It was quite a busy week with plenty of news flow, but also some very interesting price moves which have our attention. We have discussed the US Dollar a few times in recent weeks, and our view was probably best described as fundamentally constructive (after a 10% decline in the last 8 months), but waiting for market action to show signs that the downtrend was ending. We are encouraged enough by last week’s price movements to get off the side-lines and start buying.
With FX being a relative value game, it’s not just enough to say “we’re buying the Dollar”, we also have to identify which currency or currencies to sell. Having already been long the Dollar against the Japanese Yen, we have bought more US Dollars against the Swiss Franc and the New Zealand Dollar. We will explore the thinking behind these trades a bit more below.
First up, the Swiss Franc. For years, the Swiss national Bank was fighting a losing battle against a strengthening currency, cutting interest rates into negative territory, and intervening heavily in the foreign exchange markets. Currently, the overnight interest rate is minus -0.75% and the intervention has approached CHF700 billion or approximately 100% of GDP. To put that in perspective, the Fed’s QE programme at less than $4 trillion amounted to approximately 20% of GDP.
In January 2015, the SNB didn’t quite capitulate, however, they did remove a currency floor that they had been managing against the Euro for the previous three years, resulting in a near 15% gain for the Swiss Franc. Despite relative calm in markets since the January 2015 realignment, the SNB has felt compelled to continue with very steady intervention. Simply put, they will do anything to make sure that the Swiss Franc does not strengthen.
This was confirmed again on Friday afternoon when the head of the SNB said that the end of their expansive monetary policy was not a topic for discussion and that their balance sheet could be expanded if necessary. So in terms of central banks, we have the Fed Funds rate at 1% to 1.25% and quite possibly rising further as well as the start of balance sheet reduction probably starting later this month whilst at the same time we have Swiss rates at minus -0.75% and the SNB ready to do whatever it takes to maintain a not too strong currency.
In the first chart below, we show the USD/CHF exchange rate back to 2013, and have highlighted strong support (white line) around 0.9440 that held again this week. Our working assumption now is to be bullish on this currency pair so long as this support level holds, although we recognise that there is resistance to be overcome before serious gains have a chance of being realised.
Chart 1 – USD/CHF exchange rate weekly
The second chart is a close up look at the USD/CHF exchange rate looking at a daily chart. Back in late July, the pair fell back to the 0.9440 and rallied, and then last week in the midst of the North Korean missile news, the pair again fell back to the 0.9440 area, but this time only fleetingly on an intra-day basis. In fact, by the end of trading that day, the pair had rallied all the way back to being slightly higher on the day. This type of daily pattern should be taken as a bullish signal, especially when it occurs around previous support.
Chart 2 – USD/CHF exchange rate daily
From a trading perspective, the signal that got us into the trade was the pullback on Friday as some market participants saw the US employment report as mildly disappointing. When that pullback ran out of steam, and the Dollar began to improve against most major currencies, that was our cue to buy Dollars; not just against the Swiss Franc, but also against the New Zealand Dollar. In chart 3 below, we show the daily chart of the Kiwi Dollar versus the US. As with the Swiss Franc, the Kiwi Dollar peaked in late July, and since then, has been the weakest of the major currencies.
There is an old market adage that says if you want to sell something in a particular group or sector, then you sell the weakest. And so, we sold the Kiwi Dollar both because it is the weakest at the moment, and because it broke support in the 0.7200 area last week. Furthermore, as the Dollar declined on the initial employment report disappointment, it rallied back to 0.7200 and failed, indicating to us that this is now an important resistance area.
Chart 3 – USD/NZD exchange rate daily
There is one more chart to show this week that we think is important. A few weeks ago we suggested that US 10 year bond yields were getting ready for a move higher. We were probably a little early with this call, however, the price action last week is of interest. The weekly chart pattern shows an intra-week move down to previous support and a reversal. The early week move lower in yields was in reaction to the North Korean missile, however, by the end of the week, perhaps investors were focusing on the potential for greater fiscal spending from Washington, partly in response to Hurricane Harvey but also potential movement on the tax package front. We now think that price action suggests that US yields will be moving higher.
Chart 4 – US 10 year bond yield weekly
We said last week that we felt it was time for markets to make their mind up, and although it is early days, the price action in the foreign exchange and fixed income markets suggests that new trends may be emerging; specifically for the Dollar to be stronger and bond yields to be higher. We would also note that the reaction in equities was to decline early in the week and then reverse higher. So, should we now view the trend as being higher in equities? In theory, perhaps we should. However, we worry it may not take long for investors to worry that a stronger Dollar and higher yields may actually be bad news for equities. We will have to be patient and watch equity markets in the days/weeks ahead.
Summary of trade ideas highlighted in our weekly commentaries
Having bought a put option on the S&P 500, we said last week “…we have to be careful that we don’t sit on this position as the value decays. We may well trade some of the associated hedge in order to both manage risk and our bottom line profit/loss…”. As the market began to rally after the knee jerk negative reaction to the North Korean missile, we felt compelled to hedge our bearish equity positions, which we did by buying some S&P 500 futures and some Vix futures (against our Vix call spread). As the market rallied during the week, and in the case of the S&P 500, approached all-time highs, we exited these hedging transactions. (These hedging transactions are highlighted in red this week in the “closed trades” section)
These hedges have reduced what is a 43 basis points loss on these bearish equity trades down to about 14 basis points which is certainly helpful. We will continue to manage these positions closely, and will hedge if/when we think it appropriate to do so.
We have also added the two bullish US Dollar trades to the “trade ideas portfolio”. The stops on these trades are wide enough we think to give the trades time to work, and we are risking about 76 basis points on the two trades. It is our aim to tighten the stops on these trades as quickly as possible in order to manage risk.
|RMG Trade Idea Summary – Initial Notional Portfolio of US$5 million|
|Stop Loss Level||Loss to stop Local Curr||Loss to Stop US Dollar||Bps Risk to Stop||Last Price||Open P/(L)%||Open P/(L) Local Curr||Open
P/(L) US Dollar
|26/07/17||Short 100 Contracts Sept Schatz||112.03||112.3||-27000||-32130||64.3||112.227||-0.21%||-24000||-28560|
|15/08/17||Long 300 November VIX 16/24 Call Spread||0.97||0||-29100||-29100||58.2||0.92||-5.15%||-1500||-1500|
|23/08/17||Long 20 Contracts S&P 500 November 2350 Puts||29.2||0||-58400||-58400||116.8||19.2||-34.25%||-20000||-20000|
|01/09/17||Long 1.5m USDCHF||0.96||0.9481||-17850||-17197||34.4||0.9634||0.35%||5100||4913|
|01/09/17||Long 1.5m NZDUSD||0.7166||.07305||-20850||-20850||41.7||0.7155||0.15%||1650||1650|
|Stop Loss Level||Trade
|US Dollar P/(L)||Last
|14/07/17||Long 10 Contracts Sept Cocoa||1892||04/08/17||2047.7||8.2%||15570|
|14/07/17||Long 10 Contracts Sept Cocoa||1892||01/08/17||2068||9.3%||17600|
|14/07/17||Long 20 Contracts Oct Sugar||14.099||04/08/17||14.174||0.5%||1680|
|14/07/17||Long 10 Contracts Sept Coffee||132.10||04/08/17||139.4||5.5%||27375|
|19/07/17||Long 20 Contracts Sept Cocoa||1943.10||28/07/17||2035||4.7%||18380|
|19/07/17||Long 20 Contracts Oct Sugar||14.42||01/08/17||15.0245||4.2%||13541|
|20/07/17||Long 10 Contracts Sept Coffee||136.175||01/08/17||138.65||1.8%||9281|
|09/08/17||Long 10 Contracts December Gold||1274.4||14/08/17||1287.4||1.0%||13000|
|02/08/17||Long 40 SPX Sept 2400 Puts||12.7||14/08/17||12.3||-3.1%||-1600|
|29/08/17||Long 5 Contracts S&P500||2446.5||31/08/17||2464.5||0.7%||4500|
|30/08/17||Short 10 Contracts September VIX||13.2||31/08/17||12.9||2.3%||3000|
|29/08/17||Long 5 Contracts September S&P 500||2446.5||01/09/17||2474.25||1.1%||6938|
|Cumulative Closed Profit/(Loss)||$129,265|
This is not meant to be a model portfolio and it is not meant to constitute any investment advice. This is purely a way of keeping track of specific trade ideas that we highlight in our weekly investment commentaries. These ideas will consist of the more important or higher conviction ideas that we implement in our multi asset macro fund. We have chosen to have a notional starting portfolio value of US$5 million; the reason being that we can then also illustrate how much risk we are taking on each trade as well as keeping a cumulative track of how our main trade ideas are performing. This is a notional portfolio only and does not represent any portfolios that we manage. However, for the sake of clarity and consistency, we do put these trades into our multi-asset macro portfolio alongside other trades that we do not make apparent here. The prices we show in the table above are the prices we transact at for our macro fund, not including any trading expenses.
RMG Wealth Management