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Trading in financial markets involves significant risk of loss which can exceed deposits and may not be suitable for all investors.
Before trading, please ensure that you fully understand the risks involved
Trading in financial markets involves significant risk of loss which can exceed deposits and may not be suitable for all investors. Before trading, please ensure that you fully understand the risks involved

Wednesday, November 23, 2022

Inflation down for the fourth consecutive month Long: US 30 Yr. Treasury Bonds | Short: US SPX 500

By Century Financial in Investment Insights

Inflation down for the fourth consecutive month...
Inflation down for the fourthconsecutive monthLong: US 30 Yr. Treasury Bonds | Short: US SPX 500

*Trading in financial market carries risk and can result in loss of capital.
*This performance is only observed with historical backtests and not traded by the company.


The product and investment ideas do not consider the risk profile and financial position of the recipient and may not be suitable for everyone. Trading in financial markets and use of margin involves a significant risk of loss, which can exceed deposits. Please read the complete disclaimer carefully.


Past performance is not indicative of and does not guarantee future results. Please read the complete disclaimer carefully.
Trading pairs is not a risk-free strategy. The difficulty comes when prices of the two commodities move contrary to the positions taken resulting in losses. Thus, it is important to adhere to strict risk management rules when dealing with such adverse situations.
A Pair trade is always taken together and closed together. If one leg is closed and the other is left open, it's no longer a pair strategy and could result in huge losses

US macroeconomics

Inflation in the US retreated for the fourth consecutive month: It's hard to deny that the Fed's medicine is working -- although with lagged effects. The US CPI data came in at 7.7%, below market expectations of 7.9% and way below the September numbers of 8.2%.

Markets are now expecting the Federal Reserve to slow down the pace of rate hikes gradually and potentially halt hikes sooner than the market currently anticipates. According to the CME Fed watch tool, the probability of a 75 bps hike at Dec meeting dropped from 70% last month to 19%.

In fact, according to the CME Fed watch tool, 55% of market participants are now expecting the Fed Funds rate to peak at 5%. Until a week ago, 33% expected the rates to peak near 5.5%, while 40% expected it at 5.25%. So while the jury is still out on whether the inflation has topped out and whether the Fed will pivot, retail investors are pouring into debt markets, hoping to snap up the juicer bond yields not seen in over a decade.

Bonds look alluring!

The Fed's current policy has stopped the bull market in bond prices that had been running since 1982. As a result, investors have been dumping bonds because they fear higher interest rates will cause bond prices to fall. Unfortunately, that fear has become widespread enough that bonds have been beaten down alongside stocks.

The 60/40 equity/bond portfolio, which was often considered a safety hedge against the risk market decline, is on track to show one of its worst performances. A portfolio with 60% of its money invested in US stocks and 40% invested in the 10-year US Treasury note has lost 15% this year, its worst year since 1940.

However, this has created a long-awaited opportunity to buy relatively low-risk assets at bargain prices even as they pay higher yields than they have been in decades.

However, the opportunity could be short-lived.

Monetary policy acts with a lag. First, there's a tightening in financial conditions. That's followed by a slowdown in economic activity. Finally, inflation starts declining. This could mean that the Federal Reserve could potentially halt hikes sooner and opt for rate cuts in mid-2023.

With two-year US Treasury yields already trading near 4.5% and the rates expected to peak near 5%, that could mean that the opportunity to add low-risk bond ladders to your income strategy may not be there if you wait too long. This is because yields generally top ahead of a fed pivot.

What does this mean for stock markets?

The most obvious guess would be markets would rally. However, history doesn't reveal the same. In the previous 50 years, the stock market has risen before the Federal Reserve changes course and began lowering interest rates. Therefore, following the Fed's pivot, the market has generally already peaked and is about to fall considerably lower. This is due to the fact that bets are placed by traders and market participants months before a fundamental event (like Fed pivot) occurs. Therefore, the market has already moved by the time the Fed pivot happens, and the surge is over (or nearing completion).

Technical picture

The technical charts also point out to weaknesses in the indices. SPX 500 has retreated from the critical 200-day MA on the charts, coinciding with the downward-sloping trendline resistance and the psychological level of $4000. Even as far as the Ultra/SPX 500 ratio chart is concerned, it can be seen in the image below the ratio has retreated sharply from its highs in the last two years and is showing signs of bottoming out.

HI: 0.3306

Data Source: Bloomberg
Data & Prices as of : 17/11/2022

Trade Rationale

It's probably time to stock up on bonds and let the equity market run its course now that the Fed's interest rate plateau has arrived. The bond trend appears to be far more durable/ long-lasting than the equity trend. To take advantage of the scenario, the rationale narrates going long T-bond Ultra and shorting US SPX 500.

Risks and Assumptions for Back-tested trading strategies
The risks and assumptions listed here are not intended to be an exhaustive summary of all the risks and assumptions involved.
The strategy might suffer from look-ahead bias which occurs due to the use of information or data in a study or simulation that would not have been known or available during the period being analyzed. This can lead to inaccurate results in the study or simulation.
Future price movements may not be exactly the same as the historical price movements and this could lead to variation in performance.
Testing can sometimes lead to over-optimization. This is a condition where performance results are tuned so high to the past they are no longer as accurate in the future.
The model assumes no slippages in trading. Slippage refers to the difference between the expected price of a trade and the price at which the trade is actually executed.
Drawdowns in actual trading can be higher than the tested system and losses could be significant in the event of leverage.
Unforeseen events can lead to variation in performance from the tested trading strategy.
The tested result has been computed with price feeds available from Bloomberg.
The testing environment has not considered transaction or any other costs.
Trading indicators used for the purpose of testing has been provided by Bloomberg.
The strategy might suffer from data mining fallacy, selection bias and backfill bias.

Data Source: Bloomberg
Data: 18/11/2022

Arun Leslie John
Chief Market Analyst

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