Prime Trade Ideas: Could Higher Oil Prices Ruin ‘Transitory Disinflation’?

We consolidate our favourite biases into one, easy-to-read, weekly report! Please find the original pieces linked throughout and a summary table at the end of the document. Reach out to us on Slack or email the author with any questions about the content.

Latest Updates

FX, Rates, and Commodities:

• Bullish EUR/USD to 1.13 (2 August, Richard Jones).
• Bullish CAD as oil rebounds (27 July, Macro Hive, CME).
• Oil is well supported at $80 on Brent (2 August, Viresh Kanabar).

Equities and Credit:

• JETS still has a long runway(27 July, John Tierney).

Momentum Models:

• Momentum models flips bullish on USD/CAD (3 August, Bilal Hafeez).

Central Banks Views:

• Soft Landing Is Possible – With Inflation and Luck(3 August, Dominique Dwor-Frecaut).
• ECB Review: Confusion Does Not Mean Dovishness (31 July, Henry Occleston).

Bilal’s Asset Allocation

Find Bilal’s latest asset allocation biases here.

• We reduce our max overweight position in cash as the forward outlook requires a less defensive posture.
• Within equities, we shift from underweight to neutral on the US. Forward EPS momentum is now positive, fewer sectors are expected to see EPS declines next year, and we see the Federal Reserve (Fed) hiking no more than twice this year – too little to weaken the economy.
• Consistent with a less defensive posture, we shift to neutral on high-yield from underweight.
• We turn overweight on US bank IG credit given spreads are still discounting banking stress. Within IG, we favour a shorter duration.

FX, Rates, and Commodities

G10 FX

Major G3 Pairs Face a Rangebound Month After Central Bank Flurry. You can read the entire piece here.

Richard looks at the G3 currencies after the recent price action and monetary policy tweaks to update his views.

Richard is:

Bullish EUR/USD – But would like to maintain only partial long exposure. He thinks the July range of 1.08/1.13 will hold in August and would like to buy dips into the bottom of the range should they materialise.

Neutral USD/JPY – Whiplash price action in the Japanese yen last week left him less certain about JPY strength into H2 2023. USD/JPY traded in a 137/145 range last month, and he thinks this will contain the pair this month.

Neutral EUR/JPY – As with USD/JPY, volatile JPY price action last week makes him stay neutral on the side-lines in this pair. The July range of 152/158 should hold through August, although the topside is (clearly) most vulnerable to a break.

Table-Topping CHF to Keep Outperforming in H2 2023. You can read the entire piece here.

The Swiss franc (CHF) is the strongest G10 currency so far in 2023, while Deutsche Bank CHF Trade-Weighted Index (DB CHF TWI) trades at a multi-decade high.

Richard thinks CHF outperformance should continue in H2 2023. The Swiss macro backdrop is favourable relative to its G10 peers, the Swiss National Bank (SNB) remains committed and credible in its fight against inflation, and the currency might yet benefit from prospective haven demand.

How Are Oil Prices and Canadian Equity Performance Affecting Positioning in CAD? You can read the entire piece here.

Our latest collaboration with the CME looks at positioning in CAD. We find that hedge funds are turning less pessimistic on the Canadian dollar while asset managers have turned bullish, in line with higher oil prices and Canadian equity outperformance. Meanwhile, the FX volatility curve using CME options data suggests investors are in ‘fear’ mode.

We are cautiously optimistic on the Canadian dollar. Global economic data is holding up, supporting commodity prices, while Chinese industrial demand appears to be encouraging oil prices even higher. Simultaneously, Canadian equities are outperforming as strong US equity performance tires.

Commodities

US Oil Production Has Peaked. You can read the entire piece here.

Viresh looks at questions during this week’s commodities weekly.

1. What is the outlook for US oil production?
2. How does a pricing out of US recession risks impact the oil market going forward?
3. Will Saudi Arabia extend their 1mn b/d production cut?

He finds that US oil production has likely peaked, and that declining production provides OPEC+ with more market power as the US has been the largest source of global supply growth this year.

Markets pricing out a recession cuts off the left tail to global demand but does not open up the right tail. This will be driven by Chinese demand.

Finally, we should expect Saudi Arabia to extend production cuts through September.

These points mean Brent remains well supported at $80.

Singapore Cracks Rise While Short Positioning Falls. You can read the entire piece here.

Singapore product inventories have fallen to 39mn barrels, the lowest since April 2022. Singapore crack spreads for both gasoline and gasoil (diesel) continue to widen, potentially signalling a return of Chinese industrial activity. Meanwhile, speculative short positioning continues to unwind but remains within its bottom 25th percentile over the last three years.

Viresh saw upside in Brent to $85.

Equities and Credit

Equities

JETS Needs a Long Runway. You can read the entire piece here.

Airlines have been a bright spot during Q2 earnings season. They are posting solid beats and report booming demand for air travel for the foreseeable future. Yet the airline-oriented JETS ETF is still trading 45% below its pre-Covid level.

The Airline industry took massive losses during Covid lockdowns and still face rising labour costs, a hangover from high fuel prices last year, and ongoing weather-related problems. However, as demand continues to recover, we think JETS can outperform the S&P 500 over the next year or so.

Russell 2000 Rally Has Run Its Course? You can read the entire piece here.

We pitched Russell 2000 (RTY) in early June on expectations that the selloff after the Silicon Valley Bank (SVB) collapse was overdone. However, RTY trades at a premium price-earnings (P/E) ratio to the S&P 500 (SPX), but it lacks exposure to the tech sector. Loss-making companies also weigh it down. It is unlikely to produce premium earnings growth in the current environment.

We unwind our technical long position. We now think that RTY will perform in line with SPX at best, with significant downside risk in any selloff.

Cryptocurrency

Technical Signals:

Two Key Weeks Ahead for Bitcoin and Ethereum. You can read the entire piece here.

Both Ethereum and Bitcoin broke out of their downward channel in recent weeks.  

Robin still sees the $31,000-33,000 area as strong resistance, and thinks price corrects from here, potentially back to the 26,000-25,000 region. If prices do break this ‘flag’ resistance and 33,000, then there is room to further resistance around 36,000.

Fundamental Signals:

62% of the Ethereum Supply Has Not Moved in at Least a Year. You can read the entire piece here.

With the macro backdrop neutral and our on-chain/flow metrics slightly bullish, our overall signal is slightly bullish Ethereum.

The Fed is on track to hike 25bp this month, and we expect a second 25bp hike in November. Despite these two hikes, we do not think they pose a risk to the broader risk market rally.

When looking at on-chain/flow metrics for Ethereum, we have three bullish signals, two bearish, and one neutral causing us to shift to a more bullish view.

Momentum Models

Our momentum models cover FX, equities and rates. The basic strategy is to use returns (lookback windows) to give buy/sell signals. You can find the latest report here. Find out how to enhance your portfolio using momentum models here.

Momentum models were flat over the past week as gains in rates (+0.4% WoW) were offset by losses in equities (-0.3% WoW) and FX (-0.1% WoW). Performance over the past three months remains marginally positive (+1.0%), due to strong equity momentum model performance (+5.2%).

Since our last update, momentum models have turned heavily bearish on rates and EUR/CHF, and pared EUR/USD bullishness.

Central Bank Monitors and Previews:

Soft Landing Is Possible – With Inflation and Luck. You can read the entire piece here.

The expansion has long way to go provided the Fed tolerates high but stable inflation. The main risk to this rosy scenario is that the ongoing oil rally proves sustainable beyond $90/barrel, which could accelerate core inflation. In such an instance, the Fed would hike sooner and more aggressively, possibly bringing the end-2024 Federal Funds Rate (FFR) close to the Taylor rule, which I estimate at about 7 to 8%.

Even in the absence of an oil price shock, inflation stickiness implies that the Fed will hike more in 2023 and 2024, which compares with about five cuts currently priced by the markets.

ECB Review: Confusion Does Not Mean Dovishness. You can read the entire piece here.

The ECB hiked 25bp at their July meeting and confirmed that their September decision will be based on policy transmission, data, and what the September ECB forecasts say. The most important question is whether the drivers of ECB decision-making have shifted enough to allow a September pause. We do not think this is the case, especially after the July inflation print.

Henry continues to expect a further 25bp hike in September, with the risk of more to follow thereafter.

Viresh Kanabar has worked in the UK financial services industry for over 8 years including in Consulting and Investment Risk. Most recently he launched The Macro Journal Substack where he puts out regular in-depth reports covering all areas of global macro.

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(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)