On Monday, we brought you some highlights from the latest by Nomura’s Charlie McElligott who, in keeping with the recent rally in commodities and burgeoning reflation-related global risk-on sentiment, called for a “Cyclical Melt-up 2.0”.
By way of reference, here’s the Bloomberg commodities index, which has surged of late thanks in no small part to buoyant crude prices that, much to the chagrin of a certain U.S. President, refuse to pull back (Wednesday morning’s move lower notwithstanding).
This week’s price action hasn’t unequivocally supported the global reflation/melt-up story, but McElligott is undeterred.
“In light of what I already considered to be a #fakenews narrative that yesterday in macro was a ‘risk-off’ day, I found the inability for USTs to meaningfully rally rather telling, especially as many have been anticipating the potential for a counter-trend squeeze over the near-term”, Charlie writes on Wednesday.
The reference there to “the potential for a counter-trend squeeze” is an allusion to the record spec short in the 10Y, which, on a surface-level interpretation, might be seen as a contrarian indicator.
“Seeing UST yields back to Monday’s levels (reversing the noise of y’day with ease) emboldens my ‘Cyclicals over Defensives’ tactical view”, McElligott continues, emphasizing that the “US IG calendar [is] picking up again as we push nearer to bank earnings and the bond offering thereafter, which should help to keep some pressure on the long-end via rate-locking.”
But the key point comes next, when Charlie asserts that the market is underpricing the inflation story. To wit:
I continue to believe that the market’s skepticism on “higher inflation” to be a mis-priced risk that could further escalate the Rates selloff in unruly fashion, especially with the 1) “wage growth” story picking-up further yesterday (AMZN minimum wage hike), 2) four year highs in Crude, 3) the cycle-lows in U-Rate / another large “Labor” beat with ADPs today 4) cycle-highs in Consumer Confidence, 5) 17 year highs in JOLTS Quit Rate…all into the “real-time” escalation of the “QE to QT impulse” broad “bearish fixed-income” catalyst.
Don’t forget, this is one of the big risks right now. On Tuesday, at a speech in Boston, Jerome Powell downplayed the possibility that the Phillips curve might “soon exact revenge”.
He better hope he’s right.
Because at this juncture, a series of above-consensus AHE prints have the potential to force the market to reassess the whole “benign” inflation story.
If Powell ends up getting caught flat-footed by some kind of acute bear steepening episode, he’d likely have to scramble to catch up, potentially pushing reals higher to the detriment of risk assets.