ECB Beats the Fed to the Punch on Taper

Hey There Income Hunters,

Yesterday, the European Central Bank announced that it will cut back on its $95 billion dollars worth of monthly Euro bond purchases.

Those bonds had been rising the past couple of weeks in anticipation of the move. 

And are for the joke of the day? 

Raphael Bostic, head of the Atlanta Fed, came out and said the Fed can be patient because the dismal economic data that has been emerging gives our central bank room to play.

So, the ECB is tapering while the Fed is dragging its heels …

That is a recipe for a lower dollar.

And, sure enough, the dollar failed at another higher breakout attempt on Thursday.

Now we head into inflation data …

The markets are not ready for what’s coming

Are you? 

Here Is What You Need to Kno

The dollar dropped yesterday on the ECB announcement.

Looking ahead, it faces headwinds, including:

      • Global  central banks, including the ECB, Norway, New Zealand and Canada are pulling back on stimulus ahead of the Fed. That is dollar bearish
      • After taking a lead on vaccine distribution, the US is fading fast, meaning other economies can outperform us going forward. That is dollar bearish 
      • Plus, even after $13 trillion in total monetary and fiscal stimulus, US economic data is softening. That, as you might have guessed, is dollar bearish 

A Weak Dollar Destroys the “Transitory” Narrative 

Low bond yields, high stocks and a selloff in commodities indicates the consensus narrative is a Fed that is in control and inflation that will come back down …

But is not supported by the inflation forecasts:

These forecasts are from Bloomberg and Hedgeye Research, and their CPI numbers have been spot on …

 

So, 5% through the end of the year and 4.5% in Q1? … 

 

I am happy to bet against the consensus narrative and wager on higher bond yields into the end of the year based on numbers even close to those.

 

Plus, not only am I going against the herd (which is usually wrong), but I have a number of historical indicators on my side, such as:

 

Higher European interest rates that will remove foreign buying that has supported US bonds in the past few months …

 

 

An October that historically means much higher net bond issuance, which will put a lot of pressure on bond yields …

 

 

A seasonal pattern in October and November of the greatest rise in interest rates for the year …

 

 

The Takeaway: The Trade to fade consensus is to put on a bearish bond option strategy into October.

 

iShares 20+ Maturity Treasury Bond ETF (Ticker: TLT)

 

Let’s first look at the technical setup in TLT … 

 

 

Remember, this is a contrarian trade. That means going against a technical setup that is currently positive.

 

My plan is to fade the rally in TLT if it reaches the 151 area … I like buying the 146.5/144 Oct. 29 put spread; however, the specifics may change, depending on the pricing of the options once we get there.

 

Below is the current risk analysis. The return just using a 145 target price is 180%. That is an excellent risk/reward to the end of October:

 

 

Bring It Home 

 

I have traded bonds most of my career and I also know how powerful inflation can be. You want to have a position on when inflation has yet to be priced in.

 

Once psychology shifts, it will be hard to chase flows out of bonds into inflation hedges like commodities …

 

I’ll keep monitoring for impactful events, such as passage of the debt ceiling and investor selling of bonds. Don’t miss this week’s letter on other bond ETFs.

 

Have a great weekend and as always …

 

Live and Trade With passion My Friends,

 

Griff

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