One theme that pervades our multiple Fed previews (both the long version and discussions of the March meeting in several other pieces – here and here), is the idea that it’s hard to imagine what a “hawkish surprise” would look like this time around.
In the same vein, the term “dovish surprise” appears to have virtually no meaning for the March meeting. The dots have to “catch down” to the reality of the updated forward guidance in the January statement, the economic projections will almost certainly be downgraded but those downgrades won’t be too deep because the US economy is still holding up well and the idea that Powell won’t explicitly address the plan for the balance sheet in more detail (even if he doesn’t deliver a definitive end date for runoff) is a non-starter.
So, barring some kind of truly epic screwup involving, for instance, a combination of the Fed demurring on an announcement of the end date for runoff, not providing any meaningful clarity beyond what we got in January with regard to the balance sheet and the dots still showing one hike in 2019, it’s difficult to conjure what a “disaster” would look like.
In his Tuesday missive, Nomura’s Charlie McElligott seems to underscore that, although we don’t want to overstate the case.
Monday’s spot up/VIX up dynamic (which he attributes to “systematic vol sellers covering some of their short inventory”) now looks like a “mirage”, Charlie writes, noting that “once again today we are seeing spot VIX hit lower, with UXA term structure so steep and traders seeing UX2 with ~2.2 vols of roll-down apparently just being too good to pass up.”
That, “despite” the Fed “event risk” looming on the horizon. And that’s really the point. Maybe the real “mirage” is the idea that there’s any “risk” in this “event.” Here’s McElligott:
Perhaps that’s the joke here–there is no “event risk” with a Fed which has completely gone limp due to a singular focus on avoidance of contributing to “tighter financial conditions” and if anything, seeing global central banks now working to advocate an outright “reflationary” backdrop.
Right. And in keeping with that, Charlie goes on to observe that the “‘dovish / end-of-cycle / preemptive QE’ market view [being] expressed across global DM bonds” has now manifested itself in “all systematic strats showing ‘extreme longs’ in relative bond positioning size.” To wit:
Systematic Trend / CTA “Max Long” in…..everything Bond / Rates (USD 10Y, EUR 10Y, JPY 10Y, GBP 10Y, AUD 10Y, CAD 10Y, CHF 10Y, FRA 10Y, ITA 10Y, ESP 10Y and ED4 / ER4 / YE4 and L4)…
He also notes that Nomura’s QIS model “shows [the] Risk Parity bond allocation has grown by ~65% over the past 12m period, particularly via JGBs and USTs (to much lesser extent).”
(Nomura)
Here again we see the irony inherent in this entire setup (as described here on Monday evening). The “epic” dovish pivot from central banks is all in the service of reflating the global economy in the face of rapidly deteriorating growth expectations, and the notion that they (CBs) will be some semblance of successful in that regard at least partially explains the YTD rally in risk assets.
But clearly, “max bullish bonds” (as Charlie describes it) doesn’t seem to tip much in the way of confidence that CBs will in fact be successful when it comes to reflating.
And the irony of ironies is that that’s actually fine, because as long as we’re still chasing the elusive target, everything works – stocks, bonds and credit.
