GM QIS Podcast #4 Script 

Ankit:
Hello everyone. Thank you for joining our monthly podcast covering the challenges and opportunities in the risk-premia space. Today’s focus is our risk-premia publication that we released earlier this week. I am your host, Ankit Gheedia, Head of QIS Research at BBVA Global Markets.

The title of our publication is ‘After Liberation Day’. There was a lot of anticipation ahead of this event, and the day clearly didn’t disappoint. SPX 1m at-the-money volatility jumped to its highest levels on record, outside of recessions, while the US policy uncertainty index jumped to its highest “5-day moving average” levels.

And, typically, following an equity market correction of more than 20% over the past 2 decades, we have always seen the Fed put kick in. This time around, it was missing, with inflationary risks still elevated. This is in line with what we expected ahead of this event, as highlighted to investors in our ‘European Exceptionalism’ view.

That said, a Trump put did kick in somewhat, with the US administration pausing some of the most extreme tariff rates against their trading partners, with the exception of China. At the end of the day, we remain in the midst of the “once-in-a-career” shift in the global macro-economic landscape which we entered at the start of the year.

Trump’s policies have created this “short-term” approach in financial markets, which makes it challenging to enter risk-premia strategies like capturing trend. Defensive strategies have clearly worked well over the past two weeks, although to enter new long volatility strategies with volatility still elevated could be painful as volatility resets lower.

Another interesting observation for risk-premia strategies was correlation breakdown. Typical crisis correlations have broken down, with the US almost acting like an emerging market, with the US-driven crisis driving investors out of US assets. It is rare to see equity markets selling off with a weak USD and higher rates.

Having gold in portfolios has been beneficial. Asset allocator strategies that include gold have done well, but long gold seems to have now replaced long Mag-7 as one of the most crowded trades.

In our monthly risk-premia outlook, we dared to enter a contrarian trade to be long FX carry strategies, particularly in Latam. Carry strategies have been the worst performing over the past month, mainly due to their short vol nature.

Despite the Atlanta Fed’s GDP Now index currently suggesting a US GDP contraction of 2%, we believe a global recession can be avoided. And if we do not have an imminent recession, then we should see volatility reset lower over the coming weeks. In such a scenario, we believe investors could benefit from entering carry trades.

We have a particular preference for FX Latam carry, given that Mexico and Canada were excluded from the Liberation Day target list. The short-term rate differential between Brazil, Mexico and the US is still quite high and global asset reallocation away from the USD should support the flow momentum into FX carry trades.

Current expected return normalized with recent volatility could suggest a still challenging environment for carry trades. Although like us if you expect volatility to normalize then now may be a good time to consider these trades.

Clearly, a short-term risk would be if the conflict between the Fed and the US government intensifies, which, again, is not our base case.

With that, we conclude our podcast for today. Please get in touch with your BBVA sales representative for a copy of our risk-premia outlook. We have created an interesting framework in this publication to analyse various risk-premia strategies, which could be particularly useful in current dynamic markets.

As always, thank you for listening, and we look forward to discussing these ideas further.