The Trade Everyone Got Wrong (And What Comes Next)

The geopolitical situation has pushed crude prices higher. But the more important question is about how it's transmitting through positioning and the second and third order effects that are going to reverberate through the rest of

the system. The mechanics of the crude

the system. The mechanics of the crude market itself is very interconnected with the changes that we see in the global economy as well as hedge fund positioning. When you think about crude,

positioning. When you think about crude, it is in itself connected to global shipping, interest rates, hedge fund positioning, the S&P 500 and food prices. Now when we begin to think about

prices. Now when we begin to think about not just the headline around crude but the second and third order effects things begin to get very interesting.

For example, here is a chart of the changes in crude as well as inflation swaps across global markets. Now in the

blue you have inflation swaps for the US and then in yellow you have inflation swaps for Italy and then in orange for the UK, France and every major economy.

The idea behind this is that the changes in crude prices are impacting inflation expectations and they're moving in lock step. This is the second order effect of

step. This is the second order effect of higher crude prices. As a result, what we are seeing is higher inflation expectations get priced into the forward

curves of these respective countries.

Now, notice right here for the United States, we have pre-shock, you have holds and cuts priced in the forward curve from 2026 to 2027. After the

shock, you now have holds and even on a marginal basis, hikes being priced for the US. This is even more extreme in the

the US. This is even more extreme in the Euro zone which makes sense because they're more short oil as a country than the United States. Now notice right here pre-shock they have a slight biased cuts

and then postshock now they have significant hikes being priced. This is

the same dynamic in the UK. So think

about the second and third order effects of higher crude prices. The reason why this has reverberated across the changes in equity markets is because the S&P

500, the Euro stocks, the Footsie, it's not just at their all-time highs right now. This is a chart of their

now. This is a chart of their valuations, which are incredibly elevated at this top level right here.

When you have a higher elevated level of valuations, equity markets then have a greater sensitivity to changes in liquidity. And liquidity is always

liquidity. And liquidity is always connected to inflation. Now, everyone

wants to know how the geopolitical situation is going to impact equities.

But the way that you understand that is by looking at and understanding the transmission mechanism between crude prices and the rest of the market, especially via interest rates because

crude is connected to inflation and inflation is connected to interest rates. I want to start by explaining how

rates. I want to start by explaining how that's connected in this chart. Notice

in the chart you hear you have the VIX in blue, bond volatility in excuse me the VIX in purple, bond volatility in blue and crude volatility in white. All

of them moved in lock step in the initial impulse and the second impulse a little bit less lock step but still similar pattern. Now notice what has be

similar pattern. Now notice what has be taking place as we have moved into the end of March. We moved down a little bit and we began to consolidate. But in this

second impulse right here, this is really where the large majority of positioning got blown out in a second order effect for the interest rate market. And this is something that

market. And this is something that people are still not talking about because they're still focused on crude prices. The initial move up in crude

prices. The initial move up in crude really caused positioning to blow out in the crude section of the market. But

then you see crude volatility has actually been down here at this level and then bond volatility has risen which has dragged up the VIX. If you have a correct attribution analysis model which

I'm going to show you in a moment then you can begin to understand how exactly these transmission mechanisms take place. And the key thing is why they are

place. And the key thing is why they are taking place because that frames where we are going to go. So when you have this divergence like this where you have crude vault still at these lows and then

you have equity all blow out that tells you that there's second and third order effects beginning to take place that you need to understand. What I want to do is begin connecting how to think about this

transmission mechanism to the tangible changes that we are seeing in markets in the short-term interest rate complex. If

you are trying to understand how exactly the bigger picture narrative is missing the more important mechanics under the system, this is going to be really important to understand. Here's a

contract table of all the sofur contracts that are pricing the Fed's decisions over the next several years.

right here in the Z6 contract which is pricing how many cuts or hikes we're going to get over this year. You will

notice that we had a period of time this year previously in 2025 where we actually priced 75 dips of cuts in 2025.

As we came into this year, you actually had a 50 to 25 basis point range. As the

geopolitical risk came out, we had a really significant blowout in positioning so that it wasn't just pricing 25 basis points of cuts, but it actually moved up to the settlement level, which means a complete pause.

Then we moved even higher and this entire move right here is the positioning unwind that has taken place that has been really significant. If you

just look at the outright contract, you can see how aggressive the selling pressure has been as we are not just pricing cuts or repricing the cuts for this year, but we're actually pricing

the marginal probability of hikes. Now,

this is just in the US. What you want to begin to understand is how this is reverberating across every other country as well. The UK side of things is even

as well. The UK side of things is even more extreme when we look at the changes in interest rates. If we also look at the Z6 contract, you can see a massive,

massive blowout in positioning. This has

really caused a blow up in the short-term interest rate market because again, the UK is short energy and you went from pricing 50 basis points of

cuts to 25 basis points of hikes. This

is a massive massive change that has taken place in the contracts for the UK which is why the second order effects of crude have had such a large impact and

caused volatility to blow out so much.

On the European side, it is very similar with the same blowout in the Z6 contract. Now, this has caused one of

contract. Now, this has caused one of the largest moves that we have seen in a long time in short-term interest rate pricing. And it all comes down to the

pricing. And it all comes down to the risks around inflation. Now the question from here is beginning to ask how much is inflation going to actually reverberate through the system and is

this entire move that has taken place right here is it unrealistic or is the ECBOE and the Fed going to begin to hike interest rates this year. If we begin to

take all of these moving parts and say, how does that impact equities and the S&P 500 specifically, that's really where we can begin to nail down how we should think about all of these

transmission mechanisms. This model synthesizes all of these moving parts and begins to quantify how exactly it's impacting the S&P 500. Notice here in

the chart, you have the rolling returns of the S&P 500, just the basic changes that are taking place in the S&P 500.

Now when we begin to break down what is the amount of interest rate risk, crossber flows, geopolitical risk or positioning risk in the S&P 500 that is

taking place. This is the S&P since the

taking place. This is the S&P since the beginning of the year. And what you can see in the green with geopolitical risk is it has been one of the large factors

driving the S&P 500 and you can see the green not only pushing it to the downside but also to the upside during these periods of time. Now, this will be something that I break down even further

because the idea about the macro drivers and different positioning drivers in the S&P 500 and for every asset is about beginning to decompose the different

drivers, building a macro view, and then understanding how much does that single part impact the S&P 500 or any asset that I'm trading, whether that's gold or silver or anything like that. And so

this model breaks down and quantifies every single one of those moving parts.

And if you want to dig deeper into how these are quantified, how they are changing, and how it's likely to play out for the next changes and the drivers for the S&P 500, that is something I

will be covering below. And all of these models and changes that are beginning to roll out, I will be sharing those with paid subscribers on the Substack. So, if

you want to get all of these models and all the breakdowns that I'm doing and get the in-depth analysis for that, it'll be on the website at capital flows research.com. It'll be linked below if

research.com. It'll be linked below if you want to get the in-depth report on how these different factors move. And

with that, I will catch you guys at capital flows research.com.