The 2023 trader playbook - the 5 biggest themes for the year
With next week’s US CPI print and FOMC meeting offering the potential for further market volatility, it feels like these landmines are a fitting end to an incredibly eventful 2022.
We look back at the big themes that have driven cross-asset volatility and the conditions through which we’ve all had to adapt our trading – these include persistently high inflation, a worrying spike in the cost of living and aggressive rate hikes – yet resilient growth. We can also look at more regional-focused issues – a UK gilt tantrum driven by the Truss govt’s unfunded mini-budget, the invasion of Ukraine, the MOF/BoJ intervening to buy JPY and China’s Covid Zero policy.
The culmination of these factors created huge cross-asset volatility, decade-long market regime changes and lasting trending conditions.
Looking into 2023
Markets live in the future, and we look forward to the key themes that could cause volatility throughout 2023 – what’s important is not just to fully note these macro factors, but to understand the trigger points that offer a higher conviction of when to express the themes – taking this further, knowing the markets/instruments and strategies to express the theme is obviously advantageous.
These themes could alter market volatility, range expansion and market structure - so regardless of whether you’re purely automated or discretionary, it can pay to be aware.
While there are many more, these are five potential themes that I am looking at closely for 2023 that if triggered would affect the markets we trade.
1 - High inflation worries morph into growth concerns and a higher probability of a recession
US and global inflation in decline
• Market pricing (i.e. the inflation ‘fixings’ market) of future inflation shows US CPI inflation expected to fall to around 3% by year-end
• US M2 money supply has fallen from 26% to 1.3% - US headline CPI typically lags by 16 months
• Manufacturing PMI delivery-lead times and supply chain data suggest inflation falls hard in 2023
• Unit labour costs falling to 2.1%
Growth – while the consensus from economists is that the US economy narrowly avoids a recession, and EPS expectations have not been revised down to reflect recessionary conditions - the markets see a higher probability of this outcome – I back the markets, where we see:
• All parts of the US yield curve are inverted – US 2s vs 10s are the most inverted since 1981
• The US leading index (measures 10 key economic indicators) has turned negative and falling fast – this has an exemplary record of predicting US recessions
• Comments from the CEOs of Goldman Sachs and BoA warning of tougher times ahead
Themes to trade as we price in a recession
• Consensus EPS expectations are cut by around 20% (from the highs), in turn, lifting PE multiples – traders will assess the trade-off between earnings downgrades vs a lower discount rate
• Steeper yield curves are a trigger – while now is not the time to put on curve steepeners, when short-dated US Treasury bond yields do fall/outperform, we’ll see a steeper yield curve – this could be the trigger for a sharp equity rally, led by financials
• As the US data deteriorates, we will likely see equity market drawdown, US treasury buying and selling of risk FX - it’s when central bankers acknowledge that growth is a greater concern the market will feel validated in its pricing of rate cuts – it’s here we see a risk rebound, broad USD selling and housing + lumber outperforming
• As bond yields fall, we should see solid outperformance from the JPY and CHF and EM assets
• USD initially works selectively vs global FX, but then reverses as conviction of the Fed cutting impacts and traders look ahead to a trough in the global growth slowdown
• Gold and silver rally hard as a hedge vs recession risk
2 - Central bank policy – assessing the potential for rate cuts
• The base case is rate hikes finish in Q1 23, followed by a pause – we then explore the possibility of rate cuts through Q4 23 – the Fed are clearly data dependent, so trends in the US (and global) data through Q2 will be key to markets
• Since 1995 there have been five occasions when the Fed has moved from hikes to rate cuts – the average time it takes to play out is 10.6 months (the longest period being 18 months, the shortest being 5 months)
• G7 balance sheet reduction and liquidity drain - Quantitative Tightening (QT) is a big unknown. Federal Reserve liabilities are expected to fall towards 2.5t, a level where the market is concerned about the scarcity of reserves – traders will start to pay attention to the Fed funds effective – interest earned on excess reserves (IOER) spread for signs of scarcity and concerns that the repo market may be impacted and need support.
• It’s not just the Fed but the ECB and BoE (and others) will be reducing their balance sheets.
3 - China reopening and China's market outperformance
We’ve already seen a plethora of measures announced and Chinese markets have rallied hard – China is the elephant in the room when it comes to the global growth outlook for 2023 – a weak 1H23 seems likely but this will then followed by far stronger growth in 2H23 – after a poor 2022, Chinese assets could really outperform in 2023
• Long HK50 / short NAS100 could be a trade to look at if markets de-risk on a higher probability of a US recession
4 - BoJ policy recalibration – time for the JPY to fly
BoJ chief Kuroda steps down in April but there are already plans for a review of BoJ policy – it feels inevitable that we’ll see a 25bp lift to the BoJ’s YCC target to 50bp – we’ve already seen signs that Japanese banks/pension funds are moving capital back to Japan to get a more compelling return in the JGB market – but could a major policy change cause tremors in global bond markets and promote significant inflows into the JPY?
5 - Politics & Geopolitics – great for volatility, bad for humanity
Obviously one of the most important issues in 2022, not just for markets but humanity - always a hard one for traders to price risk around
• China/Taiwan – unlikely to be a 2023 story (hopefully not at all) but one that will come into the headlines periodically
• US and European/China relations
• Russia/Ukraine – could we hear more constructive signs of a ceasefire?
• Russia vs NATO – Putin has already suggested that the risk of a nuclear war has been rising – obviously if this really escalates it has the premise to dominate markets
• Given the divided Congress, could we see the US debt ceiling become a market concern?
Good luck to all
We look back at the big themes that have driven cross-asset volatility and the conditions through which we’ve all had to adapt our trading – these include persistently high inflation, a worrying spike in the cost of living and aggressive rate hikes – yet resilient growth. We can also look at more regional-focused issues – a UK gilt tantrum driven by the Truss govt’s unfunded mini-budget, the invasion of Ukraine, the MOF/BoJ intervening to buy JPY and China’s Covid Zero policy.
The culmination of these factors created huge cross-asset volatility, decade-long market regime changes and lasting trending conditions.
Looking into 2023
Markets live in the future, and we look forward to the key themes that could cause volatility throughout 2023 – what’s important is not just to fully note these macro factors, but to understand the trigger points that offer a higher conviction of when to express the themes – taking this further, knowing the markets/instruments and strategies to express the theme is obviously advantageous.
These themes could alter market volatility, range expansion and market structure - so regardless of whether you’re purely automated or discretionary, it can pay to be aware.
While there are many more, these are five potential themes that I am looking at closely for 2023 that if triggered would affect the markets we trade.
1 - High inflation worries morph into growth concerns and a higher probability of a recession
US and global inflation in decline
• Market pricing (i.e. the inflation ‘fixings’ market) of future inflation shows US CPI inflation expected to fall to around 3% by year-end
• US M2 money supply has fallen from 26% to 1.3% - US headline CPI typically lags by 16 months
• Manufacturing PMI delivery-lead times and supply chain data suggest inflation falls hard in 2023
• Unit labour costs falling to 2.1%
Growth – while the consensus from economists is that the US economy narrowly avoids a recession, and EPS expectations have not been revised down to reflect recessionary conditions - the markets see a higher probability of this outcome – I back the markets, where we see:
• All parts of the US yield curve are inverted – US 2s vs 10s are the most inverted since 1981
• The US leading index (measures 10 key economic indicators) has turned negative and falling fast – this has an exemplary record of predicting US recessions
• Comments from the CEOs of Goldman Sachs and BoA warning of tougher times ahead
Themes to trade as we price in a recession
• Consensus EPS expectations are cut by around 20% (from the highs), in turn, lifting PE multiples – traders will assess the trade-off between earnings downgrades vs a lower discount rate
• Steeper yield curves are a trigger – while now is not the time to put on curve steepeners, when short-dated US Treasury bond yields do fall/outperform, we’ll see a steeper yield curve – this could be the trigger for a sharp equity rally, led by financials
• As the US data deteriorates, we will likely see equity market drawdown, US treasury buying and selling of risk FX - it’s when central bankers acknowledge that growth is a greater concern the market will feel validated in its pricing of rate cuts – it’s here we see a risk rebound, broad USD selling and housing + lumber outperforming
• As bond yields fall, we should see solid outperformance from the JPY and CHF and EM assets
• USD initially works selectively vs global FX, but then reverses as conviction of the Fed cutting impacts and traders look ahead to a trough in the global growth slowdown
• Gold and silver rally hard as a hedge vs recession risk
2 - Central bank policy – assessing the potential for rate cuts
• The base case is rate hikes finish in Q1 23, followed by a pause – we then explore the possibility of rate cuts through Q4 23 – the Fed are clearly data dependent, so trends in the US (and global) data through Q2 will be key to markets
• Since 1995 there have been five occasions when the Fed has moved from hikes to rate cuts – the average time it takes to play out is 10.6 months (the longest period being 18 months, the shortest being 5 months)
• G7 balance sheet reduction and liquidity drain - Quantitative Tightening (QT) is a big unknown. Federal Reserve liabilities are expected to fall towards 2.5t, a level where the market is concerned about the scarcity of reserves – traders will start to pay attention to the Fed funds effective – interest earned on excess reserves (IOER) spread for signs of scarcity and concerns that the repo market may be impacted and need support.
• It’s not just the Fed but the ECB and BoE (and others) will be reducing their balance sheets.
3 - China reopening and China's market outperformance
We’ve already seen a plethora of measures announced and Chinese markets have rallied hard – China is the elephant in the room when it comes to the global growth outlook for 2023 – a weak 1H23 seems likely but this will then followed by far stronger growth in 2H23 – after a poor 2022, Chinese assets could really outperform in 2023
• Long HK50 / short NAS100 could be a trade to look at if markets de-risk on a higher probability of a US recession
4 - BoJ policy recalibration – time for the JPY to fly
BoJ chief Kuroda steps down in April but there are already plans for a review of BoJ policy – it feels inevitable that we’ll see a 25bp lift to the BoJ’s YCC target to 50bp – we’ve already seen signs that Japanese banks/pension funds are moving capital back to Japan to get a more compelling return in the JGB market – but could a major policy change cause tremors in global bond markets and promote significant inflows into the JPY?
5 - Politics & Geopolitics – great for volatility, bad for humanity
Obviously one of the most important issues in 2022, not just for markets but humanity - always a hard one for traders to price risk around
• China/Taiwan – unlikely to be a 2023 story (hopefully not at all) but one that will come into the headlines periodically
• US and European/China relations
• Russia/Ukraine – could we hear more constructive signs of a ceasefire?
• Russia vs NATO – Putin has already suggested that the risk of a nuclear war has been rising – obviously if this really escalates it has the premise to dominate markets
• Given the divided Congress, could we see the US debt ceiling become a market concern?
Good luck to all
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