Markets Ahead – A Complacent Limbo

No new developments in the ShutDown and the longer it drags, the more market limbo grows.

Limbo is a good place. Markets are actively positioning for a swift rally once the shutdown ceases, yet there is a growing fear into 17th Oct when the US Treasury department’s coffers are reduced to just $ 30 billion and no amount of Fed QE can save them because they are just not authorised to spend anymore. Coming into a head, we find ourselves in our current twilight zone.

Human minds and hearts work in the market in a mixture of Greed and Fear. The combination is never in equilibrium and the current mood is a bemused one, more optimistic of a happy ending.

As the limbo plays out another week. We should expect the mood to turn sour and extend past the 1M US tbills which appears to be bearing the brunt of hedging activity. The VIX, Gold and equities are displaying no signs of distress as yet and European periphery debt is still enjoying hefty demand.

“FX would behave as other assets markets. The victims of a bad surprise on the debt ceiling front: current account deficit currencies, high-beta currencies and currencies in which the market is long.  In the benign short default scenario, the EUR may play out as a safe haven, but if that benign outlook changes, buying of peripheral debt will reverse on a dime, and the EUR could fall back sharply.” Source : Citi

Currencies seeing overwhelming favour have been the AUD and CAD lately, ever since the IMF Cofer data that vindicated  partiality towards the pair. Yet the outflows are starting to pick up for AUD, NZD and CAD in both bonds and equities.

“Foreign equity demand is exceedingly low – Canada, Australia and New Zealand are the only regions to have net outflows. Equity flow matters for currency traders. Japan continues to capture the greatest inflows, while attitude on the US have soured. ” Source : Citi

GBP appears to have fallen out of favour this week with more than a handful of sell calls for GBPAUD or GBPJPY. Problem lies in the positioning and over bought markets.

It would be all about positioning in the days ahead.

“For clients that are interested the average correlation of leveraged flows with FX spot ranges between 40-80%. Leveraged client trends and positioning is one of the best short term indicators in the market.” Source : Citi

The longer term picture still struggles between balancing growth prospects as indicated in some of the economic numbers and the slowdown from the shutdown. 3Q has been written off with excuses aplenty and will not be hindering risk on trades the minute the shutdown ends.

I cannot find a single mainstream equity report that is downbeat, only sour grape hedge fund managers and a few recalcitrant economists are calling for corrections, to which they cannot point a figure as to the extent to expect.

Thus Greed will prevail, raring for the risk on trades which makes the biggest risk of all, Complacency.

Yes. Complacency is a good start and I was astonished to learn over tea with an old friend, who happens to be a sharp equity manager, that he thinks buying out of money puts would be a good idea if the VIX has failed us in its purpose. Never have I imagined I would hear him utter thoughts as those for his livelihood lies in the stock markets which have been very good to him in the past years. He must be in limbo too.

Just like I am tonight when I caught this monster of a caterpillar roaming in the dark. But rest assured, I am not about to test Retired Trader’s theory that they are high in protein.