Given the strong bond auctions, considerable short open interest in EURUSD (that can lead to gappy short squeezes - i.e. shorts forced to buy as stops are hit) and US Treasury selling from foreigners such as China and Russia, we are forced to consider that the markets are strong and that the LTRO, or perhaps the expectation of a massive LTRO in Feb, is shoring up risk assets.
We've consistently held the view that Q1-2 this year is likely to be strong as kick-the-can ECB measures take their toll. And at a rumoured EUR10trn, they are certainly a strong kick. I am happy to hold my hands up and admit I expected a harder sell-off given the downgrades and awful fundamental data from the EZ (Spain). One of the key factors in the decision outlined below is exactly this - a market that fails to react to bad news is a bull market and must not be faded. The rest of this post is the nitty gritty, the key message is that we are now flat risk assets.
Our outright short on the S&P from 1300 has been hedged with by buying EUR/USD and buying XAU/USD (i.e. Gold in Dollar terms) to take advantage of the "decoupling" play, covered in this blog (and elsewhere) in detail. See chart below for an intuitive visual:
(S&P in Blue, Gold in Orange and EUR/USD in Green - observe the divergence)
We bought Gold at a beta of 0.5 and EUR/USD at a beta of 0.6 split 50:50 - i.e. the hedge is a half and half in delta terms.
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