[Nov 16: While I agreed with the selloff, I an not sure where the next 25 bps would be from here. But I did think the economic downside tail had increased. These were my thoughts over the weekend. I’m not as keen now on the FFF-G punt, as the Fedspeak seems to be for a hike.]
The blow-out in rates means more opportunities and larger opportunities! We closed 151BUs [bp-units] in trades and hedges this week – three Winners and a trade that made a tiny amount that I’m just going to call a Neutral. I knew the front-end steepening bias would kick in eventually! I thought the trades would work even with a Clinton victory (just not as much). I know I cashed out Friday morning before the further selloff in the afternoon, but to be honest, I think having the largest year spread be 39bps (1.5+ hikes) is more than “fair” in an uncertain environment. I’m happy not holding something until it exceeds what I think is “fair value,” even though an overshoot argument could be made.
Now that we cleared out a bunch of trades, there are some other trade themes that I like, in addition to the trade themes I mentioned in previous sections:
- While I think Trump could be an okay President and my central view was for rates to be high, it’s not out of the possibility that one or more of his unconventional policies causes a recession. The downside tail on the economy has gotten larger. Even if the US economy looks okay, couldn’t China, the EU or Japan implode from trade restrictions and cause a global crisis? Also, if the long end really pukes, couldn’t that cause a recession with all this debt outstanding? I’m not saying these are likely scenarios, but I would think it’s got to be at least a 10% probability, and protection is cheap. So look for a new “zero-cost” recession options trade early next week, in addition to write-ups of the trades listed above.
- If you think the Fed skips in Dec, an interesting way to play for this is to buy FFF-G @ 1. This is like buying the Feb meeting for < .5bps (factoring daycount). This is very low probability, but every meeting is “live.” If nothing eventful happens in the next few weeks to cause a Dec skip, you could try to unwind @ 1.
- I also like some kind of “selloff fade” trade when the knife stops falling and the next thing we have to “look forward” to is Article 50 (after the nearly fully-priced Dec meeting). We have to first wait for the bearish euphoria to wear off.
Stay tuned for other trades.