“This is where I expect [the] next wave of monetization in hedges… to create an ‘optical’ market bounce over the coming days”, Nomura’s Charlie McElligott writes on Tuesday morning, as Monday’s panic gives was to a tenuous calm on the back of what the media is pitching as “optimistic” soundbites from Donald Trump.
It’s now widely accepted that some of the selling we saw last week was down to asset managers taking profits and CTAs de-leveraging as benchmarks fell through key trigger levels, and McElligott thinks that de-risking is likely to “thin” now. To the extent Monday’s rout was exacerbated by de-leveraging from the vol.-targeting crowd, Charlie thinks that source of incremental, mechanical selling is likely to “slow too”.
When it comes to the monetization of hedges, McElligott cites “the enormous fodder of fresh Shorts which have been piled-into over the past week and half [in] index, ETF and single-name Equities.”
As far as pivot points for CTAs, we’re back in “no man’s land”, as Charlie puts it. De-leveraging levels are well below spot, while re-risking pivots aren’t entirely out of reach – “SPX adding again above 2908, selling under 2707 and flipping to ‘short’ under 2691”, he writes.
The grab for exposure is now dust in the wind – “purged”, thanks to the recent price action. Meanwhile, we’re now squarely in negative gamma territory.
On the VIX curve – one of last week’s critical subplots – we’re still inverted, but McElligott notes that the term structure is lower DoD “off the back of a generic relief rally overnight.” The “generic” characterization is just a nod to Trump not having said anything new or, really, anything meaningful whatsoever.
“VVIX too will reset lower after yesterday’s renewed bout of tail hedge ‘grab'”, Charlie continues, reminding you for the umpteenth time that “this is all consistent with… VVIX as the ‘patient zero’ indicator, then the VIX complex, then ‘delta one’.” Here’s a recreation of a chart he’s used in two notes over the past week (this version is just larger and sharper – resolution wise – for ease of use purposes):
For those who like analogs, Charlie has one for you.
Specifically, he notes that “for a ‘Two VIX +25% prints in either 1w- or 2w-‘ period”, there’s typically a “SPX up, then down, then up big again” dynamic, if history is any guide.
McElligott sums that up in colloquial terms: “Equities squeeze over next one- to two- weeks with ‘short fodder’ added and positioning purged, chop-to-lower out 1 month again as squeeze fatigues, then higher again from there.”
So, if it’s a tactical ray of sunshine you’re looking for, one supposes you can look to the monetization of hedges as a possible catalyst for a “relief bounce”.
If you’re just not enamored with the current backdrop, then you can always just stick with the rate cut bets. “The Long Eurodollar risk-book hedge discussed… has worked as expected [and not just because] the market [is] seeking the generic safety and liquidity of US Rates”, McElligott wrote as a kind of aside in Tuesday’s note. The trade war drama has obviously stoked renewed bets on Fed easing.
Bloomberg’s Richard Jones touched on this Tuesday as well. “As the 2019 and 2020 Eurodollars approach the late March highs, expect the current rally to lose some steam and prices to pull back [but] any reversal will be shallow as market sentiment toward easing keeps the buy-the-dip dynamic in play”, he wrote, adding that “the 2019 Eurodollars have rallied 5bps-10bps this month [and] any pullback… will be snapped up by traders [who] are clear on what the Fed does next.”