How To Trade Macro In A War

[MUSIC PLAYING] The macro trading floor. With me, Alfonso Piccatello, founder of the Macro Compass, and former head of investments at the large European bank. And I am Brent Donnelly, president of Spectre Markets. I've been a portfolio manager, day trader, and market maker at the biggest commercial and investment banks in the United States. I'm also the author of Alpha Trader and the Art of Currency Trading. If you want to know what's going on in markets and where they're going, you found the right podcast. Hey, everybody. Welcome back to the macro trading floor with Alfonso and my good friend Brent. We're so happy to be back. There's a million things going on. Game theory, armchair, geopolitical analysts, including myself, because that's the only part you can play these days if you want to be a macro portfolio manager. Wow. I'm going to have to ask Brent first, as always, is the wisest guy between the two. What are we in the conference, Brent? What do you see in your franchise in FX flows? Tell us a bit what you think. Sure. Yeah, it's funny. Someone sent me something about AI yesterday. And I was like, oh, yeah, shit. I forgot about AI. There's so much going on. I mean, I think the really weird and interesting thing right now is this unstable equilibrium where basically, oil is either going to be $40 higher or $40 lower in a month. And it's not going to be here. I mean, that would be my call, just in which is nothing revolutionary. So then the question is, how do you trade that? What does it mean? Why are stocks not going down? I think I have a few explanations for that, which could be similar to the lead up into COVID or even in 2022 after Russia. The most recent invasion of Ukraine in 2022. So I think there's pretty good arguments for why we haven't really done anything yet because we're in this unstable equilibrium where people are referencing the taco idea, even though I'm not sure it applies here. And so everyone, including the central banks, is kind of in wait and see mode. But you can only stay in wait and see mode for so long because at some point, gas stations in Australia start running out of gas and people start running out of oil in different areas. And in the Middle East, some of the contracts are trading at $150 in a month and stuff like that. So this holding pattern can only last so long, but we're still in the holding pattern for now. Oh, and you said, what about clients? So we went into this thing with the market basically max bearish dollar, bullish gold, bullish silver, right? I mean, it seems like a long time ago, it's hard to remember, but that was the initial state of the market when the war happened and when the war started. And so obviously we saw big rinsed out of all that stuff. But now I would say the market has some hedges, long dollars, which is mostly short euro because people think that's a good hedge because of a term, terms of trade shock. But then on the other side of the ledger, there are people that are just like wanna be in EM and every time dollar Brazil bounces, they just buy more Brazil, every time dollar max bounces, they buy more Mexico. So I'm always wary of this idea that EM is a safe haven just because like there's no free lunch. You don't get high carry and safe haven in an asset usually at the same time. However, that said, Brazil specifically trades very well and things aren't really blowing up. I mean stocks aren't blowing up, EM's not blowing up although it is selling off in pockets. So I would say this holding pattern thing is kind of the way that a lot of people are like, okay, I have no edge on predicting when they're gonna stop the war. And I guess the thing too is people are starting to more come to the view that even if Trump says, okay, mission accomplished, we blew up all the stuff that we wanted to blow up. The IGRC doesn't necessarily have to comply with what Trump's saying. So they could just continue to effectively keep the straight of formulas close regardless of what Trump says. So overall, I would say for me, I think post option expiry, quadruple witching is often a time when things release whatever way they wanted to release. And to me, the most likely would be to the downside. And it's a little bit similar to 2018 and 2022, both midterm years, where the Fed was more hawkish than expected. And you had pretty big sell-offs in March, April of those years as well when there were no safe havens because there was kind of like this tightening by a soap on's gold and stocks all went down in 2018 and 2022. And here we are, 2026. Looks like a similar setup, but of course, the news can change at any given moment. We're taping this at 6.55 AM on Thursday, March 19th. And I just said taping, which is quite anachronistic, I guess taping is something that someone would say if they were 50 years old. Yes, there you go. Brand gave away his age. Gold is very important. We talked about it a thing two weeks ago in the last episode, Brent, it's the only asset that long, only investor held in the portfolio, which had actually held this ground and is now cracking down aggressively too, which is a sign of leveraging across real money as well. Basically, if you get the margin called on the rest of the book, you got a sell and hard has set that you own as a long position in your portfolio. People are selling precious metals. Things are getting a little bit nastier when it comes to my community of macro-hedge fund PMs. I talked to one of the research side of things. Yeah, this was a roller coaster, Brent. There were a lot of people that were trying to fade the initial reaction. The ECB is never gonna hike, why are they hike priced in, et cetera, et cetera. They try, so some people entered the episode by being very leveraged selling puts, basically, on bonds, because the idea before the world at the central bank would hike in Europe or in the UK was ridiculous. So people were selling puts and then they blew up there. People who survived, they tried to pick up the pieces of the people who blew up and they tried to fade the initial reaction. Then they were rolled over as well aggressively. And I think I'm seeing the first signs of macro PMs telling me, oh, you know, one year forward, HICP's WOP, the inflation's WOP in Europe is trading at 4%. I repeat, 4%. Inflation's WOP traders are pricing the year on year, December CPI in Europe to be at 4%. And when you think about that, yes, there are nuances. Yes, there will be demand destruction in Europe with this price of natural gas and oil or sustain, but 4% freaking percent CPI, unemployment rate in Italy, I add is the lowest in 30 years. The output gap is closed in Europe. Germany is doing a large fiscal stimulus as we speak. Consumers can handle a few HICs, guys, and the central banks are gonna think that way. They are gonna think I can hike twice or three times if inflation is 4% freaking percent. Real rates are gonna be still deeply negative as I hike. I need to somehow defend my currency and make sure that the bond market doesn't blow up in the long end. And, you know, again, unemployment rate in Italy is 5.6%. That's the lowest in 30 years. And I think for the first time today, I'm hearing portfolio managers leaning a bit on the cautious side, okay, maybe we should pay inflation's WOPs, maybe we shouldn't fade the dislikes that are priced in. So things are changing pretty quickly. - Yeah, and I think that makes sense too because there's a time condition here, right? Just every single day that the war goes on. I mean, when this thing started, it was presented as like limited strikes. Some people thought it was gonna be like June 2025. And, you know, now it's just like another full on Middle East cluster, whatever you wanna call it. So, you know, that could drag on for any amount of time. And it could also end at any time. And so I think every day that this goes on, it creates more pressure on global supply chains on oil prices and so on. And so it makes sense for the view to evolve and become more and more bearish each day that this goes on because, you know, that it's, it moves from something that's purely temporary to something that's a little bit more lasting to something that could end up being kind of structural, depending on how, on the shutdowns and how long it takes for everything to restart after the war ends. And whether the war actually ends too, right? You know, Trump could say whatever he wants. And then IGRC just keeps on bombing stuff. And, you know, it turns into one of those three year guerilla war sort of things where just stuff keeps on happening and it's never really over. It's not a clean on-off switch situation no longer it goes. So it does make sense that as it goes on, that people are going to get more and more bearish. I think your commentary about the ECB and 4% inflation all that raises the question, which is one of the stupidest and most boring debates on Twitter right now, which is, is an oil shock inflationary or deflationary. And like I think the kind of obvious new on-stands er is that it's both like, you know, in the short run prices go up. And as it persists, it becomes more of a supply and growth shock and it becomes deflationary, especially because the base effect from the industry. initial inflation goes away. So like mathematically, it tends to be inflationary at first and then disinflationary later. But then the question now for the central banks is do you react to it or not? And the interesting thing with the ECB is they've already got two examples of this, right? 2008, they hiked into oil shock, 2011, they hiked into $120 oil. And both times ended up looking bad, you know, in hindsight, but not even really in hindsight. I mean, when tree shade hiked in 2008, you know, I actually remember when it happened because I was out walking my newly born son and someone sent me like or called me on my blackberry and said the ECB just hiked. And I was short euros. And I think euro was like 156 or something. I can't really remember, but it was way up there. And it went up like 200 points that day. Obviously I got stopped out, but the euro collapsed after that. And the same thing in 2011. And so it's going to be an interesting phase here where you wonder like so RBA hiked and initially the response was the currency goes up. But then you say, well, are they hiking into a supply shock and a growth shock and, you know, an inflation that they can't control anyways. And so potentially just making the shock even worse. And then you sell Aussie like it takes a little bit of mental gymnastics to get to that point. But people get to that point very quickly with the euro. And I can't see why that doesn't potentially become the case with Aussie too, where people go, okay, well, this, this is probably a policy mistake. And you know, then Aussie's 250 points lower. So I guess the interesting thing is, first of all, you have like economists and Twitter, finance people, whatever can't even agree whether an oil shock is inflationary or disinflationary because it depends a lot on starting conditions and, and then, you know, how long the shock persists. So it's kind of a stupid debate in my opinion because it's just so regime specific. But then it's a necessary debate if you're a policy maker, they have to decide, okay, are we going to hike into this? Or are we going to wait? And like to me, the FOMC's approach of wait and see just seems a lot smarter than, than hiking into it. But we'll see. And we have the ECB meeting today. So we'll see what they say. One of the key things here, guys, and I have fallen victim of this bias many, many times in my past, I'm improving. So, you know, a bit less today is that to think and trade as if the central banks should think as you think. No, no, no, no, no, no, no, no, your paid to trade and to anticipate what the policy makers will do. Not what you think they will do. What you think they will do doesn't matter. So let's make the example of Brent. He has made a very compelling argument by which many central banks out there should look through this. We understand Brent's bias is that and fair enough, I can get the argument for that. If Brent puts a trade because of that and the ECB hikes in his face, he's going to lose money, doesn't matter what he thinks. And I'm just saying, Brent, it could be any of us doing this, you know, having this bias. I've added many, many times. So our job right now, it's to think what will the governing council at the ECB think? What will the central bank of Switzerland think? What will Sweden think? What will the Fed think? Etc. That's really our job without having an expanded bias. One thing, Brent, that I want to add to this is that there is one key difference between the 2008 and the 2011 exogenous shocks that you mentioned and it's the output gap and it's the fiscal situation. They are both different. I mean, in 2008, I challenge everyone to tell me that, you know, the economics lacking the economy wasn't widening and I challenge the same in 2011 with the European debt crisis that was already looming around us. Right now, we have no European debt crisis. BTP boons are 80 basis points. I repeat eight zero basis points. Again, we have very tight labor markets in many parts of Europe and we have Germany throwing a large amount of fiscal stimulus on the economy. That's very different than 2008 and 2011. So something to at least consider. Yeah, I think that's a really important point. Understanding like trying to get into the mind of the policymakers and not predicting or not trading off of what you think because I've like I've been victim of that many times, but you know, I also saw it so much like say from 2012 to 2017. Almost every sturt trader in the world was always paid rates because they're like the fed should hike, the fed should hike and they just weren't hiking like they just didn't give a shit for well, for a long time. Eventually they hiked, but the idea that they should do something is a really, really bad way to trade and I think you see it also in other markets like if you're an investor and you're just buying hold and you're holding the thing forever, that's fine. You can have whatever religion you want, but like I feel like say, for example, a lot of people who are more libertarian leaning will always be long gold and sure that's fine if you're an investor, but if you're a trader, you know, gold just dropped 800 bucks from 5,500 to 4,600 or that's 900 bucks, I guess. As a trader, you can't just sit there long the whole time because gold is freedom money or whatever. So I do feel like that's a really important point is that if your time horizon is less than six months, you can't have any religious views on monetary policy or asset prices. You just have to just do whatever is going to make money and try to game plan what those people are thinking and get outside of your own head. I think that's a really, I mean, that's the whole point of the Keynesian Beauty concept, Keynesian Beauty Contest concept, which I think is like a really nice simple concept. I know a lot of people already know it, but I'm just going to say it in case for people that don't, but Keynes idea was that markets are like a beauty contest, but instead of selecting the winner of the beauty contest, what you're trying to do is select who you think everyone else is going to select as the winner of the beauty contest. And I think that's a really good simple way of thinking about second order thinking and getting out of your own head. And like no one gives a shit what you think about ECB, all that matters is what the ECB is actually going to do. So I just want to reiterate that out because I think that's a really good point. Very, very good. And we agree there. Should we play geopolitical armchair analysts for a few minutes? Because I want to get your take. I mean, at the end of the day, Brent, I expect you to have no edge in this as much as I have no edge in this. By the way, something very fun is that the co-founder of my macro fund is originally from that area. I moved away 30, 40 years ago, if led, but still originally from that area. And so we always joked, you know, allokers are like, so what do you think of this? I like, do I have no edge? If there was somebody that could have an edge, it would be us, but nobody knows. Okay, that's one thing I would like to quickly stress out. And saying that, and I assume that you will agree with me, you have no edge here. I still would like to pose the game theory perspective of this, just to understand where you sit on that equation. Okay. Yeah, I mean, I think that's the thing is people make the joke like, oh, we're all vaccine experts. So we're all oil experts or whatever. But there is some truth to like as a macro trader, you have to have a basic understanding, not necessarily to be able to predict what's going to happen in the straight of hormones, but you have to at least be able to understand like, if this gets bombed, what does it mean for markets? If this thing happens, what does it mean for markets? So developing some kind of like basic framework and like very low level expertise on the each macro topic is kind of like what your job is. So people make fun of that, but it's honestly, that's the whole point of macro half the time is, you know, adapting to a new regime and understanding what's important and what's not. So like, you can get that from experts and you from following the news and all that. But for me, I think my edge comes from knowing what the weak side is and where the convexity is. And to me, I think, yes, there's convexity in both directions because if the war ended in some kind of clean way, then, you know, people are going to have massive formal to rip everything. But on the other side, I think there's more convexity now to the downside because there's still a lot of complacency, monetary policies not coming to the rescue. The price just hasn't moved that much of most stocks retail is kind of running out of money like the tax refunds are pretty much almost done now. Like people, most people that were our retail investors who are getting tax refunds would have got them by now. Soften is a turning point and you got quadruple, which in tomorrow. So I feel like a lot of things are lining up for a reprising unless we get obviously that any bear's view is always hinges on like, unless we get good news, obviously, you know, if there's some kind of massive deescalation, you're going to get smoked if you're short. But I'm going to be positioned short for next the like into tomorrow and into next week because I think that the market hasn't really priced in the supply shock damage because no one really, oh, I'm not no one, but a lot of people haven't really believed that it's going to go on for this long. And now literally just each that this goes on, it's like negative decay. You know, the price of equities should decay slightly over time and until, you know, oil stops going up. And one last thing on oil. So after the Russian invasion of Ukraine in 2022, we had like the massive blow up in oil prices, Brent traded at 130 on a Sunday night, and it never broke that high. And so I would say like if you read the most of the oil experts are like, this is the worst shutdown in history. It's way worse than then Russia, Ukraine in 2022. And I think that would somewhat be ratified if we take out the highs in Brent because like I said in 2022, we never did and things slowly calm down. So I think if we take out the highs in Brent, which I think is like 122 or something, I don't have the chart up. But if we make a new high in Brent, I think that kind of ratifies a little bit more of like the negative forecasts from the oil experts. And that could also then lead to a more a greater acceleration lower in stocks next week. So or the week after. Thanks for your game theory approach, Brent. Here is mine. I'm using a very simple model for one something I learned at university that finally becomes useful in my job. Finally, it's a little submodel of the game theory called game zero game one, which is very simple. Game one is full escalation. Game zero is full deescalation or resolution of a conflict. Okay. So how is that that game is solved? What is the inflection point? The negative convexity point at which both parties have to deescalate and find solution. It's generally when the leverage of one party is way disproportionately bigger than what the other party has to lose. So if you make the case on US and Iran, well, the Iran, the very existence of Iran and the economical drivers of the nation could, in principle, completely be wiped out if we escalate to the to the maximum extent. And I mean, if the US decides to bomb all the oil infrastructure on car, then Iran as well as revenues to exist or if the US manages to call in NATO and you know, you get UK ships, friendships, Japanese ships. I'm sorry, but we are going to crack open the straightover modes. There is no discussion there. So the question is, when do we get that point? Both parties have leverage. Both of them are interested in upping the ante in the escalation. Until, I believe, until we get to the point where the US is able to up the ante so much that Iran has no other choice than to agree to deescalate. And how is that possible? Well, first is self-inflicting pain. If you bomb the oil infrastructure of car, where oil prices are going to go. I mean, the US can do that, but the price is going to be very high to pay in the short term. The best way that Trump can escalate and force Iran to deescalate in my game theory model is to convince a couple of countries to send their naval ships to the straightover modes. Because at that point, in my opinion, as soon as the ships of NATO are going, Iran is going to have to negotiate because they know they will lose their leverage through force, basically. Right. And then Iran's leverage, I guess, is oil-based 150 or whatever. But they just keep on going. Yeah, their leverage on their side correct is to do what they're doing. They start to slowly bomb gas infrastructure, oil infrastructure. And by the way, Brand, they can step up the leverage a lot more. They haven't done anything through the Houthis in Red Sea. Not that they control the Houthis mechanically, but they could try to do something in the Red Sea. They haven't done anything with the militia, the Iran-aligned militia in Iraq, which could trigger land invasion, potentially, of other countries in the Middle East. So Iran knows how to step up the ante and they can. But there is a point at which it becomes negative complexity for them, which is when they have opted enough that NATO says, "Okay, that's enough, okay. We're going to come there and we're going to crack open the street of our mutes." Or you really negotiate. Right. Which I believe this requires maybe another tango on average. Another tango means another escalation from both parties. The easier part is to escalate, it's definitely run as we are seeing. They can escalate without much negative side effects for the time being. For the US to escalate that's harder. What do they do? They bomb a car-guile and oil infrastructure over the weekend? Where does oil open on Monday? Because that's the only thing they can unilaterally do if you are the US. They can unilaterally destroy it and oil infrastructure. But that's also self-inflicting pain. Right. So the way I see. That's what Iran's hoping for. Oh, sorry, go ahead. No, no. I mean, the way I see it is we are getting much closer to the point where the negative complexity kicks in for both parties. But we are maybe not there yet. I think we need another tango basically from both parties. And then there will be a situation where in my opinion it's the only rational thing to do for both parties is to de-escalate from there. Iran, because otherwise it stops existing either economically or they take possession of the street of our mood. So forget about it, it's gone. From any economical incentive perspective, it's gone. And the US also has to escalate to de-escalate from that point. So much harder to trade. Because this is game theory back of the NAPT in little model. If you want to trade this very mechanically, what you should do is try to be convex net short here. So I don't know, I'm being short risk buying convex is very expensive. So let's say be short risk linearly. But then be prepared to flip aggressively on the other side when there is the level of max pain. I mean, and basically when the headlines are something like the UK and France agree to send military missions to open the street of our moods. So people are going to be like, "Fuck, this is going to be war, including Europe and NATO here." That's when you're supposed to buy risk from a game theory perspective. Which nobody's going to be wanting to do. But this is my framework for how I'm looking at this. Yeah, and I guess there's sort of this weird thing in the middle where Iran can just try to do like the Afghanistan or Vietnam thing or whatever. It's just keep alive and be really annoying and just make life difficult and never surrender. And then things could just drag on and on and on. And then it's interesting because Trump's asking for NATO support, but he's been shitting on NATO for 10 years. And obviously has told every single ally to go pound sand for the last six months. And now he's saying, "Oh, I wonder why the allies aren't helping me." But so I guess that makes your scenario more difficult because he's alienated all the allies on the economic side. So then they're the reticent to join in a non-defensive military action. But then maybe at some point it pivots and becomes justifiable as defense if the world economy is struggling so much. That favors your view then. It means that Iran has all the leverage to escalate up the ante because they can. So by the way, Israel is intervening into this by apparently unilaterally going after the energy infrastructure of Iran, not making things easier for the rest of the world from this perspective. But then you have Iran that can just retaliate. You know, they can keep up in the ante until brand. Even though Trump has shaked on NATO for 10 years, you know, if you're Japan, Korea and Europe and you see not gas prices keep rising. But when you at some point the incentive scheme kicks in for you to try and do something about it. But that puts favor your view. Every day that passes on and we are in this game zero game one model, then equities have negative drift. I mean, that's exactly. And also these equities have negative drift. I think it's an incredibly difficult concept to grasp mentally. You're talking about DAS set with proven hundreds of years of positive drift. And now you have to trade it as if it's an option where you're bleeding data. Basically, this is really hard. Yeah, which is weird. That's super weird. And I mean, I think the like what you're describing is, you know, who escalates or whatever. But the the the in betweener is Iran doesn't escalate. They just keep on, you know, keeping on. But anyways, I guess we get the point. So we'll also see how this all plays out in FX. Like a lot of people like I was saying at the start of the show have have hedged using Eurodoller. So again, I think Eurodoller would be the same. It's like this sort of it bleeds lower, lower, lower. And then on any resolution, it probably rips higher because everyone takes their hedges off at the same time. And the you know, the terms of trade shop is over for Europe. So it's there's some interesting setups. If thinking about like the path of of where things are going and then the speed and direction. Isn't all the normal paths it like you were saying, you know, there's you don't usually have negative drift inequities with topside convexity. That's kind of weird. It's really weird. By the way, if the topside convex is also very expensive, it's not like how you I'm just going to go and buy some out of the money calls and sit on it and that's it. Yeah. The realized ball of this thing, you know, sorry, the implied ball in out of the money calls is way higher than the realized ball in the delta product in the SMP. So that means you are bleeding aggressively, volatility risk premium to own the trade is not like, oh, they're cheap. I'm going to buy out of the money calls and that's it. Sorry guys. I mean, people have figured out the price of convexity at this point of anything you want to trade is extremely expensive, both upside and downside. So it's a really crazy thing is going on right now is that like that's sort of this unstable equilibrium concept is that realized is so far below. implied and not so many things like inequities but in EMFX as well. Like we're implied trading versus what say dollar rent is realizing or whatever is insane, but then you know, the market's not stupid that that implied vol is high for a reason. It's because you know, we're in a really unstable situation here where things are either going to get a lot better or a lot worse. So let's see. Yeah, and this also I think makes it impossible for us to talk about macro nuances. I mean, something I've had a lot of fun with is some brokers. I mean, guys, I mean, we're friends. Ciao. I mean, this is not done to mock you, but it is very funny because the job is to of course, for their perspective, get you to trade stuff, right? And I'm here and my risk management model certainly me. Hey, Alfie, you want to add this trade to this portfolio? You think it's very smart on Switzerland rates here because they're not going to hike. I put it in, put it in and then the risk model says, eh, you are short oil. Now, what do you mean? I'm short oil. I'm trading Swiss rates. Your short oil, anything you put is where, guys, I feel like a PCA or some other risk management system that tries to identify the factor driving your macro book right now, anything you put in there, almost anything will say, you are either long oil or short oil, you're selling oil calls, you're buying oil puts. It literally says you're trading oil. There is almost no other way around, which limits our ability to talk about macro nuances, frankly. Yes, yes, we can pontificate how these might react to this. But at the end of the day, if we have no visibility, as Brent said, many times in his pieces as well, you are going to be trading the price of oil, guys. I'm sorry. I mean, that's basically most of it for the time being. And I mean, that's a good thing to know is a lot of times people don't always fully understand what the inputs are to what they're trading. At least right now, it's pretty obvious. It's oil. Indeed. Are you around Brent next week for an update? Yes, yes, I am. Very good. I will be in Orlando for hedge fund conference. I mean, when I said Orlando, you looked at the camera like what was that random? Sure. Are you going to Disneyland or something? No, no, I'm going to Orlando in the US for a conference. I'm going to take the podcast from there, I guess. If any of the listeners is in the area, I am your Lando just ping me. Maybe we can have a coffee. All right. Sounds good. Thanks for listening, everybody. Talk to you next week. Talk soon. Ciao, guys. The content provided on the macro trading floor podcast is for general information purposes only. No information or other content provided in this podcast should be considered as investment advice. Seek independent professional consultation in the form of legal, financial and fiscal advice before making any investment decision. Always perform your own due diligence.