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Saturday, November 26, 2022

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Nomura Sees An Inflection Point In ‘Crash Up’ Hedges, Warns “It’s The Dollar”, Stupid!

US equity markets are chopping around wildly in the last few days as Nomura’s Charlie McElligott notes that risk is drifting on a mini “triple whammy” causing a modest reversal stronger in the USD (after the post-CPI puke)…

1) China’s again-devolving COVID outbreak (Beijing reported 3 COVID-related deaths, Guangzhou imposed a 5-day lockdown, Hong Kong’s CEO tested positive for COVID, and Shijiazhuang–the 11m population city profiled by the FT last week as a potential “test case” for re-opening–instituted lockdowns and mass PCR testing—h/t AK),

2) the ultimate arrival of cold European weather finally seeing first drawdowns of Gas reserves and

3) a raft of better US economic data late last week (Bloomberg US Eco Surprise Index at best levels since May) is flowing-through financial markets via suddenly-squeezing US Dollar.

Bloomberg Dollar Index has now bounced more than 2% off the three month low made last week, which sits at the root of the overnight risk-asset pullback to start the holiday-shortened US trading week.

Source: Bloomberg

And naturally, as the Nomura strategist details, this is occurring just as the latest CFTC / TFF data shows both 1) Specs / Non Comms finally “net short” US Dollars for the first time since mid ’21

…and 2) Asset Managers at their most “net short” US Dollars since July ’21…

resulting in what is now the largest three session cumulative “positive” move in DXY in over three weeks, and overnight, with all G10 and Bloomberg EMFX weaker vs USD.

Remember and as noted in the days which followed the lite CPI print which set off such a profilic VaR shock unwind in legacy “FCI tightening” trade expressions most clearly represented by “Long USD,” that up until then had worked all year (and, accordingly, were VERY crowded) – the Dollar’s recent blast weaker (largest 6d drawdown since 2008) was not simply about crowded “Long USD” expressions being taken-down / stopped-out…but the fundamental catalysts (as noted at the top of this article) also shifting.

This “strong USD” impact is particularly evident with US Equities, where “USD Liquidity” (proxied by USD xccy basis swaps, as a measure of USD demand) shows “weak USD” as currently the largest POSITIVE macro factor price-driver for US Equities

…meaning “strong USD” then has the opposite effect on “lower stocks”. And even more explicitly, the largest Negative Driver for S&P 500 in the Quant Insight macro factor PCA model now screens as USDCNH… where after the shock move lower in recent weeks, we’ve now seen the largest cumulative 4 session move higher in USDCNH since September, and is a “top 10” largest 4d cumulative move since 2019…

So the fundamentals may be shifting in the most critical driver of equity strength, but, as McElligott notes, there is a perhaps even more important inflection point in risk attitudes appearing.

After an almost 9-month-long period of pervasive bids for “Crash-Up” upside in US equities (versus any fear of a “Crash-Down”) – as investors were strictly concerned about missing rallies as opposed to further selloffs, because they were so egregriously under-positioned…

And the grab for “Crash-Up” hedges prompted November’s 2nd largest daily average S&P 500 gain (following October’s explosion)…

McElligott notes that something just changed…

After the short-squeeze, SPX Index Options “Call Skew” has come off the boil…

…as we got the impulse +12% rally in Nasdaq and +8% rally in SPX in mere days post CPI miss…

…while we have FINALLY seen SPX Skew & Put Skew pick-up off historic “flats” (steepened 5 out of 6 days), which McElligott suggests is because as clients finally began getting longer again for the first time in months, they actually had some need to hedge underlying exposures again!

That said, in the sense that I think now after Thanksgiving that the fiscal year is effectively “over” for most as far as being able to deploy new risk, and after this latest rally was sooooo much about de-grossing of “Shorts”…

McElligott suggests that we can see “Skew” staying broken until the turn into 2023…and accordingly, we’ve seen VVIX trade back down near 5 year lows by end of last week, as “Vol of Vol” remains just absolutely “dead in the water”.

Given all of this, SpotGamma continues to like holding some downside “lotto tickets” given the dynamics of:

  • Put Wall staged significantly below current prices – indicates lack of hedges

  • IV/SKEW continuing to be very flat – indicates lack of hedges

  • “Medium term” IV should hold a bid due to 12/14 FOMC

  • DEC OPEX positioning could act as a catalyst to drive downside volatility

This week we look for strong support at 3900 given that traders will likely not want to carry puts over Thanksgiving, and we have smaller near term options positions.

Beneath 3900 we look for volatility to tick substantially higher, as we believe traders will need to add downside put protection.

This post was originally published on this site

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