Market Thinking

making sense of the narrative

$ to everyone : “It’s not you. It’s me”

A new government and a crisis mini-Budget are perfect catalysts for macro traders to double down on existing large and already highly profitable strategies and to produce persuasive narratives to back it up. Thus, going into month and quarter end with existing shorts on Sterling and UK fixed income and with FX and bond volatility already highly elevated, it really didn’t matter what the new Chancellor and his team said, the markets were primed to drop. More important for markets is that this isn’t really about sterling, it’s all about the $, which is becoming the most crowded trade in the world. When that unwinds, the narrative will reverse rapidly and investors need to think how they will be best positioned, not least as to where those $s may flow next.

The headlines over the last few days have been all about Sterling, as the CTA traders, already heavily short, used the Mini-Budget last Friday as a catalyst to drive the currency further down, backed up by a veritable wall of narrative management. FX Volatility jumped to the upside, which has its own knock on effects of inducing forced selling, while the panic that the traders had been looking for appears to have hit the UK fixed income markets. Evidently, some of the ‘alternative’ structures that had been offering the illusion of downside protection to fixed income portfolios by not ‘needing’ to be marked to market, have nevertheless been hit with the equivalent of some margin calls on the derivative structures. To meet these, they have been forced to sell their liquid holdings of Gilts. As the old saying goes, no market is liquid when everyone is the same direction. Accordingly the Bank of England has been forced to step in and effectively be the buyer of last resort for Gilts. The 2008 analogue is working just fine.

However, we need to step back a little and, as the title says, realise that this is really all about the $. Certainly GBP, or the Great British Peso (as Sean Darby at Jefferies calls it) is at a multi decade low against the $, but so too is the Euro, the Yen, the Swedish Krona, the South Korean Won and many others. China has managed its rate lower against the $, now down around 12%, but on a trade weighted basis is still stronger year to date as everyone else is down a lot more. The same of course applies to other ‘currencies’, like Gold and Crypto. In fact the only currency stronger than the $ this year has been the Ruble.

The only currency up against the $ this year is the Ruble

The bottom line is that the CTA traders have managed to induce the panic they needed to extract rent from the markets. Volatility is up across the board, in FX, Bonds, Commodities and now in Equities as the VIX joins the party and jumps through 30 as month end and quarter end approach.

We would take two key lessons from this. First, this is not about the Mini Budget, or even really about Sterling. This is all about the $. We will look at the UK Budget in another post, but the reality is that the reaction from the markets was already pre-packed. The details of the Budget didn’t matter, it was simply the required catalyst to boost the trade already lined up. Indeed, the sell off in Sterling was simply the last domino to fall in the long DXY trade – the Trade Weighted Dollar basket where there is a massive consensus leveraged long targeting 120. Remember, nobody really trades the basket, they trade the underlying pairs and sterling was the one with the most ‘room’ to move. Second, the situation now has a long list of the checklist for a blow off top in the $ lining up. In no particular order, these are:


  • The narrative on King $ is now all encompassing, with strong ‘fundamental reasons’ why the Yen, Euro and now Sterling are all ‘toast’. As noted, the reaction to the Mini Budget was simply an excuse to push for capitulation to profit on an existing heavy short position
  • The issue of currency has moved from the Financial pages of the broadhseets to the front pages of the tabloids, the usual sign of peak ‘noise’.
  • This is accompanied by memes from traders, in this case about the government’s lack of economic competence that are heavy on politics and light on economic analysis. This is consistent with traders’ ability to become instant experts on hot topics, but with little actual conviction, before moving on to the next topic. This is not a criticism, but rather an observation of a ‘fad’.
  • Politicians are seeking to exaggerate the issue – here the currency moves – for political gain, blaming the former on the policies of their opponents and claiming that ‘markets’ agree with them. Not true of course, but this tends to catastrophise the issue, prompting sell at the bottom behaviour by retail.
  • A carefully curated selection of ‘economic experts’, all of the opposite political persuasion, are brought forth to further ‘explain’ the currency weakness as being down to the markets giving a vote of no confidence in the policies. Ergo, the supporters of the globalist, Gordon Brown style, centre left, redistributive politics and big government economics like the Economist, the BBC and the FT are all claiming that ‘the markets’ are endorsing their own views.

Thus having started the ball rolling, the macro traders can leverage the rest of the noise markets, the one sided economic experts and the politicians looking for an edge over the opposition to push their position/agenda.

The fact that many of the experts are globalist and die-hard remainers should not be overlooked as a factor either, since they are looking for a bad story on the UK and thus are useful to keep to keep the ‘story’ running. We note that the Economist in particular has been really polemical in this. Of course, as the (well documented) ‘Front page of Time Magazine/Economist Effect’ demonstrates, by the time it gets to this level of consensus, there is no-one left to buy/sell.

Market mechanics

  • The sharp rise in US rates, particularly over the last month, has triggered a renewed scramble to close out leveraged positions, many of which are $ funded. The rise in the $ itself has exaggerated the problem, exposing investors to currency as well as duration risk. In effect, the G7 economies have become like the emerging markets economies of the 1980s, the last time the $ caused this much havoc.
  • Meanwhile, the structural problems in fixed income have worsened as the multi decade bond bull market continues to implode. The latest issue is with LDI funds in the UK who have effectively got caught in a form of margin call on their interest rate swap positions that has forced the BoE to intervene to prevent a doom loop emerging in UK Gilts. The FT Alphaville section, as usual, has a good grip on this (see here, apologies behind a paywall). The essence is that, because gilts have fallen, they need liquidity, so they have to sell, err gilts. Meanwhile, a number of other illiquid assets in the Private/alternative space also need collateral and so they too need liquidity from selling gilts. The BoE buying is actually both sensible and necessary, but is of course being used to support the narratives discussed above.
  • The $ long is the most crowded trade in the world at the moment. Not just the CTA traders who are all actively short Yen, Euro and now Sterling as they target 120 on the DXY basket, but more importantly the asset allocators who are ‘hiding’ in $, delivering a 10-20% ‘return’ in local currencies to their non $ clients. The traders will likely close first, but a reversal in the DXY will likely trigger a lot of profit taking.
  • Meanwhile, the long term investor is likely to start looking for non $ ‘value’ in Q4. To take the example of the UK, a Prime Asset – be it Residential or Commercial Property, a listed of a private company (equity or debt) or indeed any ‘trophy asset’ is probably somewhere between 15 and 20% off the peak. Factor in $ at close to parity and that approaches a 50% drop. Long term investors aren’t trying to pick the absolute low – but in the end they put it in place.

The illiquidity problems, forced deleveraging, central bank intervention and so on are all, relatively common, features of market behaviours, and as and when they get ‘sorted’, the pressure unwinds. When that happens, the narrative winds start to change as people realise that tax cuts, a competitive exchange rate, interest rates close to ‘normal’ levels and broad policies to improve productivity actually make sense. And it all swings the other way.

Long $ is the new FOMO trade

In many senses, this feels rather like this time last year, when ‘everyone knew’ that Crypto, meme stocks, ARKK, mid cap Tech IPO stocks and SPACs were all wildly over-priced, but were all holding on in for further gains believing they could get out at the top. As we discussed last December in FOMO plus LOL = OMG, these trades all started to unwind around Thanksgiving in the Hemmingway fashion of “Slowly , then all at once”, or as we used to say “Markets climb the stairs but fall down the elevator shaft”. Rather than get caught up in the Doom and Gloom (and the Doom Loop in Fixed Income) Investors perhaps need to think about how to act when, not if, this latest momentum trade unwinds.

Don’t try and call the absolute bottom in Sterling, or even the absolute top in the $, just think about how you would position when they do turn.

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