We're all scratching our heads about FX moves but are there bigger forces at play?
Zerohedge seem to think so. They've popped up a story about a large fund getting caught on the wrong of an S&P vol trade, the results of which leave the firm with a $17bn short cover, which is behind the recent drive higher in US stocks.
The details have been backed up by RBC's head of US cross asset strategy, Charlie McElligott;
"a purported / murky melt-down over the past week in a large trade by a multi-billion Dollar (open-ended) futures fund which sells vol on S&P. Without going into specifics, there is marketspeculation that the entity is effectively short upwards of ~$17B of SPX (deltas to buy) through selling February expiry upside 1x5 (or 1x4) call spreads."
There's a ton of information in the story, and most of it will be well over many of our heads, so to try and put a layman's slant on it, there's a big player who needs to cover and is getting hammered.
That's not directly reflective on FX moves but there's other forces at play. This stock rally may be sucking in other less knowledgeable players who are going to find little support underneath them if this rally ends.
What RBC also note in the mix is the state of players in the bond market.
As highlighted earlier in the week by Mark Orsley and me, the turn in Chinese data and concurrent squeeze in short Yuan trades actually has alleviated some of the PBoC's UST-selling pressure.
That and the market is still ridiculously short duration, with some leveraged funds likely covering out of frustration. Either way, it seems reasonable that a sharp-reversal in broad risk-asset sentiment could REALLY squeeze this short-base, and with no China-supply this time around. A FTQ-bid would drive rates lower and could see recently-accelerated "value" and "cyclical" equities-plays get wacked, while duration-sensitives (defensive yield-plays) would be sent scrambling-higher
Their conclusion is pretty straight and to the point;
"This could lead to a scenario where a market can "collapse under their own weight." Indeed, because if one removes the forced buying from the "blowing up fund" (which as noted above is allegedly the Catalyst Funds' Hedged Futures Strategy Fund), there is certainly a long way down"
On our side, if this is going on in stocks and Treasuries, then FX is sitting purely at the mercy of these moves, and that's why we're not moving about on the fundamentals. It's an apt time to remember that FX is often not the leader but the follower of large movements in other assets, and those moves far outweigh what we expect to see in relation to normal things like data watching.
Sometimes when things like this happen, the best thing to do is quit worrying about the reasons, and stick to the lines on the charts. You go with the holds or you go with the breaks, KISS.
