On Wednesday, Nomura’s Charlie McElligott talked at length about overtly bullish sentiment towards bonds amid the increasingly consensus global slowdown narrative and how that “bond love affair” (as he called it) was at risk from the burgeoning reflation story playing out alongside a recently soft dollar, signs of desperation in China’s stimulus efforts and risk-on sentiment catalyzed by “movement” on the trade front.
In other words, the paradox is that folks are bullish bonds due to the slowdown story, but that bullishness is set against a recently resurgent reflation narrative.
Needless to say, this kind of consensual infatuation with bonds could become “an issue” (to quote Charlie) if the data were to suddenly inflect.
He also put all of that in the context of his steepener call, something he’s been pushing for a while now.
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Like Hannibal Smith, Nomura’s Charlie McElligott ‘Loves It When A Plan Comes Together’
On Friday, McElligott revisits the above in light of news that US officials are hard at work on a “final” trade agreement (see the details here) and also on the heels of an MNI “sources” story (and anyone familiar with MNI knows those pop up every so often and can be market-moving when they do) that tips more fiscal stimulus from Beijing.
China, MNI says, “is set to announce further fiscal stimulus to boost a slowing economy, with measures likely to include raising the budget deficit, increasing quotas for local government debt and further cutting taxes and fees”.
None of that is “new”, per se, but it does lend still more credence to the notion that authorities are moving ever closer to an across-the-board, “kitchen sink” stimulus push involving both monetary and fiscal levers.
What do the trade deal rumor and the MNI story mean for Charlie’s themes? Well, he is glad that you asked.
“With bonds now ‘breaking-down’ after having been pricing in a significant global slowdown, higher nominals and the ongoing / grinding CURVE-STEEPENING look like the TACTICAL path of least resistance once again, as the above actions are optically PRO-GROWTH and REFLATIONARY, thus the recent + ‘Cyclicals over Defensives’ within Equities / + Commodities / + Breakevens dynamic should continue in the coming weeks”, he writes.
Note above how we mentioned that the infatuation with bonds could become “an issue” if the data were to suddenly inflect. In Friday’s note, McElligott picks back up on that. To wit:
Since [Wednesday], we have since seen 1) US Pending Home Sales big beat, 2) a massive Chicago PMI beat, 3) a surprisingly strong US Q4 GDP QoQ and 4) Core PCE QoQ…while last night we saw on the global front, we saw 5) China Caixin PMI Manufacturing surprise beat to the upside vs survey and prior result as well (48.5 survey, 49.9 actual, 48.3 prior)
So BOOM, there was the “global upside data surprise” catalyst which then “sparked the flame” of what is now a pretty visceral stop-out / profit-take / signal-flip / range-break in Rates, with particularly massive volumes at the 3pm ‘marks’ yesterday (MUCH higher than a typical “month end” trade): +33.5k TUM, +82k FVM, +110k TYM, +30.5k USM, +23k WNM
Yes, “BOOM”.
Here’s a chart from Charlie that shows 10-year yields breaking out of a 3-month descending triangle pattern (and regular readers know I’m not much on analysis involving lines and shapes, but hey, to each his own):
(Nomura, Bloomberg)
And here’s an update on Charlie’s famous CTA model, which “shows the commencement of a broad deleveraging of the prior Max Longs across global DM bonds week-on-week.”
(Nomura)
If you’re wondering about the risk parity side of the equation (which McElligott mentioned Wednesday), he notes that “the Nomura QIS Risk Parity model shows a large -$6.2B deleveraging in Global Bond estimated notionals WoW (primarily -$5.2B in JGB10Y) and -$3.2B sold yesterday alone (-$1.8B JGB10Y, -$300mm UST10Y).”
The problem for anyone chasing the rally in risk (where that implicitly means riding the nascent reflation story), the issue for Charlie continues to be the prospect of a March “surprise”
Read highlights from McElligott’s “Ides of March” warning
An Excited Charlie McElligott Details ‘The Makings Of A March Surprise’
“The risk continues to be this sequencing of seemingly idiosyncratic events which could converge in the same window to create a supply/demand reversal within US Equities just as investors are ‘forced to chase’ back into the market at the local 4-month highs and retail seeing capitulation from bears”, he writes Friday, adding that “a clean break of 2800 to the upside with the above positive news catalysts… sets up a dangerous dynamic where ‘late-comers’ are forced-in.”
The question, then, is this: Are you, dear reader, a “late-comer” who is being “forced in”? Or is your recent penchant for chasing the rally predicated on something you think you know about the sustainability of the reflation story that nobody else knows?
You can think on that over the weekend.
Plain talk would be greatly appreciated. I think you are saying that its a fools errand chasing the equities and going long at this point. Therefore, sell a bunch and hold a little? Or go away before May? And fahgettaboutit with bonds altogether? I will be happy to think about whatever facts there are that have a high level of certainty and veracity. Thank You for your nascent clarifications and expeditious, timely expoundments.
I agree with his assessment of perception in the bond market. But I think the equity markets are reflecting the view that there will be growth without inflation. That’s a slight nuance, but could account for both markets rising. The problem with that view is that if might be a way to thread the needle with mild growth. But if the growth is mild, how much upside is there in equities? If growth is strong, how does the bond rally continue?
Everybody wants a happy ending, but the bond market still isn’t happy.
Why? Because nobody in one’s right mind outside of China wants yuan in exchange for goods and services. A single weekend isn’t going to change that fact.
That and the US/DPRK peace talks collapse might be negatively impacting Japanese sentiment for US government securities…
Last August, when I first encountered the Heisenberg phenomenon, the topic du jour was a troubling spike in 10y US Treasury yields, which (H opined at the time) was sometimes correlated with corrections in the equities market. A little spike is a good thing (traders interpret this as money flowing from bonds to equities), but a spike of more than 1 standard deviation, can cause sentiment to change as the perceived narrative shifts: people are going to cash!
Well, look what we see over the past week in US10Y yield:
https://www.tradingview.com/x/WyJyMkro/
It’s riding the edge of its envelope again, just as it was in August, then September, then October.
Conditions are different this time: the UST yield curve is steepening, not flattening; there’s a love affair with corporate debt (but evidently not US government debt, as bond yields have been rising across the board all week). Could the signal have the same meaning? Irrespective of McElligott’s (always colorful) opinions, what I see in the bond market certainly doesn’t incline me to take risks with equities just now.
Maybe the biggest unreported story of the week. Santelli mentioned it on CNBC on Friday.