Nomura’s McElligott Says Market Is Waking Up To Likelihood Of ‘Guns Blazin” Fed Easing

When it comes to ‘splainin last week’s “front-end inversion spasm”, Nomura’s Charlie McElligott thinks you need to “use your imagination”.

And by that, he means you should consider the possibility that when the Fed does ultimately embark on explicit easing (as distinct – sort of – from the implicit easing inherent in the end of runoff and MBS reinvestments into USTs), the committee will come out “guns blazing”.

He sets the stage by using overnight consolidation as an excuse to recap recent “insane moves” in rates. “Front-end / STIRs spreads reversed part of the panic inversion and steepening [with] EDM9EDM0 from -41.5bps lows overnight to current -36.5bps of implied hikes between Jun19-Jun20, while in Bonds we seem some profit-taking / unwinds of curve steepeners”, he notes, before delivering the following assessment of the catalyst for the front-end “insanity”:

I continue to believe the largest catalyst for last week’s front-end inversion spasm was the market’s realization that the Fed’s “spastic dovish overshoot” since start of January + especially since last week’s “escalation” would mean that when the Fed DOES indeed “ease” again, they will come-out “guns blazing”–meaning AT A MINIMUM, 50bps of cuts + LSAP + likelihood of new repo facilities + (use your imagination).

As documented at length here on Monday, policies that used to be confined to the “imagination” may ultimately shape our reality going forward, considering how close we appear to be to the limits of what, until 2019, could be described as “unconventional” policy.

From here, we may need to redefine what counts as “unconventional”, and that goes for both monetary and fiscal policy.

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In any event, getting back to McElligott, he writes that yesterday’s extension of the incredible front-end rally “again featured crushing tightening in swap-spreads driven by convexity hedgers (both Mortgage players as well as VA flows) receiving against some clients and dealers running ‘long’ spreads.”

He also calls the move in rates vol. “a real one”.

Next, Charlie draws your attention to where 10Y yields are now and where they were when the term premium was last near current levels.

“Remarkably, the all-time UST 10Y Term Premium lows came July 8th, 2016 as 10Y yields tagged 1.35%–now, today’s revisiting in the TP low comes with 10Y yields at 2.45%”, he marvels.

(Bloomberg)

You might recall how, a couple of weeks back, Charlie described a bond “love affair” amid ongoing signs that the global economy is on the cusp of experiencing a synchronous downturn. Late last month, he mentioned that his risk parity model showed a notional allocation to bonds that was the highest going back at least seven+ years.

He revisits that on Tuesday, noting that despite risk parity being a “very modest seller into the recent escalation” (where “escalation” just means the DM bond rally as growth fears proliferate), “within larger context, the RP allocation to Global DM Bonds remains at highs in the history of the model series back to 2011.”

(Bloomberg, Nomura)

As far as CTAs go, it’s “max long” in everything, as the entire complex is “deeply in-trend.”

(Nomura)

Finally – because “popular demand” calls for it – here are a couple of quick passages from the equities section of Charlie’s Tuesday note which include the celebrated CTA “triggers”:

As anticipated, the Nomura QIS CTA model did indeed see the position in Russell 2000 Futures “flip” to -100% “Max Short” yesterday as both the price signal weakened and the “sell trigger” moved mechanically higher due to the impact of the 1Y window drop-off dates–however, it should continue to be noted that BOTH the S&P 500- and Nasdaq- Futures positions are now at their largest $allocation of the overall portfolio since December 3^rd, 2018, with both remaining above their “sell triggers” (although SPX MUCH closer to SELLING than Nasdaq):

• S&P 500, currently 100% long, selling under 2794.55 to get to 52% , more selling under 2590.65 to get to -100% , flip to short under 2590.93, max short under 2590.65
• NASDAQ 100, currently 100% long, selling under 7105.26 to get to 52% , more selling under 6448.09 to get to -100% , flip to short under 6448.82, max short under 6448.09