•Global macro hedge funds selling USD and buying EM equities more eagerly than at any time since last year.
•Risk-taking looking more and more likely to resume Global equity markets, although still subject to some push and pull, have gotten onto arecovery track.As the curtain falls on this month’s “sell in May” impetus, we are seeing early signs of a resumption of risk-taking. It has been a bumpy May, with investors at times taking a disliking to such developments as the spike in inflation signals, the market turbulence in Taiwan, and the cryptocurrency sell-off. However, the S&Pseems to have quickly recovered from what turned out to be a shallow dip (down to as faras 4,056 on 12 May). To all appearances, there is still quite a bit of dip-buying demand among investors looking ahead to an expected resumption of economic activity.

Our ownUS equity market sentiment index has been slowly but steadily improving (Figure 1). This index climbed further into positive territory yesterday (24 May) than it had at any time since 7 May, arguably making it look as though investors have fully digested the abovementioned bits of bad news that emerged in May. Most major classes of hedge funds, meanwhile, have seen their performance either stop deteriorating or start recovering (Figure 2). The VIX has stabilized below the critical line at 20. With investors now facing less pressure to recognize losses or over hedge, the preconditions for the sort of resumed risk-taking we have been envisioning appear to be falling into place.

Of course, US equity markets are not enjoying a proper rally yet; what we are seeing at the moment looks like a simple consolidation. Some speculators are still licking their wounds, and seem to be waiting for just the right time to start going long again. We therefore do not expect to see an obvious speculator-led bout of risk-taking until June is underway. In futures markets, we estimate that CTAs have put a stop to their unwinding of long positions in S&P 500 futures. We estimate that CTAs’ recently acquired long positions (net buying since November 2020) break-even at around 3,900 on average, which means that CTAs are sitting on unrealized gains with the S&P 500 where it currently is. Given that volatility has already died down, we would expect CTAs to start chasing the market up again now that the S&P 500 is climbing back towards the near-term peak of 4,238 recorded on 7 May.

•In cash equities markets,we expect to see long/short funds take a renewed liking to long positions in cyclical sectors. We estimate that long/short funds had until recently been trimming back some of their long exposure to cyclical sectors while conservatively staking out long positions in defensive sectors so as to be braced for any “sell in May” flare-up. Looking ahead, we expect long/short funds to come to see themselves as over hedged, at which point we expect to see them take to selling defensives and buying cyclical.

•Global macro hedge funds selling USD again in their hunt for yield. In forex markets, meanwhile, one current development that arguably signifies resumed risk-taking is the pick-up in USD selling as a byproduct of the global hunt for yield. Global macro hedge funds—the stalwarts of fundamentals-oriented investing—are rapidly taking their net exposure to USD (30-day beta estimate)further to the short side. At the same time, these global macro hedge funds have been covering short positions in EM equities and look increasingly likely to go net long. A close reading of global macro hedge funds’ positioning suggests that they had spent all of 2021 up through April expecting USD to gain and EM equities to soften (presumably on fears of a rise in US long-term interest rates), but that they now have flipped to expecting USD to fall and EM equities to rise.

We estimate that CTAs, which are trend-following systematic funds, are chasing global macro hedge funds in their pursuit of the downside in USD. We estimate that CTAs have already swung net short and that they have plenty of capacity to take their position further to the short side. Looking at specific USD pairs, we see that CTAs are selling USD against most major currencies, some Asian currencies excepted (THB, MYR, and JPY). The pace at which CTAs are selling USD has been alternately speeding up and slowing down, but the general preference for going short looks likely to stick for now.