Pre-NFP Risk-On/Risk-Off Positioning Update

we’ve been away from posting for a couple of weeks, one because we have seen the market unfold exactly as planned with bonds rallying to new highs as we stated in the Internal Conflict Inside the Fed’s Bubble of Fear while stocks melted in a deep correction as we stated in Like a Hot Knife Through Warm Butter  but also two because we got busy with an outside project that took up significant free time.

Fed’s Bubble of Fear (3/28):

Meanwhile, stocks continue to rally making it hard to short but even harder to buy.  For bonds its the opposite, they are hard to buy but even harder to short.  There is a definite internal conflict that is in the process of being reconciled.  It feels like there is a lot of tension built up and it may be time for some fireworks.  We envision a stock market correction that everyone has been waiting on for 2 months to ignite thoughts of QE 3 and a bond market rally, perhaps to new highs.  But the big trade is after that move, not from here.  From here the inverted risk-on/off boys look for another ride.

Warm Butter (4/17):

If we fail up there that has very dangerous implications for the market.  It would imply an ABC correction which would be either a B wave or a II of some degree.  If that’s the case the dreaded C or III would follow and it would be a violent sell-off that would slice through support..  The 1340 level that everyone is seeing as big support would be warm butter and target a test of 1300/1290.

As we approach the May NFP report on Friday with the markets continuing the moves we outlined in March and April we wanted to provide a Risk-On/Risk-Off positioning update and posit what this may mean for price volatility into the summer months.

We check the CFTC COT report every week because we think it provides a relatively current broad based picture of how the speculative and real money community is positioned.  Readers of this page know we have been watching what we deem as the inverted Risk-On/Risk-Off trade that sees HFs long $FV_F (Risk-On) while being short $ES_F (Risk-Off).  In fact HFs have been net short $ES_F the entire rally since the lows last October.  While fighting the tape they finally covered into a b wave high on the April stronger than expected ISM report earlier this month.  Since then the market has been straight down.  HFs have re-initiated short positions as we hit new lows and could provide buying support though we can see another leg down to elevate the fear factor.

The liquidity is about to dry up as the boys hit the beach but we think the big trick now that they are feeling comfortable they sold in May and went away is that this summer the market could be melting up instead of down.

In the bond market the HFs have maintained their heavy net long $FV_F position sitting near cycle highs with yields near cycle lows.  Out the curve they remain short the$TY_F in what has appeared to us as a steepener trade perhaps to position for the end of Operation Twist (in effect taking the other side).  But this week we noticed an interesting development in that they have gotten very long the long bond contract $US_F in a abrupt reversal of the past 12 months that has seen them short.  At the same time the commercial hedgers which includes the primary dealers are now heavily short after being long the past year suggesting they are long cash duration.

We don’t want to draw any large conclusions on this bond market positioning but would note that the heavy bets both long and short by the specs could set up for some volatility if the data comes in strong and the equity market can find a bottom.  We have been anticipating this melt up in bonds and when it’s over the ensuing reversal could be violent.

This is not a week to be a hero and you need to trade what the market gives you.  That said you have to think like a crook.  The market is well aware of the slowing growth and risks in Europe.  Don’t be surprised if they sell the news so to speak and play the big trick on the consensus and reverse the inverted Risk-On/Risk-Off positioning.  Ex Ante…

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About exantefactor

capital market veteran of over 15 years covering multiple asset classes. Focused on analyzying markets ex ante (before the event).
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