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Wednesday, 22 May 2013

Bernanke testimony a watershed ?

The Fed finally acknowledge the possibility of tapering & QE exit. Barring weak data, I think equities run into the sand here, so I've cut all my FTSE long this afternoon, sold some S&Ps to offset my AAPL long (not at a great level) and to keep a semblance of balance, covered half of my short in EDU7 and all my jgb short.

Basic view is that the dollar rally continues (so keeping the short in audusd, the long in usdjpy and the Aug put spreads on gold), and that the bond market needs to probe the upside in US yields. Perhaps 2% becomes the floor in 10y yields, and we set up for a test at 2.35-2.40 (obvious when you look at the chart). I don't see how equities can ride out the uncertainty of an end to QE3 in the meantime, and the direction of most pain now seems to me lower - so net short stocks, for the first time since I can't remember when.

Another trade I like is buying EDU4/EDU5 below 40bps (currently 37). It's a big if, but if the Fed starts tapering in Sept (so they can see Jun and Jul payrolls before starting the communication process at Jackson Hole and Humphrey Hawkins in Aug), then they could reduce in 20bn increments every 3 months and terminate QE3 by next Jun, when it looks as though unemployment will hit their trigger of 6.5%. In that scenario, U4/U5 should be closer to 75bp, so perhaps 50-60bp risk-adjusted. The low in the last 2 years is 23bps. Scale in from 37 down to 28bp.

That timetable looks persuasive to me since Bernanke retires in Jan 14 and has to hand over to Yellen or whoever else it turns out to be before then. The big unknown is what the economy (& the stockmarket) does in the face of higher yields. Cross that bridge when we come to it...

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