Previously moribund rates vol. snapped back to life over the past week like a presumed-dead villain at the end of an 80s slasher flick.
We’ve been over this ad nauseam, but now that it looks like things may be calming down, a visual retrospective in the form of the five-day move in the … err… in the MOVE, shows we’ve just witnessed something of an anomaly.
“Today’s reversal in Rates too will provide relief for Systematic Rate Vol Carry strategies where many have lost the entirety of the year’s gains over the past two weeks after suffering yet another -3 z-score drawdown yesterday”, Nomura’s Charlie McElligott writes on Thursday, adding that “to this point, Merrill’s MOVE index has seen its fourth-largest cumulative 5d move of the past 30 years, a +5.3 SD event (30Y relative).”
Charlie notes that the folks/flows which acted as accelerants during the past several days of “raging” rates moves may have finally squared things – for the moment at least. To wit:
Yesterday / overnight / today, we finally see some tactical selling in Reds / front-end “downside” being bot via options (the well-publicized EDZ9 Put Condor now stands in excess of 200k contracts, amongst various other Put / Put Spreads trading) on a view that the front-end move has finally “overshot,” in conjunction with reversals in swap spreads (as the forced convexity hedgers look to be ‘adjusted’ for now, moderating potentially “THE” key driver of the multi-day panicky Rates move) and what looks to be profit-taking via overnight block sales in TYM9 and monetization in 5s30s steepeners (-4bps).
Again, the above is mostly about the accelerants of recent rates moves/ front-end action and shouldn’t be confused with the underlying “cause” of the DM bond rally which is, simply put, global growth jitters.
Whatever the case, any abatement of the insanity will likely help stabilize equities. And speaking of equities, McElligott notes that “the window for a pullback in US stocks is ‘now’ into the month-end ‘turn'”. That’s a reference to his “March surprise” thesis which included the caveat that, once the month flipped to April, the dynamics change.
“Catalysts for the ‘pullback window’ thesis will soon be exiting the picture, one permanently, one just temporarily before later returning approx 2 weeks out”, Charlie writes.
By definition, any quarter-end rebalancing flows (out of stocks and into bonds) will roll off as the new quarter dawns. For McElligott, it’s possible that some of the impetus for recent “midday” swoons (i.e., around the European close) is attributable to rebalancing from an “EU entity”.
“The ‘Extreme Quarter O/P of US Eq vs Bonds’ analog, which shows that the Pension rebalance flows are ‘real’ when you’re dealing with an outperformance to this extent QTD as stocks ‘underperform into, the rally out of'”, Charlie goes on to write, adding the obvious, which is that “this ‘flow’ will exit the picture into the month-end turn, losing a key Equities ‘sell’ force.”
Later in the note, he quantifies things via the following table which “shows a very POSITIVE out-trade as a ‘post April 1’ SPX upside catalyst–especially looking out the 5-6 days after.”
How about CTAs? Well, the S&P has remained above the QIS model’s sell trigger levels, despite those levels being mechanically pulled higher.
What does that mean going forward? The short version is that this possible downside catalyst will remain in play for another five days before briefly abating and then coming back into play after that. Here’s the detailed version from McElligott:
Our “forward dropoff” analysis for the CTA Trend SPX model shows that we have approximately 5 days left (first 5d ‘red block’ in forward signal table below) of the “mechanical” pulling-HIGHER of the “SELL TRIGGER” closer to “spot,” before then again reverting “out of the danger zone” and heading LOWER for the following THREE sessions thereafter (meaning “sell trigger” drops further below “spot” again–see days 6,7 and 8 below).
Importantly however as a forward “U.S. EQUITIES PULLBACK WINDOW” catalyst, we will again see the “sell triggers” again moving mechanically higher out nine days from here–and WAY HIGHER OUT THREE WEEKS (second red block highlight, starting at the 9d count on top).
Nobody is ever going to be able to accuse Charlie of being scared to put numbers to his calls and pseudo-predictions, that’s for sure.
Importantly, he also says that dealer gamma should flip negative at SPX ~2790 or, more to the point, right at the CTA pivot levels. The implication there is this:
“THUS, THE ‘PULLBACK WINDOW’ HAS TO HAPPEN ‘NOW’, so this next five days is the “PEAK WINDOW” for this “alignment” of Dealer Gamma, Rebalancing flows and CTA sell triggers.
If you’re following all of that, you can pretty easily derive why Charlie thinks US stocks have managed to generally hang in there. Hint: The S&P and the Nasdaq 100 haven’t moved below levels that would trigger CTA deleveraging (on Nomura’s model) and dealer gamma hasn’t flipped. To wit:
- “Spot” remains meaningfully above CTA sell-triggers (SPX and even more so NDX remain comfortably “Max Long,” although position sizes / $ exposure is just a fraction of last year’s Jan18 / Sep18 peaks)
- Dealer “long Gamma” remains at current levels and “holds” us, only turning “negative” (per our latest inputs) approx 20 handles lower in SPX ~ 2790
The upshot of all this is that there’s still scope for a pullback over the next five days, but after that, the picture brightens a bit as the potential for rebalancing flows to dent stocks rolls off and the commencement of earnings “sees PMs tune out macro noise”, to quote McElligott one more time.
Got all of that? Great.