Report summary

I. Investment Summary

1. At the end of the third quarter, speculative net short positions in the US dollar and US bonds reached their highest level in 20 years, which suggests that the upward pricing of inflation expectations is already sufficient.

2. Under the weak endogenous growth of the economy and the search for coordination between US fiscal and monetary policies, shorting the dollar and US debt transactions is a contradiction.

3. Shorting the US dollar and US debt is a highly risk-prone transaction. Ignoring the differences in fiscal stimulus between China and the US means that the underlying logic is flawed.

4. Stimulating the economy is what financial markets expect, but epidemic prevention may be the US government's top priority. Record short positions in US dollars and US debt are the result of linear logical pricing.

II. Risk Reminder

Extensive vaccination

Report text

Risk sentiment in overseas markets became more unstable in October, and it seems that the risk on/risk off mode has returned to the risk on/risk off mode. As the US presidential election approaches, investors' attitudes about short-term uncertainty fluctuate, and their behavior pattern is like Robinhood Investors (Robinhood Investors) who prefer to gamble with short-term options. Objectively speaking, this year's US presidential election is full of uncertainties. These uncertainties are transmitted to US stocks, US debt, and the US dollar by influencing the direction of inflation expectations. While it is important to analyze the transmission path of these effects and their results, it is more important to determine whether they can change trends in various asset classes. Whether based on the Federal Reserve's new inflation targeting strategy or the likely outcome of the future US presidential election, the mainstream perception among investors is that pricing is only beginning to rise in inflation expectations. However, the pricing in the financial market shows that the price of rising inflation expectations is sufficient, and can even be said to have reached an extreme level — net short positions in the US dollar and 10-year US bonds have reached record highs at the same time. The scenario of rising inflation expectations after the 2016 presidential election may be difficult to replicate.

1. The US dollar and net short positions in US debt reached a new high at the same time

According to data from the US Commodity Futures Trading Commission (CFTC), as of September 29, the US dollar speculative net short position reached 194,000, the highest since April 2011; two weeks ago, the US dollar speculative net short position hit 225,000, the highest in 20 years. At the same time, speculative net short positions on 10-year US Treasury futures broke through the 200,000 mark, setting a new historical peak of 180,000 shares in 2006, the highest in 20 years. In the last week of September alone, short positions increased by 50,000 shares. If net short positions in leveraged funds are added, the total net short amount of long-term US bonds as a whole will reach 620,000 shares.

If you think of shorting the US dollar and shorting US bonds as two separate transactions, then they all have their own core logic: the Federal Reserve's monetary easing lowers the actual US interest rate, putting pressure on the dollar downward; the widening US fiscal deficit increases the US debt, the price of 10-year US bond futures falls, and interest rates on long-term US bonds rise; and record net short positions in US dollar and US bond futures are not unusual. Once these two deals are linked, a fundamental contradiction will be discovered: assuming that the Fed increases easing and puts more downward pressure on the dollar, then the market doesn't need to worry about the US debt oversupply caused by the expansion of the US fiscal deficit. If shorting US debt is just gambling with the Federal Reserve; assuming that the US expansion of the fiscal deficit causes interest rates on long-term US bonds to rise, the implicit premise is that the Fed will not further increase easing. Against the backdrop of the Federal Reserve's negative interest rate expectations fading, continuing to short the dollar has lost its core logic.

Therefore, in a period where endogenous economic growth is weak and US fiscal and monetary policies seek coordination, shorting the US dollar and betting on rising interest rates on 10-year US bonds is not a wise trading decision. One of them must have made a mistake in their transaction, and they will also falsify another transaction. If shorting the US dollar is wrong, then the inflation expectations supported by rising commodities are wrong. The current high output gap in the US does not support the continuous rise in interest rates on 10-year US bonds; if shorting US bonds is wrong, then the interest rate curve on US bonds will flatten, and falling inflation expectations will push up cross-asset volatility, and the dollar will be supported by liquidity demand.

2. Reviewing the history of shorting US dollar and US bond futures

Looking at trading positions, it is rare for net shorts in US dollar and US bond futures to reach new highs. The last time this happened was in April 2006, when the US real estate market cooled down and residential fixed asset investment slowed down. At that time, speculative net short positions in US dollars reached 188,000, and 10-year US bond futures speculative net short positions reached 154,000, both of which hit the highest level since 2000. Speculative short positions in US dollar and US bond futures were withdrawn from May to October of that year. The US dollar index rebounded from 83.9 to 87.1 during the same period, and interest rates on 10-year US bonds fell from 5.2% to 4.8%; the corresponding MSCI emerging market stock index fell 8.3%. Furthermore, large-scale simultaneous shorting of US dollar and US bond futures also occurred in the second half of 2009. The outbreak of the Greek debt crisis prompted shortfall in dollar and US bond futures. From December 2009 to June 2010, the US dollar index rebounded from 74.4 to 88.4, and interest rates on 10-year US bonds fell from 3.8% to 3.1%.

Judging from the relative trend, the most typical period for the simultaneous decline of the US dollar and 10-year US Treasury futures was 2003-2007. The US dollar index declined from 92.5 to 82.6, and interest rates on 10-year US Treasury bonds rose from 3.1% to 5.3%. This period had two notable characteristics: the bubble in the real estate market boosted household consumption in the US, and the rapid growth of China's export-oriented economy drove the entire commodity supercycle. What was behind it was positive feedback from endogenous demand and nominal prices in the global economy, and dollar arbitrage trading was popular. Also, in 2009 and 2011, there was a brief period of simultaneous decline in dollar and US bond futures. Driven mainly by China's fiscal stimulus and disruptions in crude oil supply, the US household sector's deleveraging has dragged down global aggregate demand, and this positive feedback has never recovered. Since then, dollar arbitrage trading declined, commodities entered a bear market in 2012-2016, and US dollar and US bond futures rose simultaneously.

Based on the above analysis, record short positions in US dollars and 10-year US Treasury futures are a type of bet with a very high risk appetite. At least, I think the 2008 economic stimulus results will be repeated. In previous reports, we have explained the huge difference between US fiscal stimulus in 2020 and China's fiscal stimulus in 2009: the idea of fiscal stimulus between China and the US is fundamentally different. The former adheres to supply management, while the latter adheres to demand management. Without changing the focus of fiscal strength, the US fiscal stimulus only stabilizes aggregate demand and has no fundamental impact on the outlook for inflation. This means that the underlying logic of shorting the dollar and US bond futures is very flawed.

3. Linear pricing of presidential election results

The 2020 US presidential election has been labeled by financial markets, particularly in pricing inflation expectations. After the first presidential debate ended on September 29, the rising probability of Biden winning the election caused the market to bet more on the decline in US dollar and US bond futures. Investors believe that Biden will launch a large-scale infrastructure stimulus plan in a short time after being elected, and will finance this plan by widening the fiscal deficit. Assuming Biden can actually be elected, the first and most urgent task is probably not to implement fiscal stimulus, but to vigorously prevent and control health incidents. The Trump administration did not strictly implement prevention and control measures, and will eventually restart after Biden comes to power. Economic recovery and inflation expectations will be hit twice, leaving the market caught off guard. Simply put, the “heavy economic stimulus, light epidemic prevention” policy logic adopted by Trump in order to run for re-election was also applied to Biden. This gave rise to a linear logic leading to re-inflation, leading to record levels of short positions in the US dollar and US bonds. Stimulating the economy is a core external constraint on financial markets, but it is not always the core external constraint of the US government, and as a result, the upward path of inflation expectations is not straight.

Whether by coincidence or as a matchmaking strategy, record short positions in the US dollar and US bonds mean that “reinflation” is increasingly becoming a broad and linear flock trade (flock trade). In a context where endogenous economic growth is weak and health events have not been effectively controlled, betting on fiscal stimulus can cause the dollar to depreciate and interest rates on US bonds to rise. The risk-to-reward ratio is not very attractive.