Prime Trade Ideas: Positioning for a Weaker UK Macro Backdrop

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

Asset Allocation

• Turning less defensive and fading the ‘Fed model’ (13 July, Bilal Hafeez).

FX, Rates and Commodities

• Receive 2-year Gilts and short GBP as the UK economy weakens (13 July, Richard Jones).
• Leaning bullish on Ethereum (11 July, Bilal Hafeez, Dalvir Mandara).
• Turning neutral CNH, staying bullish on INR, KRW and THB (10 July, SGX Asia Currencies Insights)
• Bearish on Dutch TTF futures as EU gas prices to fall further (14 July, Viresh Kanabar).
• We are neutral on oil (7 July, Viresh Kanabar).

Equities and Credit

• The S&P 500 is trading near fair value (18 July, John Tierney).
• Keep holding the airline ETF JETS and the regional bank ETF KRE (14 July, John Tierney).
• Investment grade credit is the better value now (10 July, John Tierney).

Momentum Models

• Momentum models flip bearish on FTSE 100 but are less bearish on JGBs (3 July, Bilal Hafeez).

Central Banks Views

• Fed Monitor: Data Remains Ambiguous (19 July, Dominique Dwor-Frecaut).
• UK Inflation Offers Path for BoE Pause (19 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 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

GBP and UK Short-End Yields to Fall in Tandem. You can read the entire piece here.

Richard looks at market pricing for future BoE rate hikes and concludes expectations are currently very aggressive. With economic data, especially housing and employment metrics, starting to look shaky, the BoE may deliver less tightening than markets are pricing.

Market implications

Bullish 2-year Gilts as the yield nears its cycle peak – it traded at a ~15-year high last week above 5.5%, with market expectations of additional BoE rate rises driving UK yields higher. We think outright yield levels in the UK short end are attractive and therefore like scaling into a long 2-yr Gilt position. Because so much is priced in, we like this exposure from a risk/reward perspective.

Bearish GBP as lower UK yields will weigh on the currency – sharply rising UK yields have driven sterling resilience this year. The favourable yield differentials that have led GBP higher will dissipate if UK yields fall as we expect. We therefore stay bearish on sterling.

EM FX

Our latest Asia currencies insights, in partnership with SGX. You can read the entire piece here.

We look deeper at the recent weakness in Chinese data and explore the potential implications for spillovers to for broader Asian FX.

We also refresh our views on Asian FX, turning neutral on CNH, while staying bullish on INR, KRW and THB.

Commodities

Eight Points on the Oil Market for H2 2023. You can read the entire piece here.

We are neutral on crude as industrial demand is slowing. However, OPEC+ production cuts are beginning to tighten the physical market. We can see this via observing Dubai crude, which now trades at a premium to Brent, encouraging global refiners to increase imports from elsewhere (e.g. the US) or draw down inventories.

However, builds in Chinese inventories combined with Russian production cuts mean both the right tail and left tail have been cut off this year leaving a rangebound market.

EU Gas Prices to Fall Further. You can read the entire piece here.

Gas in storage remains at seasonally record highs of 80% and could reach 90% by September. Driving gas prices lower are weak gas consumption, ample LNG supply from the US, and continued supply from Russia.

Therefore, we remain bearish on Dutch TTF futures following the spike in price after the maintenance issues in Norway.

Equities and Credit

Equities

Our broader equities view remains the same. We remain tactically bullish on airlines who benefit from strong air travel demand and regional banks, which should catch up with some of the larger winners so far this year.

Why the S&P 500 Is Trading Near Fair Value. You can read the entire piece here.

Temporary policy rate increases will have little impact on the SPX as long as investors believe they will not hurt the economy or earnings outlook – exactly what we see today.

Investors are hoping for an eventual rate cut below the current 5.25% but have yet to price this in, suggesting they expect elevated inflation and dovish Fed policy to persist.

The market is assuming long-term earnings growth rate that is conservative relative to the average experience of recent decades. That may limit downside risks. And even a minor upward revision will spark another upward leg in the equity rally.

Equities will be on hold until we see whether the upcoming earnings season justifies another upward revision in earnings outlooks and a further rally. 

Will Q2 Earnings Be the Stockpicker’s Delight? You can read the entire piece here.

Early indications from this quarter’s earnings season reveals that:

• People with money are prioritizing destination vacations, preferably by flying there, and momentum is still rising.
• Industrials appear to be on hold – keeping busy but not in robust growth mode.
• Banks have been in the doghouse since the Silicon Valley Bank collapse, but results from three too-big-to-fail banks suggest that the pessimism was overdone.

This will likely be a stockpicker’s earnings season – one where surprises are richly rewarded – but a rising tide to lift all boats never quite arrives. John still likes holding the airline ETF JETS and the regional bank ETF KRE.

Credit

Investment Grade Is the Better Value Now. You can read the entire piece here.

Credit spreads tightened significantly over the past month as equities continued to rally and the VIX index of equity volatility traded at post-pandemic lows. John examines the drivers of high-yield credit spreads and conclude that high yield is trading near fair value, while investment grade is still cheap following the Silicon Valley Bank collapse.

We would scale back more aggressive high-yield positions and overweight investment grade.

Cryptocurrency

Technical Signals

BTC, ETH Hold Resistance on Rise to New Highs. 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 25bps this month, and we expect a second 25bp hike in November. Depsite these two hikes, we don’t they post 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 progressed +0.5% WoW, having stumbled for the first time in seven weeks in last week’s report. Performance over the past three months remains positive, with equities driving the average return higher (+5.9%).

Since our last update, momentum models have flipped slightly bearish on the FTSE-100, become slightly less bullish on JGBs, and now signal EUR/CHF downside as well as NZD/USD upside.

Central Bank Monitors and Previews

Fed Monitor: Data Remains Ambiguous. You can read the entire piece here.

The evolution of the SEP end-2023 inflation and unemployment forecasts shows the Fed is much more focused on the employment than on the inflation leg of its mandate. The Fed has already announced a rate hike at the 26 July FOMC meeting and another hike in 2023.

Dominque believes the hawks and doves mainly disagree on two things:

• Whether the impact of policy tightening so far has already fully transmitted to the economy.
• Whether the banking crisis will tighten credit conditions above and beyond what is typically associated with a Fed tightening cycle.

Dominique still expects a second 2023 hike in November. This is based on continued MoM core inflation prints around 30bps as well as Chair Jerome Powell’s June announcement that the FOMC was slowing rate hikes.

UK Inflation Offers Path for Pause. You can read the entire piece here.

UK CPI came in less than expected today at 7.9% YoY (headline) and 6.9% YoY (core).  Henry believes that the BoE can afford to take its foot of the accelerator from here. He warns that its ability to do so in the near term however may be limited by it having been bitten in the past. However the positive news is that the underlying story for disinflation is now much stronger than it was in January.

His central case is that the BoE will hike by 25 bps at their next meeting but with a hefty tail risk of 50 bps.

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.

Photo Credit: depositphotos.com

(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.)