Nomura’s McElligott Explains Why Some Traders And PMs Are Set To Fade Jerome Powell

Jerome Powell appears to have made some meaningful strides when it comes to figuring out how to communicate with markets.

As of 2:00 PM in New York, stocks are hanging on to monumental gains logged on the heels of a blockbuster jobs report and the beleaguered Fed chair’s successful efforts to convince (if only for a day) market participants that policy is not in fact on a preset course and that the FOMC will consider any and all options (including tweaking balance sheet runoff) in the event conditions warrant a rethink.

S&P futures were up a ridiculous ~4% off the overnight lows.

(Bloomberg)

And assuming stocks hold on, this will be the second insane rally in the space of two weeks (the other being December 26).

(Bloomberg)

The problem, of course, is that allusions to halting or otherwise slowing runoff are something different than actually taking concrete steps in that direction. And when you think about the other risk-on catalysts from Friday, it’s worth noting that the PBoC’s RRR cut was expected (if not this soon) and doesn’t constitute the kind of all-out stimulus push that’s probably necessary to bring about a sustainable turnaround in domestic equities, let alone the Chinese economy.

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China Delivers RRR Cut Amid Rapidly Deteriorating Sentiment

As far as the jobs report goes, it’s nice, but let’s not forget about yesterday’s December ISM manufacturing print.

If you’re looking for an excuse to fade Friday’s action, you might simply point to this:

Schumer: Trump said he'd keep the government closed for months and maybe even years.

— Heisenberg Report (@heisenbergrpt) January 4, 2019

Or, you could consider what Nomura’s Charlie McElligott wrote in his Friday missive which made the rounds prior to Powell’s remarks in Atlanta.

 “FWIW after speaking with a number of traders / PMs yesterday, it is my sense that the preferred sequencing within US Equities is to see a ‘dovish rally’ today (or say after next week’s Powell Econ Club speech) that most then voice a DESIRE TO FADE at ~ 2575 / 2600 level”, Charlie wrote, before explaining why folks are predisposed to fading Powell as follows:

Why fade it? Because a pivot towards a pause or even outright ‘easing’ is happening for bad economic reasons.

“Bad reasons” is obviously a nod to poor data, and that underscores the main risk in a Fed pause: depending on how it’s communicated, it could serve to “confirm” the market’s fears about a downturn or even an imminent recession. That’s why a tweak to balance sheet runoff might be preferable to some overtly dovish lean vis-a-vis the rate path.

In any case, McElligott goes on to remind you that it’s not the inversion you should fear, but the subsequent steepening. He’s noted this before, but it seems more urgent now. Here are the two visuals that illustrate his point:

(Nomura, Bloomberg)

“As stated repeatedly, the steepening is due to the Fed being perceived as ‘done for the cycle’ –but it’s because the slowdown is likely-then seen as a true recession risk”, he writes, adding that “the trade is to cover or go tactically long into an ‘easing’ inflection from the Fed, but that you then want to short it because it’s occurring due to negative economic developments, ESPECIALLY with the current unwillingness to adjust the balance-sheet run-off / QT.”

That last bit is important. Until the Fed decides to actually announce a rethink of balance sheet runoff (as opposed to just alluding to it), the market may have a tough time sustaining a rally – especially if Donald Trump continues to hold the government hostage in lieu of $5 billion in ransom money for his wall/slats.