QCP Market Update
It has been a quiet week for big macro data releases in the past week, with the next major economic data release being ADP on 8th March next week.
More importantly, what we have been watching recently is Fed speak. Fed speakers continue to talk about higher for longer, and some are even alluding to the difficulty of achieving a soft landing.
We believe this month's FOMC (22 Mar) will set the stage for the rest of the year as market participants will be able to see where the Fed sees the terminal rate in 2023, and if the Fed sees cuts in 2024.
Dollar weakness earlier this week was due to Chinese manufacturing PMI numbers coming in at 52.6. With this, the China reopening narrative has reawakened, but we remain wary.
We expect DXY to head higher, and risk assets to come under pressure for over the longer term.
Firstly, yield curves have been shifting higher as markets continually price in a higher terminal for longer.
Secondly, global liquidity is tightening again as the PBoC and BoJ reduce liquidity injections, and will continue to decrease as central banks continue their fight against inflation.
Thirdly, the S&P 500 forward P/E ratio has been creeping up despite real yields moving higher. A violent correction is on the books if these two measures continue to diverge.
Despite the doom and gloom, crypto continues to hold up extremely well with BTC staying above 23k despite the S&P 500 breaking below the key 4000 level last week and now looking to test the 3900 level.
However, if equities continue to fall, and the DXY and yields continue to move higher, crypto prices might struggle to sustain these levels.
In the options space, we saw massive unwinding of long option trades (particularly calls) as bulls lose faith on a topside break. We've also been seeing strong interest in option-based yield products as yield seekers are no longer finding viable strategies in the lending/borrowing market. This has been putting pressure on vols.
The vol curve is also notably flatter than we've seen in previous sell-offs, suggesting that the market expects a sideways trading environment in the medium term.
At these vol levels, we are positioning long vega in anticipation of some volatility as we head towards FOMC at the end of the month.
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