Everything FX Traders Need To Know About Bonds
I’ve been meaning to write this piece for a while now but breaking down such complex information requires attention to detail. I hope you enjoy. What Is A Bond? Simply put, a bond is an IOU between the lender and borrower. Now these “IOU” agreements can range over different maturities from a few months or less than a year (T-bills) to 10 or 30-year maturities. Your next question may be, who issues these instruments? Governments, corporations and municipalities (local/town governments). Now, these entities will issue bonds to fund projects and expansions. As you know if we were to walk to a high street bank and request a loan for £3,000 we will end up paying more than the original principal borrowed; we would pay the bank a premium for providing the capital; the same applies to institutions. This is known as the yield an investor receives annually for purchasing a bond, an incentive to lend relative to the risk/credit worthiness of the borrower. Attractive Yields, Bond Prices and Rates With bonds the higher the price, the lower the yield and the lower the price the higher the yield. Bonds are one of the greatest instruments which serve as a proxy for risk tolerance, interest rate expectations and the strength of an economy. During times of perceived risk, you’ll see investors run to U.S10y bonds and the dollar respectively, this demand for bonds drives the prices higher and yield lower . Usually, it’s such the case that when yields are lower the domestic currency will follow suit and depreciate, however, when dealing with the dollar, due to it being a world reserve currency many factors affect its correlation. One thing you have to keep in mind is that it’s never just one variable that will drive a particular asset, currency or instrument’s performance/correlation, things such as interest rate differential, yield differential, monetary policy, commodity influence and trade balance all will impact the movement of that instrument. But for today, let’s keep it top level and assume that lower yields tend to drive the domestic currency lower as well. You’re probably asking why is that the case? Here’s an explanation: Economies that offer higher yields on their bonds tend to attract more investment. This would make their local currency more attractive than other countries offering bonds yielding a lower rate; as a result, an appreciation in the currency. For instance, let’s consider something ongoing in the macro landscape. Japan and the U.S both offer 10year debt instruments (US10y and 10y JGB). Interest rates in Japan sit negative at 0.1%, over in the U.S interest rates sit at 1.75%. As interest rates rise , prices fall and yields rise ; as rates fall prices rise and yields fall which is what we’re seeing in Japan. Currently, US10y is yielding roughly 3.30% per annum and 10y JGB (Japanese Government Bonds) yielding 0.23%. As an investor, with capital ready to deploy, which instrument presents the better yield? Clearly the U.S10y yielding you 3.30% vs 0.23% from Japan. Now here’s where it gets fun, due to the yield differential of 3.07% (3.30 - 0.23) the dollar is now more attractive than the Japanese yen and because of this, the currency rates will show that. You can see the heavy devaluation of the Yen and the appreciation of the dollar across this time span from 2022 onwards. This is known as the spread between two countries’ bonds. As the bond spread between two economies widens, the currency of the country with the higher bond yield will appreciate against the currency of the country with a lower bond yield. Another great example if you’re a trader and can recall the 23rd of June 2016, Brexit day. When the UK exited Brexit, credit spreads between the UK and U.S widened roughly 90 bps; presenting a short trade for GBP/USD as you would have been able to realise investors will flow out of UK Gilts and into U.S10y due to greater safety and better yield. If you’re like me you can then begin to look into more complex trades such as a carry trade and try to understand how that would work out. But for the purpose of this piece, I won’t dive into this. I hope you enjoyed the 101 breakdown— bonds are something that still confuses me but a basic understanding can help you navigate FX markets with greater confidence. Go on and share this with whoever you chose! It’s always good hearing and seeing your feedback Until next time
Jun 22, 2022 · 4 min read
Recession Risk Resurfaces
Hi guys, glad to back again. I know what you’re thinking, “Joe, where was the Tuesday note?” I’ll spill the beans, I’ve been working on a ‘guide for traders learning macro’ covering the three foundational pillars of macro and a step by step process on how to acquire actionable macro knowledge FAST! It’ll be out before Christmas, just pure value. And yes, it’ll be free. So make sure you’re following me on Twitter and Instagram to keep updated with the drop. So that’s why I’ve been under the radar. Back to it! We’ll dissect the global picture, signs of a deepening recession, the strong dollar and how the U.S is positioned. As always, enjoy. Global Macro Picture, Inflation & The Dollar Alright, we all know the root cause for double digit inflation across Europe and the Uk is food and energy prices. For the U.S, the peak in inflation back in June was 9.1%, which since then has retreated a little over 1.4% to 7.7% annualised. As it stands here’s the interest rate positions of the Fed, BoE & ECB: Fed: 4.00% BOE: 3.00% ECB: 2.00% After Jay Powell said: This has given investors confidence that inflation is headed in the right direction and as a subsequent event, that it could be time to rotate towards riskier assets. So much so that we’ve seen the yield curve across the US10Y retreat to 3.5% . What’s even more worrying is the the inversion between the 2s/10s; this is viewed by many investors a reliable signal that a recession is likely to follow within a short time span (<48months); and as it stands the inversion hasn’t been this deeply inverted since 1980’s where unemployment topped 11% and inflation topped 14%! What exactly does this mean? Looking at the Treasure curve, the frontend of the curve is loaded with rate hikes which is why the yield on T-bills (debt instruments with a 12month maturity) are yielding 4.70%. Now, within a healthy economy the yield curve slope is positive, meaning that bonds with a longer maturity date pay a premium yield compared to bonds with a shorter tenure, this is simply to account for the interest rate and inflation risk associated with holding a bond paying a fixed rate over a longer period of time. As you may have guessed, a flat yield curve means you’ll be paying the same to borrow money for one year as you would for 10 or 30 years, so applying this knowledge to the current macro landscape we can speculate what investors perceive as the current global trend. Prolonged periods of low nominal global growth and lower future interest rates as shown by the yield curve. Inflation in commodities If you recall my recent article on November 11th, the current macro picture pt.2 , this is how my commodity screener was looking. VS my commodity screener today. Friday 9th December The price inflation of major components of fuel/heating have released steam from the high prices, heating oil down 32% from November highs, WTI Crude Oil down 19% , Brent Crude Oil now in negative territory down 21% and gasoline prices down 22% YTD. So, with the declining price pressure on commodities this should continue to allow inflation to retreat back below the 4-5% margin. Commodity shorts, particularly oil shorts, something I mentioned in that same article here . Always good to see a trade idea play out. So stay alert on trends we notice here! Now, onto more pressing information, the dollar and the reason behind the rally of the year. There’s a few reasons at to why we’ve seen the USD gain so much strength this year. Here’s the layout. The dollar is a counter-cyclical currency, meaning when the global economy weakens the dollar strengthens and when the global currency expands the dollar weakens, here’s the reason why. When the global economy weakens this is usually due to a tightening in monetary policy, a restriction in the circulation of dollars domestically and internationally, this has an appreciation affect on the dollar because economies around the world use the dollar to “access” the global liquidity system (bond market). An example, an emerging market economy such as Ghana may issue bonds in USD in order to attract greater foreign investment and activity due to the dollar being the global reserve currency. So, for emerging markets, frontier markets, mainly economies across Asia, Latin America, Eastern Europe, Africa, and the Middle East, to access the global credit system they must do so through the dollar. Result? Take a look at 2022, in a battle against inflation the Fed were forced to hike interest rates, tighten up monetary policy. This leads to less $$ in circulation so the USD global liquidity tightens, now there’s not enough dollars in the world so countries are short on dollars for payments, leading countries to purchase more dollars due to finance dollar denominated debt resulting in the dollar to appreciate widely. So in laymen terms, global tightening/weakening leads to USD strength. A narrative for 2022. Take a look at figure 5 to see how the dollar has faired over the year. Now for the opposite, here’s why the dollar weakness. As the world economy expands, the global system creates more dollars . The institutions responsible for the dollars being printing are not the central banks, it’s the high street and investment banks, the credit system that creates the excess USD; this is through physical money being injected directly into the economy which can be spent, i.e loans, commercial loans and other forms of “real economy” money, very different to what the central bank prints. Looking forward I’ll begin to eye up the next macro trend from which we can put together some actionable trade ideas, something I know you guys want to see more of. Trust me, it’s coming Thanks for reading through, you’re a real one ;) As mentioned at the start of this piece I’ve been working relentlessly to make sure this macro guide I’m creating for you guys puts you on a straight narrow path to acquiring the understanding required to find macro plays and trades. I know I could easily charge for this but I want to give it out for free to you guys, so stay tuned to my Twitter and Instagram especially as I’ll be dropping the release date there. If you’re looking forward to that, I’ve got one ask. Show some love and share on Twitter, Instagram, tag me I’ll engage! Share this with someone who can learn something and get a new perspective on markets— I’m working on much more things for you guys, you’ll see Until next time
Dec 9, 2022 · 6 min read
China Is Back. Prep The Bulls
Hey guys, Welcome back to Market Macro Hub. It’s been a hectic week, I’m building something for you guys which is coming soon, you’ll love it, guaranteed. As you can tell by the title, China is back, and that’s huge for global markets; in this piece we’ll look at: As always, lend me your attention: China’s Detrimental Position In Global Macro People don’t pay China the respect they deserve when looking at the global economy as a whole. By the end of this article, you’ll be more attentive to China than before. With a GDP of $14.72 trillion , China is one of the worlds largest and most powerful economies. Second in fact, only to the U.S, with a GDP of ($20.89 trillion) , but first when it comes to consumption of commodities, producing electrical goods and driving global synchronised growth. Let’s get into China’s influence on the worlds economy, starting with non other than the U.S. As you may or may not be aware of, the ISM indicator is one of the best indicators of where the U.S economy is headed, with a near direct correlation with U.S equities, as shown below. Let’s go back to figure 1, you can see clearly that when Chinese ISM drops, U.S ISM has a lag of 2-4 months before it falls in line with the direction of China’s ISM strength or weakness. 2020 and November 2020 (China) are two examples where China both bottomed and peaked to which U.S followed suit in line with the moves in China. So, if U.S ISM leads U.S equities markets, and U.S ISM is led by China, it’s pretty clear the effect a China re-opening would have on U.S equities, risk on sentiment. This is known as the 2nd order effect , which refers to the indirect or secondary consequences of changes within one country’s economy and what that means on a global scale. With that being said there’s more to the story than a China reopening, the Western world is currently experiencing a slowdown, or better know as disinflationary periods as interest rates rise across Europe & the U.S, so a clear bet or trade idea to long U.S equities may be premature. Needless to say, China’s trade presence is renowned worldwide; an economy such as Australia ( the largest exporter of Iron ore globally), stands to benefit the most from a Chinese reopening. Australia’s largest trading partner is China, which accounts for more than 26% of Australian trade. Investors are looking at Chinese stocks as a good allocation of capital, and as a result the Australian dollar is receiving a lift higher as Australia is set to see a boost in trade activity and demand for its commodities. China’s top three commodity imports: Commodity longs? In short, yes. WTI Crude and Copper are two commodities that are directly linked to periods of global expansion and growth, the more global economic activity, the greater demand for commodities such as oil to transport goods, for copper to be used in the manufacturing and making of goods. At the time of writing spot WTI is trading at the $78.00 per barrel handle, and it’s safe to say that oil trading within the high $80’s region isn’t a wishful thought at all, something I’ll be looking at myself as an opportunity. Copper is another commodity that will see additional uplift due to the reopening of China; although Europe and U.S are both experiencing slowdowns my ideology behind commodity longs are simple. The largest global consumer of commodities have reopened there economy and are set to see an increase in both trade and activity, an example of this scenario would be the reopening of Europe and U.S where Covid restrictions were relaxed in 2021; SPX delivered 28% incl dividend. Now, surprisingly Gold is making a comeback amidst the China reopening. You would expect oil to have such a move to the upside but there’s more to the story once again than a China re-opening. Gold is affected by many factors, but mainly, treasury yields , inflation and the dollar . The $1900.00 mark has been broken through by the yellow metal, levels not seen since April 2021. Recent U.S CPI came out inline with expectations dropping to 6.5% for the month of December; treasury yields , both front end and long end bonds have been declining as investors reduce expectations of aggressive federal funds rate for the future. Gold and bond yields have an inverse correlation, as bond yields decline, gold rises due to the yield attainable in bonds; but as bond yields decline gold receives some allocation. If we continue to see treasury yields fall this will add further strength and investor sentiment towards Gold ; as investors reposition away from Treasuries the yellow metal is a prime allocation of capital; however as 2023 is still a year of the unknown when it comes to future central bank decisions so it’s worth seeing how the Fed meeting in February goes and what tone will be set out for the future of global central bank activity. Guys, that’s it for today thanks for reading; I hope you was able to take away some knowledge and trade ideas within the commodity space as China reopens! Big announcement: I will be moving Market Macro Hub to Substack in the upcoming weeks, as we grow, I want to be able to interact more with you guys and even offer a premium level of service for those who are either wanting to learn at more about the global macro space and or those who want more actionable suggestions such as this piece here. More about that soon… But for now, I’ll make the transition smooth for you so no need to worry or do anything for now! As always, I appreciate you sharing these macro breakdowns on your social media, Twitter and other platforms, it allows other people like you to gain an advantage and access clear cut information. No jargon. I’ll be with you guys next week, until then, have a good one MMH crew! Joe
Jan 13, 2023 · 6 min read
From Wars To Margin Calls: 2022, A Year In Review
Hey guys, To all my new subscribers and loyal ones, welcome to Market Macro Hub! Man, it’s been a while, firstly happy holidays and happy New Year! If you were following my Twitter and Instagram you would be aware that I released my free guide for traders learning macro which you all showed so much support and love for. Thank you. Now, you’re probably thinking 2022 is over, is there much value in reviewing the major events? 100%. We’re not here to predict, we’re here to react to market cycles and conditions, from which we gather calculated trade ideas. Something that you’ll be seeing a lot more this year from me, actionable trade ideas I’m looking at. Without further due, lend me your attention ;) 1. Russia’s Invasion of Ukraine Russia invasion of Ukraine has to be one of the most prominent events of 2022; an event which central bank leaders such as Jay Powell used to explain why inflation was running so hot. On 24th of February, Russian military launched a full-scale assault on Ukraine to conquer Ukraine and replace its government. Immediately the West reacted by imposing thorough sanctions on Russia, the aim being to financially destabilise their economy, pressure the Russian government to steer away from its military decisions to invade Ukraine and de-escalate the rising global tensions. Regardless of the sanctions, the decision to ban Russian banks from SWIFT, freezing Russian central bank deposits and massive corporate pull out from the nation, the Russians still advanced further into Ukraine. Surprisingly they were met with equal and adequate force from the citizens of Ukraine which held back the troops. The relevance? Apart from this flagging up geopolitical risks, social, financial and any others you would like to think of, the war destroyed more than 16% of Ukraine’s grain storage facilities and destroyed crops totalling more than $2.1 billion . It’s expected that c 59% of the increase in inflation is due to the Russia-Ukraine war according to central bank comments. 2. The Year Of Global Tightening 2022 will go down as the most prominent global synchronised central bank tightening we have ever seen! Nearly every central bank hiked over 250bps this year, we saw the likes of the ECB a central bank that has kept deposit rates in negative territory at -0.5% since 2012 to now hiking 250bps throughout 2022. In a fight against inflation central banks around the world were forced to shift away from loose monetary policy conditions of low-interest rates, and cheap access to credit to a high-interest period which many developed economies have not been accustomed to over the past decade. Comments from Fed Waller put additional pressure on equities & risk assets to perform: 2022, the SPX index returned -19.24% , and the Nasdaq -33.45% 3. The Trade of The Year, Dollar Longs Pretty obvious right? Well, here are a few reasons why this trade was named the trade of the year: A number of factors have led to this dollar rally: Although the dollar let off some steam towards the end of the year due to month and year-end liquidation of dollar-long positions, the dollar still managed to return a respectable 8%. 4. Euro Area Fragmentation Risk The ECB raised rates 250bps throughout 2022 in hopes to claw back inflationary pressures, the main concern, however, is that through the raising of interest rates, fragmentation risk also becomes a far more significant issue. For those who aren’t familiar with this term let me explain: Within the Eurozone, fragmentation risk is the widening of sovereign spreads in some countries within the EU as the monetary policy system leads interest rates higher. The risk here is that as rates across the Eurozone increase, so do the refinancing costs involved with each and every country, even the vulnerable ones like Italy particularly. To factor for this risk investors require a ‘risk premia’ and as this process happens the spreads on such vulnerable countries widen to a point where the goal of progressing monetary policy across the grouped economies within the Eurozone becomes delayed due to uncertainty surrounding the weaker economy’s ability to maintain financial stability. The effect? As you can imagine fragmentation risk within the euro area puts additional pressure and sensitivity around every move the ECB makes, mainly preventing them from moving in line with countering central banks due to the risk of a mechanism breaking within their economy, the wider scale effect can be seen through the drastic decline in the Euro through 2022 where €1 was equal to $1 , parity. 5. UK Gilt Markets Collapse & Pension Funds Margin Called Looking back, financial markets really saw it all during 2022. Can’t believe some of these things actually happened. After Liz Truss came into power on September 6th 2022, her Chancellor of Exchequer Kwasi Kwarteng released what may go down as one of the worst budget plans the Uk has ever seen. The worry that the Uk would not be able to finance such costs with debt and rates relatively high sent investors away from Uk fixed-income markets and that revealed the underlying liquidity issue. As pension funds began to get margin called due to the price of their bonds not meeting the collateral requirements yields on long-term gilts soared to as high as 4% - 5% , whilst bond prices lost as much as 52% as shown from the chart below. The Bank of England was forced to step in and purchase specifically long-end bonds to prevent the Uk from having a full-scale market implosion. 6. The Bank of Japan FX Intervention As mentioned above, 2022 was full of central bank tightening. All except for one central bank, the BoJ. Since 2016, the BoJ has implemented YCC keeping rates negative at -0.1% and pinning their 10Y JGBs close to zero. Up until 2022, that was a policy which could have sailed quietly in the distance however, as interest rate differentials kicked in and traders began noticing the stubbornness of President Kuroda of the BoJ, they began shorting the Yen as it depreciated heavily against the dollar. This is up there for the trade of the year alongside dollar longs which I was exploring as a carry trade idea where one longs the dollar and shorts the yen simultaneously. On the 22nd of September the Bank of Japan intervened in its currency for the first time since 1998, the BoJ sold off FX reserves sending Yen rates lower temporarily before the Yen weakened even further after the intervention. 7. FTX Blowout & Crypto Implosion This had to make it in the 2022 year-in review piece. In a drama unlike one seen before SBF embezzled client funds from his crypto exchange firm and used those same client funds to trade within his hedge fund Alameda Research. The company which was once seen as the JP Morgan of the industry is now responsible for the loss of more than $6bn of client funds. Using his swiftly acquired wealth to buy influence amongst various US politicians, particularly within the Democratic Party Bankman was second in funding only to George Soros. His “donations” totalled over $40M to Democratic leaders running within 2022, a fraudster purchasing his way through day-to-day life and in the midst hurting hundreds of thousands if not millions of clients. And that’s a wrap! A longer piece than usual but that’s required given the year we just had. Every week I’m sending out 1-2 macro breakdowns with actionable trade ideas. I’m building an encyclopedia for traders who want to advance their knowledge above the average standard level. More details coming soon, it’s going to be a heavy one that will take me TIME; but this will be 10x better than my macro guide. In the next piece, we’ll have a forward-looking perspective on how the global macro space is being shaped.
Jan 3, 2023 · 7 min read
The Fed: Don't Buy The Dip.
Welcome back to Market Macro Hub, Glad to be back guys, man, it’s been one heck of a week in markets; let’s break it down here. As I mentioned last week, I’ve been working tirelessly on a ‘ Guide For Traders Learning Macro’ for you guys to really accelerate your understanding of macros and how you can trade that in the FX & commodities markets (as I know that’s what most of you trade). This will be out sometime next week, so make sure you’re following my Twitter and Instagram as I’ll announce details about the drop first! Oh yeah, it’s free ;) All I ask is you continue to share this, engage and put to action what you learn here. For now, let’s talk Fed, particularly the recent inflation print Inflation Lower, Rates Still Heading Higher! On Tuesday afternoon U.S CPI came in at 7.1% vs 7.3% forecast! Now, for some context the MoM CPI increase was also lower at 0.1% vs 0.3% forecast ; finally core inflation also surprised to the downside ticking down to 6.0% vs 6.1% forecast. Off the back of the release U.S equities rallied hard, crypto’s were relieved from recent losses and bond yields collapsed, this bullish move into equities is known as the “vanilla reaction”, when one buys equities as a result of lower inflation, but this risk on shift in markets was shortly lived. The bond yield collapse was shortly turned around and yields on treasuries ranging from the 1M to the 30Y treasury all received a lift in yields after Jay Powell and the FOMC forecasted interest rates to rise even further and stay at 5.1% through 2023 - so investors began pricing higher interest rates through the debt market. On last week’s note I touched upon the 2s/10s inversion as it deepened, and from figure two you can see how yields across all instruments have risen, yet the inversion is still in the -0.7% , as we all know an inversion signals a recession, which the Fed isn’t scared of doing after listening to Jay Powell’s press conference. Here’s why. Jay Powell outlined three components of inflation that he is paying attention to: That was it, the last component, “non housing related core services”, is what caused risk assets to quickly sell off right after the inflation release came out. The reason behind that is that non-housing related core services are the stickiest component of the inflation figure because that covers wages and labour related costs which are extremely difficult to bring down once they go up. Unlike goods inflation, which are directly affected by supply chains tightening up or flowing smoothly, wage inflation isn’t as malleable, so the only way the Fed is able to bring inflation down even further, particularly the non-housing related services inflation, is to break the labour market driving unemployment higher. So, now you see why stocks, crypto and all risk assets done a U turn after the release; investors understand that this drop in inflation will not result in a ‘Fed pivot’ move, instead we heard from a very hawkish Federal Reserve at the press conference. (figure 3 below) Here’s some interesting takes from their December SEP (Summary of Economic Projections) The FOMC Federal funds rate projection for 2023 is 5.1%! As it stands the Federal funds rate is 4.50% after the recent 50bps hike; so going into 2023 we can expect a further 60bps of hikes from the Fed. The question is, can markets withstand interest rates at 5%? In my opinion, I don’t think so. From Jay Powell’s press conference he hinted on this point every so slightly I think many may have missed: He went on to say how he believes financial conditions have tightened “significantly” in the past year, now I’m not sure how true that statement is. Let’s look at ‘07 and make a judgement. For those who follow my articles religiously, firstly, shout out to you! My point being, you’ll be familiar with what this chart below represents, but for the new readers I’ll explain what you’re seeing: The National Financial Conditions Index focuses purely on financial markets, and provides a weekly update on U.S. financial conditions in money markets , debt and equity markets and the traditional and “shadow” banking systems.The idea is when the NFCI index is below 0, this means financial conditions in markets are particularly loose, meaning access to things such as credit, leverage and risk are widely available meaning the economy should experience periods of expansion and inflation, shown around 2007. The opposite is true for when the NFCI is positive and well above 0, this shows periods of overly tight conditions within financial conditions. You can see, as we approached the GFC during 2007 the rate at which we saw financial conditions tighten was swift with no loosening, below 0, up until the recession was at its height and conditions had to loosen to reset the economy. The opposite is true for where we are now. Looking at 2022, conditions have materially tightened across the whole, and peaked around the September/October period but since then financial conditions have been loosening in the U.S. mainly access to credit and leverage. I’m inclined to account this loosening in financial conditions to the lower than expected October inflation figure we saw in November, sending markets into a positive frame that inflation is indeed on it’s way lower and that the Fed may be approaching it’s halt in hiking to eventually pivot. Here’s a very interesting chart on Treasury yields within the U.S, I’ll let you break this down and we’ll have a further look in our next piece together! As mentioned at the start of this piece I’ve been working relentlessly to make sure this macro guide I’m creating for you guys puts you on a straight narrow path to acquiring the understanding required to find macro plays and trades. This is coming out next week, so stay tuned and I know you’ll gain tremendous value from this. Until next time -
Dec 16, 2022 · 6 min read