Macro and Flows Update: June 2023 - e18

Summary

The video discusses the current economic climate, focusing on the Federal Reserve's actions in response to core inflation stabilization at around 5%. Despite headline CPI decline, the Fed increases interest rates by 50 basis points, indicating a misunderstanding of the situation. The market's rally, driven by short squeezes and options trading, is contrasted with the anticipated liquidity draw and potential market liquidation by year-end. The video suggests a shift from NASDAQ outperformance to a more negative outlook, recommending strategic hedging and a focus on downside opportunities.

Takeaways

• 📈 The core inflation has stabilized at around 5%, indicating a secular sticky inflation trend.
• 📉 Despite headline CPI decline due to cyclical pressures, the Federal Reserve is actively using interest rates to combat inflation.
• 🚀 The FED increased their dot plots by 50 basis points, surprising the market.
• 💹 The market largely ignored the FED's actions, with yields declining on the day of the FED meeting.
• 🌐 Central banks globally are tightening liquidity, affecting markets outside of China.
• 🏦 The US interest rate market has experienced a 5% lag, impacting liquidity in the economy.
• 💰 The Treasury General Account needs to refill approximately 1.4 to 1.6 trillion in liquidity, impacting the system by year-end.
• 📊 Market rallies have been driven by Vana and charm and volatility compression, leading to short squeezes.
• 📈 The market has seen significant upside, particularly in the back end after two to three months.
• 🔄 Positioning incentives have made a U-turn, with sentiment indicators showing more bullishness and less bearishness.
• 🔽 The NASDAQ is expected to underperform as volatility declines in the short end of the curve, leading to a market downturn.

Q & A

What was the recent CPI report's impact on the market?

The recent CPI report showed a slightly weak headline but core inflation remained sticky, around 5%, indicating a stabilization of core inflation which is a critical secular aspect of the economy.

What does the term 'secularity' refer to in the context of the script?

In this context, 'secularity' refers to long-term trends or conditions in the economy, specifically relating to inflation and interest rates.

How has the Federal Reserve responded to the current economic conditions?

The Federal Reserve has increased its dot plots by 50 basis points and is using interest rates to influence the economy, despite the headline CPI showing a decline due to cyclical pressures.

What does the term 'dot plot' refer to in the context of the Federal Reserve?

A dot plot is a chart used by the Federal Reserve to show the interest rate projections of Fed officials over the upcoming years.

What is the significance of the market ignoring the Fed's actions?

The market's disregard for the Fed's actions indicates a potential misinterpretation of the current economic situation and could lead to a misunderstanding of future monetary policy impacts.

What major event in March caused a significant impact on the banking sector?

A bank run occurred in March, which, along with the debt ceiling debate, influenced the Federal Reserve's decision to pause its actions to ensure no liquidity tail occurred.

How is the Treasury General Account affecting the market?

The Treasury General Account needs to be refilled, which will require pulling approximately 1.4 to 1.6 trillion of liquidity from the system, impacting the market significantly.

What is the expected outcome of the liquidity draw mentioned in the script?

The liquidity draw is expected to lead to a decline in asset demand and potentially a market liquidation, particularly in the second half of the year.

What recent market trend was discussed in the script?

There was a sizable rally in the market, with an almost 7% increase over two to two and a half weeks, driven by factors such as Vana and charm, volatility compression, and market positioning.

What is the expected change in the NASDAQ's performance?

The NASDAQ is expected to underperform as volatility declines, particularly in the short end of the curve, leading to a NASDAQ downtrend.

What is the recommended strategy for investors based on the script?

The recommended strategy includes short stock focus, short put in the portfolio, and considering NASDAQ underweight relative to previous overweight positions.

Outlines

00:00

📉 Market Analysis and Inflation Trends

This paragraph discusses the current macroeconomic situation focusing on the Federal Reserve's recent report and its implications on inflation. The core inflation rate has stabilized around 5%, indicating a secular trend of persistent inflation despite headline CPI showing a slight decline due to cyclical pressures. The Fed has increased its dot plots by 50 basis points, surprising the market, but the market largely ignored this change. The Fed is not advocating for fighting inflation but is instead trying to manage it through interest rates and other economic tools. The pause in the Fed's actions is not seen as a long-term stop but rather a temporary measure to address issues such as the bank run in March and the debt ceiling debate. The paragraph also highlights the global tightening of liquidity by central banks and the impact of the US interest rate market with an 18-month lag on the economy. The Treasury General Account's need to refill by the end of the year, which will pull liquidity from the system, is also discussed, along with the ongoing quantitative tightening (QT) and debt forgiveness issues, all contributing to a sudden tightening of liquidity in the economy.

05:02

📈 Market Rally and Positioning

This paragraph examines the recent market rally of almost 7% over two and a half weeks, despite the liquidity draw and concerns discussed in the previous paragraph. The rally is attributed to the power of vanna and charm, as well as volatility compression, which led to significant buyback into poor short positioning. The market has been waiting for a blowoff top, which has finally occurred, leading to a short squeeze. The paragraph also discusses the market's positioning, particularly in the NASDAQ, and the shift in sentiment indicators towards bullishness. The increase in call buying and the potential for a market downturn, especially in the NASDAQ, is highlighted, along with the expectation of a decline by the end of the year. The paragraph concludes by suggesting that the market is entering a period of increased volatility and potential opportunities on the downside.

10:04

🔄 Market Expectations and Hedging Strategies

The final paragraph focuses on the expectations for the market in the coming months, particularly the late third quarter and early fourth quarter. It suggests that there will be an acceleration in market movements, but not a straight line, with bumps along the way. The paragraph discusses the potential destruction of call buying and delta in the NASDAQ, as well as the speculative nature of these trades. It also touches on the shift from heavy put to heavy call positioning and the dealers' need to sell stock as volatility declines, leading to a market downturn. The paragraph advises on hedging strategies, recommending a focus on short stock positions and short put in the portfolio, with NASDAQ underweight relative to previous overweight positions. The paragraph concludes by reiterating the importance of not fighting the Fed's actions and the potential for a decline in the market as the year progresses.

Keywords

💡macro

The term 'macro' in the context of the video refers to macroeconomic analysis, which involves examining the behavior of large-scale economic variables such as inflation, interest rates, and GDP. It is crucial for understanding the overall economic environment and how it affects financial markets. The video discusses various macroeconomic indicators and their impact on market trends.

💡CPI

Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. It is a key indicator of inflation and is used by central banks to formulate monetary policy. In the video, the discussion of CPI helps to understand the current economic climate and the FED's actions.

💡core inflation

Core inflation refers to the underlying trend of inflation that excludes volatile price changes from food and energy, providing a more stable and long-term view of inflationary pressures. It is significant because it helps central banks assess the health of the economy and make informed decisions about interest rates. The video emphasizes the stabilization of core inflation around 5% as a critical factor in the current economic situation.

💡FED

The Federal Reserve, often referred to as the FED, is the central banking system of the United States, responsible for implementing monetary policy to promote economic stability. In the video, the FED's actions, such as adjusting interest rates and dot plots, are central to the discussion of market trends and economic outlook.

💡liquidity

Liquidity refers to the ease with which assets can be converted into cash without affecting their market price. In financial markets, high liquidity means that there is sufficient demand and supply, allowing assets to be bought or sold quickly and without price distortion. The video talks about the tightening of liquidity by central banks globally and its implications for the economy and financial markets.

💡QT

Quantitative Tightening (QT) is the process by which a central bank reduces the size of its balance sheet, typically by selling assets it has previously purchased, to decrease the money supply and combat inflation. It is the opposite of Quantitative Easing. In the video, QT is mentioned as one of the factors contributing to the changing liquidity environment and its potential impact on financial markets.

💡short squeeze

A short squeeze occurs in financial markets when a rapid increase in the price of a stock forces short sellers to buy the stock to cover their positions, leading to a further increase in price. This is often triggered by positive news or events that cause a sudden rise in demand for the stock. In the video, the short squeeze is discussed as a result of market positioning and volatility compression.

💡Vana and charm

Vana and charm are terms used in options trading to describe the positive skew in the distribution of returns, where the probability of large positive moves is higher than would be expected in a normal distribution. This phenomenon can lead to higher implied volatility and is often associated with market conditions that favor long options positions. In the video, the power of Vana and charm is highlighted as a factor contributing to the market rally.

💡NASDAQ

The NASDAQ is a major U.S. stock exchange known for listing technology and internet companies. It is often used as a benchmark for the technology sector and is sensitive to market volatility and changes in investor sentiment. In the video, the NASDAQ is discussed in relation to its performance compared to other market indices and its positioning in the current economic environment.

💡volatility

Volatility is a measure of the variation in the price of a trading instrument over time. High volatility indicates that a security's price is subject to large fluctuations, while low volatility suggests that the price does not change much. In the context of the video, volatility is discussed as a key factor affecting market dynamics and investor strategies.

💡macro and flows

Macro and flows refer to the analysis of broad economic trends and their impact on financial markets, including the movement of capital and investor behavior. This type of analysis helps investors understand how macroeconomic factors influence market liquidity, asset prices, and investment strategies. In the video, the speaker provides a monthly update on macroeconomic trends and their potential effects on market flows.

Highlights

The FED reported after a CPI that was slightly weak on the headline but core inflation remained stable at around 5%.

Core inflation stabilization indicates secular sticky inflation despite headline CPI decline.

The FED increased their dot plots by 50 basis points, surprising the market.

Market is largely ignoring the FED's actions, with yields declining on the day of the FED meeting.

The pause by the FED was not a secular pause but a wait through tail-centric outcomes.

Macro liquidity is being pulled by central banks globally, impacting the economy with a lag.

The US interest rate market has experienced a 5% lag, affecting liquidity broadly.

The Treasury General Account needs to be refilled, requiring significant liquidity to be pulled from the system.

Markets are starting to price in a liquidity draw as we enter the second half of the year.

A sizable rally in the market, up to 7%, has occurred despite liquidity concerns.

Vana and charm, along with V compression, have contributed to a higher skew in the market.

Short positioning and structural flows have led to a significant buyback into a short squeeze.

The market is at an interesting moment with an increase in market up Vup and risk to the downside.

Sentiment indicators have turned bullish, with call ratio and put positioning changing dramatically.

NASDAQ positioning is expected to lead to underperformance and a market down V down scenario.

Volatility expansion is anticipated in the later months of the year, with an acceleration expected.

NASDAQ underperformance and a decline in the back half of the year are predicted, not necessarily fast but significant.

Investors should consider hedges and decay-neutral strategies for the upcoming market conditions.

The transcript concludes with a reminder that the information shared does not constitute investment advice and should be considered with professional advice.

Transcripts

hello and welcome back to another macro

and flows update here we are uh at June

quarterly

expiration the FED has just kind of

reported after a CPI that was uh

slightly weak on the headline but sticky

once again on uh the core which I think

has been the trend we've really seen a

stabilization of core inflation which is

the critical secular part that we've

been talking about at around 5% um that

speaks to that secular sticky inflation

despite seeing headline CPI decline on

the basis of more cyclical pressures

that the the FED is really um pushing

through um with the lag and interest

rates and whatnot that's been pushing

through the

economy um don't fight the fed the FED

just came out increased their dot plots

by surprising 50 basis points um out on

the curve before flattening uh but the

market is ignoring it for the most part

right uh the day of the FED meeting

yesterday uh we actually saw yields

decline um kind of completely fighting

the FED um from macro perspective uh the

FED paused this time around but we

believe that sit at the core of a a

broad misunderstanding and

misinterpretation of what has been going

on the pause was not a secular pause it

was not intended as a a stop and C

really it was really um in order to to

wait through what has been a very very

tail Centric uh set of outcomes one with

the bank run that we saw in March as

well as the debt sealing debate and the

issues surrounding that um so the pause

really was a function of making sure

there was not a liquidation tail not uh

a a pause in terms of the inflation

fight that the FED sees itself on on a

more secular basis um not surprising to

us as we have mentioned that inflation

has been sticky and the FED is coming

back into The Fray macro liquidity not

just from the Federal Reserve but also

from other central banks globally has in

started to uh more increasingly uh you

know pull on

liquidity um we've seen this in Europe

we've now seen this in Australia um

we're seeing it globally um in most

places maybe outside of China um and

that is on most liquidity models

dramatically pulling on

liquidity that's the part with a lag

right we've already done

5% in the US interest rate Market with

an 18month lag and guess what that is

starting to hit liquidity broadly in the

economy pair that with the QT that

hadn't happened as a function of several

other effects which are now starting to

really push through the system as well

one of those major effects which I'm

sure you've heard a decent amount of is

the treasury general account draining

lead leading into the debt ceiling

debate now that we had the debt sealing

resolution guess what that treasury

general account is having to be refilled

by most metrics that's about 1.4 to 1.6

trillion of liquidity that needs to be

pulled from the system by the end of the

year um by uh most metrics they've

reduced the speed and duration of that

liquidity because of their own fears and

concerns um but by the end of this month

we're still expecting approximately 400

million uh sorry 400 billion of

liquidity draw um that's begun but

there's still a lot to come uh pair with

that not just the lag in interest rate

policy we've talked about not just the

QT that's still happening but the debt

forgiveness issues that we're seeing on

on the individual uh you know the debt

um forgiveness from uh educational uh

loans um and you're seeing uh a

situation where liquidity in general is

dramatically starting to pull all of a

sudden here as we enter the second half

of the

Year our belief is that the actual

pricing in markets or or the the

disbelief from markets um of what is

happening and what the FED will be doing

is a function of markets basically

telegraphing that the back half of the

year has awul liquidity and will Lo

likely see some level of Liquidation in

markets and a decline in asset demand as

a function um either way it represents a

draw on liquidity from markets either in

the short term or in the longer term as

a function of sticke markets um that's

the macro perspective but what has

happened in the last month why have we

seen in the face of all of this

liquidity draw and and in the face of

all these concerns a pretty sizable

rally in the last two weeks of almost 7%

two and a half weeks um pretty pretty

simple something we've talked about for

quite some time um to our investors

which is the power of Vana and charm and

V

compression we have seen we saw uh

dramatically higher skew in the last

month um this is the proverbial wall of

worry in a mathematical term um paired

with a quarter expiration with

significant open interest um you you

pair those two things together and you

get significant buyback into what has

been poor short positioning we have been

waiting for several months this is what

we've talked about in our macro flows

videos we've been waiting for that

blowoff top that that actual squeeze

before the opportunity for this Market

to turn and that was a perfect

opportunity have short positioning under

investment which we've been talking

about squeezing with structural flows

with v compression you pair ball

compression ball Supply uh with a high

skew and put positioning and guess what

as you get into that big positioning

decaying you get massive buyback into a

short squeeze so that's what we have

finally gotten brought us into this 44

uh quarter to 44 um 30 area which we

believed was toward the higher end of

where we might be and here we sit at a

very very interesting moment uh the

market has seen a significant amount of

market up vup um particularly on the

back end after two three months out um

which we believe is appropriate at this

point it represents an increasing amount

of risk to the downside in the short

term

um what uh are we looking for does this

mean a big V crash or a a a massive

Market

liquidation that part of the tail that

part of the distribution is definitely

increasing but we believe the real tale

is in a decline essentially um by the

end of the year by the by the Q by Q4

that is significant that does not mean

it needs to be fast in the short term

but that does in our belief mean a

liquidation is coming now what that

looks like we will see um positioning

incent has not surprisingly made an

absolute U-turn which is what we've been

looking for a aii sentiment indicators

have turned on a dime um people are

dramatically more bullish um

dramatically less bearish by all

sentiment indicators put call ratio

ratios have exploded to the call side

we've had record call buying in the S&P

500 record call buying in the NASDAQ in

particular in the AI names um and it's

been particular speculation

driven those

realities are very very important to the

oncoming move that NASDAQ fall

positioning in particular as V declines

here in the short end of the curve is

likely to mean more NASDAQ now not more

an a a a turn in the NASDAQ and a NASDAQ

underperformance going forward we have

called uh back in in um early late uh

late Feb early March for a turn from

Russell to NASDAQ NASDAQ

outperformance um we are now taking that

off and turning to NASDAQ put hedging um

at the very least we believe the NASDAQ

will now begin to perform in step with

the Russell and likely start to uh to

the downside at be more negative again

that is a contrarian call to what you're

seeing now and that's driven by the

dramatic turn and positioning that has

now gotten went from heavy put to heavy

call and now guess what dealers who are

short call dramatically in the NASDAQ

long stock as V comes down they have

that stock to sell so expect a market

down V down uh exercise here um in the

markets and particularly with the NASDAQ

leading that would be in the short term

U that said we do believe that we will

get V expansion calendar expansion is

the name of the game here and we believe

that as we continue into the uh later

months later uh the late third quarter

um early uh fourth quarter that we are

likely to see an acceleration of that it

will not be a straight line uh expect uh

bumps along the way but we believe uh

call buying and the NASDAQ uh for Delta

are actually going to get destroyed here

in the that La back half of the year it

has been paid very handsomely obviously

to in the gamma squeeze but not

surprisingly these trades get uh hot

first create squeezes but

eventually uh become speculative uh

money for for the market makers and we

believe that is where we are now in this

part of the cycle so NASDAQ

underperformance uh broadly Vol bleed um

in the short end of the curve uh and in

the short term Market down Vol down

um but particularly as we start to go

into um you know a month forward from

here we believe we'll start to see the

back and continue to pick up so calendar

spreads particularly the downside are

very interesting at this point um

particularly in the NASDAQ um and puts

broadly in the NASDAQ relative to

Russell here now uh which is a

significant ter from our our spoton call

in February and March um we've heard a

lot of talk about the blowoff top we do

believe that sentiment reversal that uh

speculative call versus put reversal um

is is quite the sign and it lines up

with that quarterly expiration and those

dramatic flows so an interesting time um

to to not only place Hedges but

particularly hedges in ways uh where

they are more Decay neutral and gaining

ball um as time moves forward so expect

uh a stair step down into increasing

opportunity on the downside as we get

back to the half back half of the year

so not a quick liquidation but a a

decline um in the cards as we see it

here in the short term we have been less

directional in that call and more long

call short stock leading up into this

moment uh this is the time to now um be

much more um you know short stock

focused um with uh with maybe um some

short put in the portfolio short data

longer put longer ated um and some

interesting opportunities there again

NASDAQ underweight relative to what

we've been overweight NASDAQ in the

short term so that's the flows

perspective the macro flows um in

particular um big overhang increasing in

in its bearishness uh the FED itself has

told you um what it is doing uh everyone

is ignoring it don't fight the FED uh is

is the core belief here important run we

just had time to take advantage of it uh

wishing you all the best be water till

next time this is jeem Caron from Kai

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