Anyone who attributed Friday’s turnaround in US stocks to “optimism” on trade had two whole days to rethink their assessment.
At some point on Saturday, we suggested that was a lazy take. More likely, vol. sellers had reemerged, helping to calm things down.
On Monday morning, Nomura’s Charlie McElligott notes that “similar to last Thursday, Friday too saw systematic vol selling/put underwriting flows which coincided with the turn in Equities Futs off the lows [and the] turn in Vols off highs.” He calls the latest swoon in US equity futures on Trump’s “clap-back” unsurprising.
Fortunately, both the S&P and the Nasdaq 100 are still “deeply in the money” vis-à-vis Nomura’s QIS CTA model. “The next deleveraging/flip to ‘Short’ in S&P futures [is] deeply below spot at 2711 and for NASDAQ [is] waaaay down at 6893”, Charlie continues.
The yuan is, of course, under pressure. USDCNH pushed above 6.90 for the first time this year on Monday. Markets appear poised to test the PBoC (i.e., “Let’s see how far they’ll let it fall”).
That’s clearly a problem for EM FX and ongoing turmoil in “hot spots” (e.g., Turkey) isn’t helping. McElligott says the complex is “in a very tough spot” given i) rampant speculation about retaliatory measures from Beijing, ii) a dollar that refuses to roll over amid a strong domestic economy, rates that are still “high” compared to ex-US DM and the persistent supply/demand distortion in Treasurys created by Fed balance sheet runoff of heavy issuance sapping dollar liquidity, and iii) crude rising, which constrains the ability of some EM CBs to ease policy (i.e., fear of a double- inflation-whammy).
“Where is some of this EM outflow *potentially* heading? “, Charlie asks. One possibility is crypto. Have a look:
“Crypto—at least optically—seems like a reasonable thought, as EMFX currencies are at risk of CB rate cut risk and destabilizing currency outflows”, McElligott continues.
Expect the EM discussion to heat up going forward. EM equities and FX are sitting at their lowest since January and things aren’t likely to get any better until the trade narrative improves. “Trade-orientated EM currencies are being dragged down by concerns about the worsening trade outlook, while higher volatility is hurting carry trades”, TD EM strategist Mitul Kotecha said Monday, adding that “there is little that is unscathed in this environment as EM investors reduce and withdraw portfolio capital.”
Whether or not US equities can weather the storm remains to be seen. Remember, there’s likely to be some further de-risking from volatility-control funds this week after trailing realized was pulled higher, so although CTAs might not become forced sellers (again) unless we gap materially lower, the flows backdrop doesn’t feel particularly benign. As Goldman put it on Friday evening, “in general, there is limited combined firepower to buy US stocks.”
Oh, and as far as risk parity goes, Nomura writes on Monday that RP “continues their very ‘end-of-cycle’ allocation — massively long Bonds while reducing Equities.”
“[They’ve] been selling US stocks [and] now [they’re] selling EM and Rest of World too”, McElligott says.