The trade is in the liftoff, not the landing

For the past three weeks, the strongest trend in global macro has been the selloff in Treasuries and other government bond markets. While a lot of breath has been expended on the nature of the economy’s eventual landing, the more interesting trade is to play the sharp and globally coordinated liftoff in economic data.

I admit that I’ve changed my view from my last post where I expressed doubts about whether improving data would translate directly to a sharp rally in yields. Since that post, the Fed’s Mester and Bullard both suggested in public speeches that a 50 bp hike should not be ruled out. It was previously believed that the Fed would be hiking in 25 bp increments going forward, so their comments moved the Overton window on how aggressive the Fed could be in their hiking campaign if inflation remains sticky. Neither Mester and Bullard are voters this year, but they are both highly influential members of the Fed board.

There are signs that this improvement in data will be durable for at least a couple quarters. The primary source of the improvement is the China reopening, coupled with the flood of liquidity coming out of China.

Improvement in China excess liquidity is now being followed by better coincident data. Source: Variant Perception

This is feeding into stronger Eurozone S&P Global composite PMIs, which have increased for 3 months straight.

The recovery has now reached the US, where the S&P Global composite PMI ticked higher in Jan, led by services PMI which jumped to 50.5 from 46.8 (corroborating the upside surprise in services ISM).

What’s the trade here? I’ve seen excellent arguments for why an improving economic backdrop is bullish for equities and bearish for equities. I’ve also heard great reasons for why the China reopening and improving economy is good for USD and bad for USD. All these arguments are valid, and the push/pull of these competing narratives are why equities and USD have been choppy for the last three weeks. The one area where the narrative is straightforward has been yields, where it’s pretty clear that good data = higher yields.

The risk off/bullish USD views out there involve a sequence of sticky inflation —> higher yields —> hard landing. Instead of betting on the hard landing, which is path dependent and uncertain in timing, why not just bet on the closer step in the sequence - higher yields? US Treasuries have been responding to improving data by trending lower, and if data continues to come in hot, we may see 10 yr yields revisit the highs of 4.25% and beyond. I am going short March 10 year Treasury futures at 111’10 (111.31) with a stop at 112’05, initial target of 108’16. The stop is close, so the time horizon is only one week or more. Yields are breaking through the technical pivot of 3.90% today, making me more confident this trend will continue. If this is a false break, then a move back below Friday’s low in yields would protect the position against a reversal of the trend.

This position is also a portfolio hedge against my short USD positions against JPY and XAU. Giving back profits on my usd/jpy short has been annoying, but instead of covering shorts, I’d rather hedge the US component of the trade by positioning for higher US yields in order to allow my view of BoJ policy normalization to play out.

The risks to my short Treasury trade would be a string of poor data that suggest that China’s recovery is a dud, or that the Jan data in the US was exaggerated due to seasonal effects.

I am also exiting my long in WTI crude at 76.30 for a small 1.30 profit. Oil has not been responding well to an improved global economic backdrop for three reasons - elevated US inventories (including further sales of the US Strategic Petroleum Reserve), Russia meeting China’s petroleum needs, and a risk off tone permeating the markets since last week.

Current Positions:

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