Alpha Report: Election Hedging

Macro flows and macro catalysts

We are entering an important period of time where hedging pressure and its connection to macro catalysts will be instrumental in taking asymmetrical trades that generate alpha. The macro views have been laid out in the following reports thus far:

• Comprehensive Macro Report

• Alpha Report: Disruptive Technology Is Built On Disruptive Knowledge

• Alpha Report: Will rate cuts reignite inflation?

• Trades: Update On Bonds

If you are new to the Substack please review the alpha primers and specifically the one on hedging pressure because it will be critical to understand the analysis below:

Macro Alpha Primers:

• Macro Alpha Primer: Credit Risk and Duration Risk and Macro Podcast: Macro Alpha Primer

• Macro Alpha Primer: Correlations and Macro Podcast: Macro Alpha Primer

• Macro Alpha Primer: Macro Catalysts, Hedging Pressure, and Positioning and Macro Podcast: Macro Alpha Primer

• Macro Alpha Primer: Positioning Premiums and Macro Podcast: Macro Alpha Primer

• Macro Alpha Primer: Stacking Edges To Identify a Sucker

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Big Picture:

We remain in a Goldilocks regime where growth remains strong and the risk of a recession remains low. Within this regime, inflation has ticked up marginally and growth has surprised expectations to the upside (all of this was laid out in the macro report).

When we approach this regime, we are always trying to identify HOW positioning is extracting the expected returns from this regime. One of the ways we do this is by watching how hedging pressure takes place through macro catalysts. There are 3 primary macro catalysts in the immediate future that are likely to have a large impact on equities and the rate complex:

• NFP

• FOMC

• The results of the US election

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Asymmetry:

Each of these catalysts is important because assets are compressing in their risk reward set up for a larger move. The beginning of these moves are likely to be initiated by the unwinding of hedges through these catalysts.

Both ZT and ZN have sold off significantly since the last NFP print with the short end back at the low of the CPI level:

We are now pricing a much lower probability of a 25bps cut for December which is quite surprising.

You will notice ES has been compressing in a range since the last CPI print. This range in ES is directly connected to the range we are seeing in ZT. ES couldn’t sell off and close BELOW the CPI level today. Additionally, ZT is unlikely to make a durable close below that CPI level.

Why is this connected? Because oscillations and variance from positioning can take place within the larger macro regime. Goldilocks remains the dominant regime even if we have short term shocks.

As we move through the NFP and FOMC catalysts, we are likely to make more of a durable bottom in bonds. If Powell shifts his tone and forward guidance, he will basically be walking back the entire framework he has laid out since Jackson Hole. We have not seen enough progression in the economic data to justify such a shift in Powell’s rhetoric.

The election hedging is the wild card in terms of predicting the short-term direction. Managers are going to be well-hedged into the election, taking idiosyncratic bets or waiting to put more cash to work AFTER the election outcome is clear.

This is part of the reason we have seen a short-term compression in ES as the VIX remains so elevated:

As we move into the election, you need to be prepared to wicks in price action to the upside and downside. If ES sells off marginally any time around the election, this will likely be a buying opportunity. The question will simply be WHEN to initiate the long. I would not be short equities here based on the macro regime or positioning set up. It is too much of a coin flip. If my strategy triggers another ES long, I will share the timing with paid subscribers.

I am still holding the ES long I opened at 5,825. I would not be surprised if we made a pullback over the next 2-3 weeks but would not be betting on it. I am simply prepared in terms of position sizing to take advantage of it.

While there are specific trades that can be run into the election, patience is critical here to add equity exposure potentially.

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Pulling Things Together:

When you are in periods of time like this waiting for a fundamental catalyst, you can have a ton of short-term variance where positioning is just moving around the price in a range until we finally see pressure to move the price. This is why I am not taking any large swings. I am simply waiting and preparing for action if the market provides the opportunity.

Thanks

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