*Fed creates optionality around Yield Curve Control and its “now in doubt” September review – which by definition creates volatility
*We are watching with interest to see if USD higher / risk lower persists, but we do not think the “highs” are in
*We believe the market is yet to begin considering a potential sweep by the Dems – this is a core theme on the radar for the Autumn
Despite having been quite sanguine about the Fed, the golden rule of the Fed “creates” volatility worked once again. There is clearly pushback within the FOMC itself to Yield Curve Control, recognising the upside of entering into a policy that the market is defacto already following is limited. Instead, the Fed has created optionality for itself. Additionally, the market started to question whether the results of the Fed’s policy review would indeed be presented in September, where average inflation targeting – ie letting inflation run Hot – would be a core part.
The timing of such a big announcement is creating an issue for the Fed, given the election, the recovery and the situation with the virus. September we believe will be entering a period of max uncertainty on the those three issues, which makes commitment to long term plans hard to justify, and it may be the Fed it trying to – again – create optionality for itself by delaying until, lets say, December.
But given the correlations we have been highlighting between rates, equities, commodities (Gold is correlating strongly with TLT, for instance) and realised volatility, any sense that rates COULD go higher caused the spill lower in stocks, especially given the horrendous breadth in US equity leadership, weakness in Asian stocks and a stalling in European markets.
Radar Additions :
USDCNH support zone at 6.85-6.90 is on the radar – and has held first time. Given the stretched nature of markets we renewed our 1mth VIX call spreads as the previous ones rolled off – we like to keep paying for what we think are great risk reward bets to keep in the book.
We note that TLT VIX (20+yr bond ETF) picked up from the 12/15 support zone on the radarscreen, and we added 04Sep AUDUSD put spreads to the trade opportunities sheet, risking 0.1% of capital.
We do NOT think the highs are in, but we recognise that markets that have been anaesthetised by not just liquidity, but the expectation of supportive conditions FOREVER. Anything that shakes this sense creates an uptick in volatility which, by definition, causes position sizes to be reduced, not increased.
Re the election – the market has yet to really focus on the potential of a Biden victory. The effect of both share buybacks and Us tax cuts have created a perfect environment for equities to rally in the US, yet the leadership remains so so narrow. More than this, what happens if the Dems sweep all three houses? This would change – materially – the support for equity investors in the US. A core theme we do not think the market is fully appreciating.