Recession cancelled. For now.
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What a change in scenery, huh?
Two weeks ago, markets were in panic mode, as US unemployment peaked slightly higher, and job creation was lower than expected. The Yen carry trade unraveled that same week, and we got some weaker tech earnings, and soon enough, all hell broke lose. Markets started to heavily price in a recession, with 5 cuts before the end of the year (in which we still haven’t had a single cut).
And yet, two weeks later, a completely different picture. Markets back close to all-time-highs, vol pinned down, Mag 7 in the driving seat once again, rate cut expectations back to normal, soft landing narrative reigns supreme. As if the whole recession scare didn’t even happen.
Why? We got two decent jobless claims reports (this Thu and last Thu), a lower than expected CPI and PPI inflation (not too low to signal slowing down of the economy, but just enough), and much better than expected retail sales. The economy is therefore NOT in a recession.
Nothing paints a better picture of “false alarm” than what happened with the VIX:
As I mentioned on Tuesday, the main play of the past two weeks was short vol. VIX went from a high 60 on Monday, Aug 5th to close at less than 15 this Friday. After going up over 100% on that day of panic driven by the Yen trade and recession pricing, all it took were a few good data prints to have it back to where it was before the mid-July sell-off.
And just like that - recession cancelled!
For now.
Today, let’s play devil’s advocate and talk about a potential deleveraging that we might still be in line for. In other words, we’re not out of the woods just yet.
This also does not mean go full short. It simply means to reenter the hedges while they are cheap. When? Let’s talk about it.
Finally, Jackson Hole is coming up next Friday. This is the Fed’s summer retreat and in terms of market reaction you can treat it like a regular FOMC meeting. They don’t make policy decisions there, but they do communicate on what they plan on doing. And it tends to moves markets. In 2022 it started the final leg of the 2022 bear market sell-off, and it was brutal. This time, I expect something different.
Deleveraging
First of all, what does deleveraging mean? It implies systemic selling of risky assets (like equities or crypto), while shifting into low risk assets (like bonds or gold), and can be triggered by a whole number of things - like the recession scare from two weeks ago.
The way it typically happens is that leveraged investors (those buying risky assets on margin - there’s a LOT of such investors) become forced to sell assets as negative price action triggers their automated stops, or even worse - are forced to fund their own margin calls. Margin calls happen when you over-leveraged and lost on your bets, and need to pay back the loan you took (as that’s what leverage basically is, a loan from your broker). Large deleveraging episodes tend to happen after significant market triggers. Once again, just like the one we witnessed two weeks ago.