The paper cuts were many.
That’s what Nomura’s Charlie McElligott had to say on Friday about the series of events that conspired to sour sentiment over the last 24 hours.
He is of course referring to the ECB’s deep cut to the euro-area growth outlook, China’s lackluster February trade data and the overnight rout in Chinese equities, catalyzed by a state-directed sell call from Citic on previously high-flying shares of People’s Insurance Company (Group), which plunged by the limit on Friday.
“The ECB’s decision to re-embark upon a new round of TLTROs after slashing their EU growth and inflation forecasts drove a powerful flattening of EGB curves which, in turn, destroyed SX7E Banks and was a ‘worst fears confirmed’ moment for Europe and the ECB, as the market sees the continent looking increasingly ‘recessionary'”, McElligott writes, underscoring the notion that dovish turns by policymakers are only “good” news if they aren’t predicated on overtly dour growth projections and underlining Credit Suisse’s warning that when you’re mired in NIRP, the prospect of further rate cuts (or even the promise that rates won’t be rising anytime soon) is bad news for bank equities.
On that latter point, recall the following chart we highlighted minutes before the ECB decision on Thursday:
Charlie goes on to reiterate the “ammo” problem, where that means that with rates still negative, the ECB is constrained in its capacity to combat a slowdown.
“With no normalization ever begun [they have] no room to cut further without completely ‘nuking’ deeper into NIRP and existentially crushing banks and savers in the years ahead”, he notes, adding that the “ECB [is] looking increasingly [like the] BoJ.” That comparison has been a fixture of recent commentary and it’s illustrated rather poignantly in the following chart from BofAML’s Barnaby Martin:
From there, McElligott proceeds to employ some of his trademark sarcasm/humor in the course of lampooning the above-mentioned People’s Insurance Company Group and reminding you that the dollar’s hot streak was turbocharged on Thursday thanks to the ECB’s “gong show” to the detriment of EM FX (a risk proxy). To wit:
We also saw Equities “purge” after an ultra-rare “Sell” rating from China’s largest brokerage Citic on “bubble” poster-child PICC (whose stock had previously surged “limit up” for five consecutive days, LOLOL) was read as a sign that Chinese authorities / regulators were signaling a desire to cool-down the recent speculative-froth of the market. Under the radar for some yesterday was the mini-implosion in Emerging Markets currencies with the worst-day for my EMFX basket since the global cross-asset de-risking of Oct 4th 2018, as the US Dollar ran wild following the ECB’s gong-show meeting.
Here’s the PICC chart again (because it’s fun to revel in the casino-like absurdity that still defines the onshore Chinese equity market and makes it possible for something to trade limit-up in five consecutive sessions).
Hopefully MSCI is paying attention, because this is the kind of thing that makes folks skeptical about lifting the weight of A-shares in global benchmarks.
After reiterating the dynamics that comprise his now well-circulated “Ides of March” risk thesis for equities, Charlie takes a moment to tout his core (and oft-repeated) bull stepeener breakout call. He’s been talking about the burgeoning steepener for months. Long story short, the idea is that it has the potential to really take off (i.e., dramatic steepening on top of what we’ve already seen) on the back of two possible catalysts, one being a material weakening in the data which would pull forward expectations for rate cuts, prompting bull steepening. The other is the converse, where reflation catalysts (e.g., kitchen sink Chinese stimulus, etc.) gather more momentum, prompting bear steepening.
As far as what could “make the Fed more dovish from here?” (i.e., pull forward rate cuts), Charlie says “worse data” is a good candidate. A convincing inflection (lower) stateside would “feed right back into the pervasive ‘end-of-cycle’ sentiment and then zoom in to [the] core ‘bull-steepener’ breakout, as curve caps trigger in conjunction with likely contingent SPX lower”, he writes.
In that regard, February payrolls is interesting. On one hand, the headline was a grievous miss, printing just 20k, the worst reading on the US labor market since September 2017.
On the other hand, wage growth came in hot and there’s an argument to be made that, depending on the context, “rogue” inflation prints are the worst news imaginable because if paired with still solid data (e.g., if payrolls were to rebound next month without a concurrent cooling in wage growth), it could put hikes back on the table.
In any event, Charlie notes that the 5s30s is nearing his colleague’s 68bps target.
Finally, McElligott notes that the flows picture continues to suggest that investors are adopting an “end-of-US-cycle” mentality, with the WoW data betraying still more inflows into money market funds, bonds and IG while junk and equities all saw redemptions.
Meanwhile, the Nasdaq 100 is all set to snap its best win streak in years.
“The paper cuts are many” indeed.