Having warned last week that the market is close to a violent unwind of the Trumpflation momentum trade, today RCB’s head of cross-asset strat, Charlie McElliggott, takes a victory lap following Trump’s overnight comments that the dollar is “too strong”, while slamming the Border-Adjustment Tax – a key catalyst for a dollar stronger as much as 15% in the future – and warned that the start of the “pain trade” has arrived.
The full note from RBC’s Charlie McElligott
TRUMP DUMPS BORDER-ADJUSTED TAX, “LONG DOLLAR” TRADES UNDER PRESSURE
Commence “pain trade.”
Let us begin today by taking it back to last Wednesday’s now-prophetic “RBC Big Picture” note:
“Fundamentally with the USD bull-case, this is a large part of why there is SO much focus on key items like the border-adjusted tax element of the Trump policy push. A large part of the Dollar’s strength (beyond ‘just’ the data) post- the election has been based upon this, where if the corporate tax rate were cut to say 20%, the Dollar would by economic theory have to then appreciate 20% (and of course too, an additional ‘tax factor’ driving the USD bull-thesis is that a meaningful chunk of $2.5T of profits held overseas by US corporates would be repatriated following a ‘business friendly’ incentive package / one-time cut to the repatriation tax to say 8-10%).
There is a view though within some verticals of the business community is that the border-adjusted system represents a very significant risk (consumer retail most notably) to their businesses / the broad economy as imports become more expensive and will create trade distortions (while the CBO itself says that the border-adjusted system would NOT reduce the trade deficit, which is a driver of its political popularity). There is so much discourse on this issue currently on this topic within the C-suite in fact some in policy circles are now saying they believe it appears increasingly likely that the ‘full’ border tax adjustment (currently in the Houses’ version of the bill) ends up being watered down to a sort of “relocation penalty” (which would likely then appear in the Senate-version of the bill).
Again, this is all a hypothetical, but if some of this ‘sense’ around said USD ‘bull driver’ turning potentially bearish was to ‘leak’ into the market, it would take some of the air out of the “long USD” trade–and that is where things could go off the rails. If the Dollar broke lower, its likely too that bonds and duration would rally; defensives (staples, utes, reits) and growth (tech / biotech / discret) squeeze against crowded value unwinding (fins, energy, indus); yen and euro would squeeze mightily; gold squeezes while copper pukes in a favorite commodities ‘pair’ unwind; HY could reverse weaker vs IG (currently everybody long CCC vs BB on the high beta trade)…this would be the theoretical path to our next pain-trade or even VaR shock.”
…AND SCENE.
Overnight, we see that Donald Trump has indeed talked-down the BAT, criticizing it in the WSJ as “too complicated” and stating that the US Dollar is “too strong.” With this confirmation that the Trump administration is indeed backing-away from the BAT, we see USD smashed-lower against all G10 and all 24 EM currencies, with the Bloomberg USD Index down 1.1%, a 2.5 standard deviation move (relative to the past year’s historical returns).
As such, expect there to be significant buy-side performance pain today with regards to the below key “long USD”-linked “US reflation” trades (as quoted above) seeing real capitulatory / unwind flows:
- UST complex ripping / curve bull-flattening (2s10s -4.3bps)
- Massive squeezes in Yen, Euro and EMFX as stop-losses are triggered.
- CNH coming unglued -1.0% and through the 6.80 level
- Russell-minis and Spooz spanked to session lows currently
- EU heavy cyclicals like metals & mining -1.7%
- EU Xover CDX seeing its largest widening day of the year
- Gold squeezing higher +1.3% while Copper is being crushed -2.1%
- VIX ripping / squeezing +12.9%
Per the tea-leaves from Kristen Arey’s CFTC positioning update Friday night, the focus of the pain will come from leveraged funds and their FIC shorts, as the already record shorts in FV and ED grew even-further to NEW record shorts. This is going to leave a mark, and recall the point I’ve been making on said short—all of the positive PNL from this trade was last year, meaning that chief risk officers are going to be that much quicker to ‘tap out’ on these significantly underwater shorts just 2 weeks into the new year. Also worth noting that the 14k new VIX shorts added last week will likely be stopped-out.
Upon the US equities session, expect more of the same—‘value factor’ / cyclicals (ex energy which benefits from crude / Dollar relief) are likely to be underperforming defensives / anti-beta / bond proxies, as “long duration” will see major outperformance as per the UST-move. Expect ‘growth factor’ to see some ‘haven’ status gains too (tech, cons discret) as the January factor mean-reversion should run-further.
I will try to update late day if possible on anecdotal observations on “where to from here” with the USD-unwind.
via http://ift.tt/2jjOQp4 Tyler Durden