Nomura’s Charlie McElligott really has a knack for engaging market commentary – perhaps you noticed.
On Thursday, he’s got some fire for you – in hip hop parlance, Charlie is comin’ with that heat. And we mean that literally. He actually says that:
But for the real “HEAT” of today’s note, see see my “CLARIDA’S COMMENTARY ON TUESDAY WAS A MAJOR ‘TELL’ ON A NEW FED PLAYBOOK…
Before we get to Charlie’s hottest “bars“, though, it’s worth noting right off the bat that equities are still benefitting/vol. is still being suppressed by “very significant long gamma”, where “very significant” means “84th %ile $Gamma between SPX and SPY consolidated options, while too we see ‘extreme’ $Delta at 95th %Ile”, according to McElligott.
If you’re looking to explain why SPX remains “pinned” ahead of expiry and, relatedly, why Wednesday’s range was the second smallest of 2019, that’s one answer. “Six of April’s nine trading days thus far [are] within the top 20 smallest intraday range list YTD”, Charlie goes on to write.
He also notes that “VVIX is starting to ‘get legs’ a touch here”. For Charlie, that’s down to “the PUT WING (think ‘old regime’ VIX at 8-9-10 again) re-entering the imagination and ‘worth something’ again, as CB’s mutilate vols and the entire world pivots back into ‘roll-down’/’carry’ mode.” He goes on to marvel that “as it pertains to VIX options, the 1m PUT Skew is 90th %ile vs 1m Call Skew only 46th %ile!”
As far as the overarching macro narrative, McElligott says things may be setting up “for another ‘cyclical reflation’ run” and as was the case earlier this year, that’s pretty interesting when juxtaposed with “enormous ‘length’ in DM Bonds / Rates.”
“‘Long TIPS’ and ‘VIX roll-down’ feel like the place to be”, Charlie says.
Earlier this week, you’ll recall that McElligott talked at length about the extent to which the repricing higher of growth expectations off the late-March scare (which was exacerbated by a positioning squeeze that caused manic rates moves following the March FOMC, magnifying the DM bond rally and thereby contributing to something of a “false optic” re: how “bad” things were from a growth perspective) is rippling across equities.
He revisits that on Thursday and in part attributes it to comments from Clarida. Here’s Charlie:
Within US Equities, the significant April MTD “+ Value, (-) Momentum” dynamic continued again y’day—which I believe is tied-into not just the ongoing trend of “re-pricing of Growth HIGHER” following the late-March overshoot in Rates, but also the VERY notable comments from Clarida Tuesday night which speak to the possibility of running an asymmetric policy on inflation potentially via the Labor market.
After recounting the ongoing outperformance of various value factors, McElligott again employs a bit of amusing pop culture parlance, noting that in conjunction with the Value factor run-up, Momentum continues to “get served” – God bless him. To wit:
Conversely ‘Momentum” continues to get served—Vol Adjusted Momentum is now -2.3% MTD and -5.0% YTD; Sector-Neutral (“quant”) 1Y Momentum is now -2.4% MTD and -6.7% YTD; and “pure” 1Y Price Momentum is now -3.5% MTD and -8.4% YTD as “Growth”- factor chops and Defensives / Low Vol / Bond Proxies struggle (against the aforementioned “Cyclical Beta” rally)—reversing much of the 2018 dynamic inherent in 1Y Momentum.
So, what about Clarida has Charlie all fired up? Well, the NAIRU comments. Specifically, these (from the text of a speech at the Minneapolis Fed):
[The U.S. jobless rate, currently 3.8%] has been interpreted by many observers as suggesting that the labor market is currently operating beyond full employment. However, the level of the unemployment rate that is consistent with full employment is not directly observable and thus must be estimated. The range of plausible estimates likely extends at least as low as the current level of the unemployment rate.
For McElligott, this is a big deal. “[This] does not just simply speak to the ‘pivoted’ Fed outlook where rates at the very least may need to stay at the effective lower bound for even longer”, he writes on Thursday. For Charlie, it goes beyond that, because in his eyes, Clarida’s remarks “iterated a shift towards ASYMMETRIC POLICY where the Fed is acknowledging they may need to be cut lower from here if they continue to be unsuccessful in getting Core PCE to run sustainably at their 2% objective.”
He goes on to say that Clarida’s comments are consistent with a paper you can read here called “Asymmetric monetary policy and the effective lower bound”. I’m guessing nobody is going to read that paper and Charlie appears to think the same, so in order to help folks along, he highlights the “punchline(s)” which are as follows:
This result suggests that the ELB (“effective lower bound”) is a particularly pernicious constraint on policymakers who are unable or unwilling to influence private sector expectations through credible commitments.
As an alternative, we consider policymakers with an asymmetric loss function that places weight on deviations of output below potential but no weight on deviations above potential…we show that policymakers who minimize such an asymmetric loss function are able to achieve better inflation outcomes than policymakers with a symmetric loss function.
This result suggests that policies that systematically ease more in circumstances when inflation is low than they tighten when inflation is high can be an effective way of mitigating the undershooting of inflation caused by the ELB.
What does all of that mean? Well, the short version appears to be that this is yet another nod to the idea that we’re going to see a reflationary shift in the policy framework going forward.
“With this fresh set of ‘tells’ on the Fed mindset… my view here is the Fed is looking to run the jobs market SUPER hot going forward through said ‘policy asymmetry’ in order to reset inflation expectations”, Charlie muses.
Were Donald Trump capable of understanding all of that, it would probably please the president, who would just love to see (and then brag about) a 2-handle on the unemployment rate.