graph shows that the best start to a year since 2012 in developing-nation stocks has depended on a single industry -- information technology. That’s under threat now as software companies such as Infosys Ltd. and Tata Consultancy Services Ltd. depend on H-1B visas to staff U.S. operations.
If Monday’s H-1B lottery program proves adverse to developing-nation tech companies, the rally could lose its main engine. At the same time commodities, energy and finance companies are losing momentum faster than the main MSCI Emerging Market Index.
Politics Pushing Down German Yields
Political risk in Europe has investors piling into German debt, according to UBS O’Connor LLC portfolio manager Erin Browne. If centrist Emmanuel Macron prevails over euro-skeptic Marine Le Pen the upcoming French presidential elections, yields could spike.
“I think 10-year German bunds could rise to 50 basis points from their current 24.7 basis points on a Macron victory as investors unwind their long bund positions,” Browne said.
Fans of Floaters
Leveraged loans have been a haven for investors seeking upside in the floating-rate asset class that benefits from rising rates. Mutual funds and exchange-traded funds that purchase corporate loans saw their 20th consecutive weekly inflow last week, bringing year-to-date assets to $11.4 billion, according to Deutsche Bank. That compares to $5.9 billion of outflows from junk bonds this year, the closest comparable asset class.
Foreigners have poured as much as $65 billion of speculative capital into Czech assets, including bonds with negative yields, on hopes for quick gains in the country’s koruna currency once the central bank ends its cap. Policy makers and some analysts have warned that those investors may struggle to find enough buyers, limiting the room for appreciation and boosting the prospects for increased volatility in either direction.
— With assistance by Julie Verhage, Cameron Crise, Kristine Aquino, Srinivasan Sivabalan, Rita Nazareth, Steve Voss, George Lei, Alexander Nicholson, Faris Khan, Oliver Renick, and Krystof Chamonikolas