Global risk sentiment has taken a dramatic turn for the worst on Tuesday, starting in Asia where investors have seemingly given a thumbs down to China’s efforts to rescue flagging domestic equities with rhetoric.
The macro narrative since the end of August has revolved around the real-time appraisal and re-appraisal of whether we are “growing faster than we are tightening” or “tightening faster than we are growing”, to quote Nomura’s Charlie McElligott, whose near-real-time daily missives are quickly becoming “must read” material.
The selloff in equities this month has led to a tightening in financial conditions. You can see that in the following chart:
What’s also clear from that visual is that Donald Trump’s protestations notwithstanding, we’re a long way from “tight”.
Of course that could change considering how critical the equity rally was in keeping conditions loose during 2017. Another leg lower in stocks would put the squeeze on, especially if it’s not offset by a weaker dollar and a rally in Treasurys.
As far as Tuesday goes, the above-mentioned Charlie McElligott calls this a “classic Risk-Off move with USTs, Reds in ED$, Gold, CHF and Yen all bid against Crude [and] EMFX and Equities beat-down.”
“This then looks like general Macro consensual positioning gross-down flow, as Longs in SPX, Nikkei, Crude and USD are under pressure, while Shorts in USTs, ED$, EUR and Gold all squeeze”, he continues, in a note out this morning.
On gold, McElligott reiterates that the “legacy Max Short” in Nomura’s systematic model is on the verge of triggering a “massive notional of $46B to buy on a cover to get back near flat at just -16% Short”.
Charlie goes on to warn that the consensus view of U.S. stocks as the “global equities safe haven” trade is “cracking”.
“After shattering through the 200d MA once again yesterday, S&P futures are now again within reach of the MTD lows (2712) as discretionary tactical longs tap out and asset managers continue to sell-down legacy longs (still ~$80B in SPX)”, he writes, underscoring de-risking from the Long/Short crowd before raising the “gamma gravity” specter. “SPX see big gamma at 2700 strikes (~$3.9B for 10/26 expiry, ~$3.6B for 10/29 expiry) with the largest pull remaining at the 2750 strike (~$4.7B / ~$4.0B)”, he notes.
Meanwhile, don’t forget that playing out in the background is a debate about whether the rather precarious setup that finds the U.S. issuing mountains of new debt to fund stimulus and pay for the tax cuts while the Fed hikes and unwinds its balance sheet is sustainable/viable (where that means it can persist without causing problems). That scenario puts more and more of the onus for absorbing new supply on investors who aren’t the Fed or, more to the point, more and more of the bid is price sensitive. Obviously, the market for U.S. debt is always going to clear, but that leaves open the question of whether clearing prices will ultimately be lower (higher yields) and also entails sapping dollar liquidity from the rest of the world.
That dynamic conspired to break the spell that previously allowed the Fed to normalize without driving up the dollar. The shift in the UST supply/demand function has also stoked fears that the term premium could finally make a comeback.
“Despite higher front-end yields via Fed policy normalization, a weak USD and suffocated VIX has helped offset and actually ease U.S. financial conditions since the hiking cycle began, [but] now, a stronger dollar and pivoting VIX are contributing to tighter conditions as the UST term premium is reintroduced to the market,” McElligott writes on Tuesday, reiterating the points above and underscoring the fact that a data-dependent Fed is a Fed that no longer hikes with the market’s implied “consent”.
The bottom line, McElligott writes, is that “we are experiencing a shift to a RISK-NEGATIVE mindset again, as the market pulls-forward the end-of-cycle timing” and anticipates a policy mistake.
“Eurodollar futures implied hikes for 2019 are now again slightly BELOW a full two-hikes (and again massively below the Fed’s currently-projected 3 hikes)”, Charlie adds, before again imploring you to watch EDZ9Z0:
2020 again edges closer to inversion (which would imply more likelihood of a CUT than additional hikes)—as the Rates market is fading the Fed’s ability to stick to their dot-plot, instead believing that the market will force the Fed to “pause” their normalization / slow “quantitative tightening”…or even outright EASE.