Happy Friday!

Every week, we dive deep into macro trends, analyze asset movements, and uncover the best value plays in the world of macro. These insights are shared with hedge funds and institutional clients, and each Friday, we’re bringing them directly to you.

While the macro landscape can be complex, we believe it doesn’t have to be intimidating. In this recurring series, we break down the key takeaways from the week ending, explain what we’ve told hedge funds, and outline how we’re trading these ideas—all in a straightforward and actionable way.

What We Told Hedge Funds This Week

#1 – The Fed has recognized the need for more market liquidity and will act as early as December → Lower bond yields and a weaker USD

The market has rolled back on rate cuts from the Fed over the past couple of weeks, but while the job of the Fed has been made a lot more tricky with regards to setting the appropriate Fed Funds rate, there are risk-favoring trends looming underneath the surface.

The amount of USDs that the Fed makes available for the commercial banking system, in macro terms labeled “Central Bank liquidity,” is a great way of understanding how accommodative the current policy mix is towards higher equity prices, bond yields, and a more risk-asset-friendly environment.

Over the past couple of weeks, we have seen this measure of liquidity tighten substantially in our models, together with a firm weakening of both inflation and growth. This places us in a “Down, down, down” environment going into next week’s NFP, which historically has been very good for bonds but more punishing towards equities, commodities, and the USD.

The Fed highlighted the tightening of liquidity this week in their Meeting Minutes (which summarizes their detailed discussions at the previous meeting earlier this month) and is planning to improve the liquidity picture as early as December by cutting the overnight reverse repo facility rate by 5-10 bps. The overnight reverse repo facility is a facility within the Fed where institutions can park their money overnight and yield the so-called repo rate. With the current repo rate being higher than short-term US bills, institutions are currently incentivized to keep their money within the Fed instead of making it available for markets.

Hence, by cutting the repo rate, you provide an incentive for institutions to pull their money out of the repo facility and place it in bills instead, increasing liquidity. Should the 5-10 bps cut come through, we are talking about a net addition of $100 billion in liquidity (there are currently $170 billion parked at the facility). Given the signs we are seeing in the US growth picture, it’s not unlikely that we are getting a 25 bps cut from the Fed in December on top. This would be a HUGE tailwind for bonds and a weaker USD, but the downturn in growth poses some headwinds for equities.

What is the trade?

Long bonds, short USD and a bit more caution when it comes to equities. We still like long-exposure to risk-asset and especially interest rate sensitive equities like Russell while we are more cautious with Dow / S&P 500.

Chart 1.a: Everything is weakening in the US at the moment