Nomura’s Charlie McElligott got a hearty laugh out of the idea that the “only” sticking points remaining between the US and China on a trade deal are implementation and enforcement.
“More China / US ‘trade deal optimism’ per the FT story [with the] only ‘hold-up’ being implementation / monitoring, LOL”, Charlie wrote Wednesday morning, expressing incredulity at the notion that anyone would describe “implementation and monitoring” in terms that suggest those two things are somehow trivial matters.
McElligott’s Wednesday note centers around something he talked about on Tuesday, namely that with some folks positioned for a return to the “old” slow-flation regime, further signs of “green shoots” for the global economy (e.g., Monday’s manufacturing data out of China, the ISM beat stateside, Wednesday’s solid services PMIs, etc.) could be a problem. He pairs that with a discussion of a reversal of last week’s manic rates moves/last month’s bond love affair.
“As per my commentary over the past month when discussing the ‘asymmetric positioning risk’ associated with the scale of both the 1) enormous DM Rates ‘Long’ held by Systematic CTAs and Risk Parity funds and 2) the collective embrace of the ‘Slow-flation’ narrative within consensual Equities positioning (the ‘risk barbell’ positioning of Long ‘Secular Growth’ and Long ‘Quality / Defensives / Bond Proxies’ vs Short ‘Cyclicals / Value’), we are now beginning to see even just ‘incrementally better’ global growth data now begin to drive a repricing / rebalancing in said ‘status quo’ trades.”
Point one just suggests that the long in DM bonds could eventually tip over, buckling under its own weight should global growth suddenly inflect higher, while point two suggests violent moves for Momentum.
“As it pertains to Equities—and similar to the behavior seen on Monday following the post China Manu PMI / US ISM ‘growth repricing HIGHER’—we see another BIG move overnight in Global Equities ‘Value’ factors, as ‘Value Longs’ are largely ‘Cyclical’ in nature”, Charlie writes, adding that “in light of pervasive skepticism towards any sort of global growth reacceleration at this point in the cycle, along with a TOTAL DISREGARD for anything associated with actual inflation upside risk—these ‘Cyclical’ sectors / names have become ‘placeholder underweights’ across consensus portfolio positioning.”
And so, the knock-on effect of global Value factors ripping ends up being what Charlie calls “REAL pain” in legacy 1Y Momentum factor strategies. Specifically, he notes that “the 4-day cumulative move in EU ‘1Y Price Momentum’ is the largest drawdown since the 4-d period ending April 13th 2016 at greater than -4 SD’s (relative the past 5Y returns).”
He goes on to say that with the Chinese economy showing what we’ll generously call “concrete” signs of bottoming, and with sentiment inflecting in Europe, the dollar now has a reason to soften up a bit beyond the “Well, the Fed is dovish” thesis, which you might recall burned some dollar shorts earlier this year (Goldman included).
“What does this still-nascent boost to global growth data out of China and EZ mean from an FX perspective?”, Charlie asks, before answering his own question as follows:
That for the first time in a long-while, the Dollar now has incremental (YET ONLY ‘TACTICAL’) set of catalysts for a pullback besides just a generic “dovish Fed pivot” thesis, as key pairs Euro and Yuan again try to “get their legs” following the data bounce
If that were to pan out, it would obviously be a boon for the reflation narrative more generally, especially to the extent it gives crude more momentum.
Critically, McElligott points out that what you’re seeing this week in terms of growth expectations perking up despite what, on balance, has been mixed data, comes after a week during which a lot of folks mistook a positioning squeeze for a growth scare. While there’s no question that the ferocious DM bond rally that grabbed headlines from New York to Tokyo late last month was in part down to growth worries, it coincided with convexity flows/hedging dynamics that served as accelerants.
For Charlie, that means last week was a bit of a Fata Morgana. Here is perhaps the most important passage from his Wednesday note:
Currently this is simply about the RE-PRICING of growth expectations which, to me, is partially due to the potentially ‘false optic’ created by the enormity of the convexity hedging impact on Rates over the past two weeks into the rally having caused an ‘overshoot’ of the growth-scare narrative.
Also – and this is amusing – to the extent the last two weeks’ acute growth scare was something of a “false optic” as described above, it also suggests the repricing higher of growth expectations on the back of what, if everyone is being honest, is merely incrementally good data, could itself be the product of a subverted perspective, as market participants who couldn’t spot the impact of convexity flows following the March Fed, similarly can’t discern the extent to which this week’s back up in yields is simply a correction of that downside overshoot.
In any event, with positions now squared, the impetus for a further repricing higher of growth expectations has to be something real (so to speak). McElligott floats two possible catalysts for a meaningful change in the market’s opinion of the outlook for global growth, the first being details from the Fed on a new inflation framework and the second being, paradoxically, a inflection back lower in the data out of China which would then prompt the kind of “kitchen-sink” stimulus push that has for months been the Holy Grail for optimists.
We talked about that latter point earlier this week. Charlie puts it as follows:
…if the Chinese data were to indeed again mean-revert lower as we push in Q2, it then becomes increasingly likely that they would then push ahead not just with further RRR cuts, but potentially even to relaxation of prior property sector restrictions—which in-turn could then see a true “Cyclical Melt-Up 2.0” phase in pure “end-of-cycle” fashion.
Finally, McElligott offers a zinger on the Mainland equity “re-bubbling” and the out-of-the-blue surge in crypto currencies.
CSI 300 is now +37.0% YTD, SHCOMP is +32.3% YTD and SZCOMP is +43.4% YTD…so color me cynical, but is it really so difficult to now rationalize the returns on Cryptocurrencies (again further extending overnight) in light of this Chinese “speculative wealth effect”?!