am/FX: Time Dilation 15Aug22

Time Dilation

The pace of Quantitative Tightening doubles in a few weeks, and while “liquidity increasing” vs. “liquidity decreasing” has been an important input for risk appetite and the dollar since 2010, the relationship is anything but 1:1. Here is the evolution of the Fed’s balance sheet and the S&P 500 in 2017/2018, the last (and only) time we saw QT:

3-month change in Fed balance sheet vs. 3-month change in SPX last QT

The Fed started QT in October 2017, but (similar to this time), meaningful balance sheet reduction took a while. The big reduction in the size of the Fed’s balance sheet started in the summer of 2018 and stocks traded well that summer before crashing in Q4. The peak was September 21, 2018. So, I suppose the acceleration of the Fed’s liquidity reduction should be a yellow light for equity investors again into Q4, but the relationship is murky, and the timing is debatable so it’s more like a reason to lean cautious, not a reason to buy SPX 5-delta puts.

Reminder: We know nothing

The dominant narrative has gone from stagflation to recession to soft landing in the past few months and the rapidly changing points of view are just a reminder that nobody knows what is happening and even fewer people know what’s going to happen.

I was thinking about how far we have come in the past year and flipped to some notes from less than a year ago. Comments like this were common:

I judge at present … commencing policy normalization in 2023 would be entirely consistent with our new flexible average inflation targeting framework.

Clarida, less than a year ago

At least half of the 18 FOMC participants in their Summary of Economic Projections (SEP) submissions projected that these necessary threshold conditions for liftoff will be met by December 2022, and all participants but 1 project that these conditions will be met by December 2023.

Clarida 11 months ago

My expectation today is that the labor market by the end of 2022 will have reached my assessment of maximum employment if the unemployment rate has declined by then to the SEP median of modal projections of 3.8 percent.

Clarida last October

I post these as a reminder of just how useless Fed guidance can be and how difficult it has been for anyone (Fed or private sector) to forecast this economy. We are in a completely different regime. It’s like an AI combined 1974, 2000, 2008 and 2018 to create 2022. Still, we get three or four Fed governors a week coming on TV to confidently bloviate about what’s next for the economy and Fed policy.

The Clarida comments are also a reminder of how quickly time passes these days. Since those comments less than 12 months ago, inflation has gone from 2% to 9%, three senior Fed people (including Clarida) have resigned in a trading scandal… And Clarida has already returned to a high-paying job at one of the most storied bond trading firms in the world. Amazing.

Markets and trades

I am taking profit on the EURAUD trade here as I am nervous the risky asset rally will fade as we near 4300 in SPX, China keeps dipping, oil sags, crypto looks toppy and the meme stock run points to silly exuberance again in contrast to 2008-style levels of bearish sentiment just four weeks ago (!!!!)

Short EURUSD should continue to work as global growth sputters, the chart held perfectly, and the energy story remains problematic (lower oil prices are not super relevant to the EU energy story).

Given the chart breakdown, I don’t think EURUSD should go back above 1.0360 at this point if the trade is right, so I’m moving my stop way down to 1.0376. As discussed late last week in “am/FX: Nice location for short EURUSD” a key technical characteristic of this down trend in EURUSD has been that every old support becomes resistance on the way down. It has worked seven times now. Here is how it played out this time:

EURUSD support becomes resistance for the 7th time in this down trend

Final thought

Has oil gone from a supply shortage to a demand shortage? Have an artificially intelligent day.

good luck ⇅ be nimble

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An old statue of a rapper

My son got access to DALL.E (the artificial intelligence engine where you type in text, and it draws an image based on your inputs). This was some of the output.

Pixel drawing of a giant skeleton attacking a village

One billion cats

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