Well, this is just a goddamn mess.
It seems like everything has its own discrete narrative these days which makes it virtually impossible to summarize – let alone analyze – the overarching story.
You’ll see a lot of commentary that reads like it’s lifted from the last scene of The Usual Suspects. That is: “it all makes sense if you step back and look at it.”
Only it doesn’t.
Sure, every asset class is always going to be driven at least in part by idiosyncratic factors and, relatedly, by a storyline that’s unique to that asset. But generally speaking, those discrete storylines usually fit together in predictable ways to form a kind of coherent whole.
When they don’t, you end up with a jumbled mess.
And attempts to explain said jumbled mess invariably reflect the desperation inherent in trying to bend the facts to fit what everyone thought was supposed to be the script.
There’s no better example of this than Goldman’s hilarious attempt to explain away last week’s deflationary spiral in crude. To wit:
That’s laughably absurd.
The reflation narrative shriveled up and died on the vine as it suddenly dawned on everyone (during CERAweek no less) that the fundamental backdrop against which oil was trading was decidedly bearish. The bottom fell out (much to “Steve’s” chagrin). All the spec longs were caught offsides and got hosed like a fat girl who didn’t realize that limb over the creek wouldn’t hold her:
Suddenly an already shaky commodities complex was confronted with plunging crude. Correlations between HY and oil and between HY and copper spiked – hard:
And just like that, we got a deflationary bombshell just a few days before the Fed was scheduled to signal the committee’s unwavering confidence in the reflation narrative.
So what to do? Well, Goldman had an idea. They’d simply say that the reflation narrative that we all thought was one narrative was actually two narratives. We just didn’t know it until the entire commodities complex went to sh*t.
Suddenly, there were two narratives (a “manufacturing” narrative and a “services” narrative) behind one narrative (the “reflation” narrative) which was itself supporting another narrative (the “Trump trade”).
How many goddamn narratives is that?
And don’t forget that every component of what we might call the “hard” reflation narrative has its own narrative. Like crude. Where everyone is f*cking “bigly” long (although we’ll find out tomorrow how much of that money ran screaming to the exits last week when the latest CFTC data is released) against record US stockpiles and record production and where we can’t possibly make any real sense of the OPEC “cuts” because i) they weren’t really “cuts” in the first place, and ii) the Saudis look like they may have said “f*ck it, we’re ramping this up again” (and we can’t even be sure of that, because just a few hours after Riyadh admitted to rolling back 1/3 of the January cuts, the kingdom tried to play it all off like they were just kidding).
So why am I going over all of this again? Well because Thursday was a perfect example of what happens when every single asset has not one, but five or six narratives driving the price action, forcing traders to try and think twelve steps ahead and compelling everyone else to try and discern how to read the market action after the fact.
Take OATs. Here’s a chart:
So what’s going on there? Well, first there’s the Fed. How should a “dovish” hike effect core EGBs? But wait, it doesn’t matter. Because OATs don’t trade like core EGBs anymore. Why? Because a lunatic has a non-negligible chance of becoming president and if she does, there’s a non-negligible chance she’ll drag France out of the EMU, triggering a €1.7 trillion sovereign default and leaving the entire € credit market to wonder what happens when something like €410 billion in French IG debt (roughly a quarter of the entire € IG market) is suddenly subject to a redenomination event.
Ok, so that’s the narrative, let’s analyze it that way. Fine. Geert Wilders fell short in the Dutch elections. Which ostensibly bodes poorly for Le Pen in France. So OATs rally. Makes sense. But then OATs suddenly gave it all back (see chart). Why? Well because again, everyone has to think twelve steps ahead and after all, the French elections haven’t happened yet. And then there’s Draghi. Is he going to hike ahead of a taper? Is there room to deviate from the capital key to prop up French debt if everything goes to sh*t? Here’s how Bloomberg (tries) to explain it:
Bund futures dropped from the open as Dutch election premium unwound. OATs opened sharply higher, though with no signs of follow-through buying from investors, the bonds slid, eventually erasing all of Wednesday’s gains.
Dutch election outcome prompted some rethinking of risk hedges in core, said trader; German 2-5y yields were higher by 3bps heading into the close
Strong bull steepening move seen in Treasuries, was faded from the open in London, with overseas real money seen selling the belly, and putting on flatteners, said trader
BTPs were volatile, opening sharply higher with OATs, before following French debt lower; 10y yields higher by around 5bps heading into the close
Spanish bonds gained initially as risk appetite improved, with stocks gaining and credit spreads tightening, before sliding after soft pricing on one of the 10y issues in the auction’ the sector led losses closing higher by around 5bps
Now let’s look at an example of the same clusterf*ck unfolding closer to home.
The post-election equity rally is part and parcel of the reflation narrative. A Fed hike is tacit confirmation that the committee has confidence in the validity of the reflation story. So in that regard, a hike is good (i.e. bullish for stocks). But then again, we don’t want the messaging to be too hawkish because if we got a sharp repricing of yields (like say if 10s breached 3% all of the sudden), then the stock-bond return correlation would likely flip positive (or, said differently, the rates-stock correlation would flip negative) causing a tantrum (i.e. everything sells off together). So in that regard, we need a dovish message. Which is what we got on Wednesday. So stocks rallied. But the very fact that the message was perceived as dovish was evidence that the Fed wasn’t very confident in reflation after all. So stocks got cold feet on Thursday.
It’s the same convoluted shit with rates. A hike should send yields higher, driving rate differentials wider and thus supporting the case for a structurally strong dollar. But it was readily apparent heading into 2:00 pm Wednesday that that wasn’t what was going to happen. Because after all, rate differentials are already wide. And so a whole bunch of Japanese Treasury selling notwithstanding, appetite for US debt is supported by yield pickup. So a hike only underscores that, driving a bid for USTs. Throw in a 3-sigma short in the belly that gets covered as yields fall and you’ve got a setup for much lower, rather than higher rates. Which is what happened yesterday. But not today. Because today Treasurys gave back some of Wednesday’s gains. Why? Well because according to a whole lot of people (like say Goldman), the market misread the Fed who will now try and walk back a dovish slant they put on a hike.
See what I’m saying? It’s absurd.
Which is why I said f*ck it and went to the beach after lunch.
Thank God for four months of sobriety because the old Heisenberg would have been at the bottom of a good bottle of scotch right now…