Another late-cycle dynamic that demands our focus is the dominant global liquidity paradigm that has been aggressively augmented by DM central banks over recent years. In all likelihood, DM central bank balance sheets will be a net drag on global liquidity by year end, leaving weak U.S. dollar-dependent FX reserve growth as the lone pillar of critical liquidity support for global risk assets.

Given that other traditional hedges are not as effective now, due to high levels of implied put volatility and the negatively convex profile of owning duration, long USD expressions are a sensible hedge to potential contracting global liquidity.

Positioning for the new volatility regime

We find that in spite of 2018’s dramatic environmental changes, our early-year portfolio posture has served us quite well. Accordingly, we continue to barbell exposures, earning solid risk-adjusted carry from both securitized assets and the front-end of the U.S. Treasury curve.

We attempt to capture upside with equity options that are still the most convex risk asset expression, in spite of slightly elevated premiums. We still favor EM assets that have been resilient in the face of the recent tariff/trade distractions and still fairly compensate us for the risks that exist today.

Finally, we are reducing unsecured global credit assets and are avoiding long duration assets that are vulnerable to a glut of new supply as fiscal stimulus is financed. Whether or not the heightened volatility regime is indeed a wish come true, it is likely to be a lasting cyclical theme with a reflexive feedback loop that heavily influences investor behavior. We are braced to ride out the turbulence as long as necessary.

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