It’s “Global Growth Scare 3.0” on Wednesday, following lackluster April activity data out of China.
As bond yields tumble, Nomura’s Charlie McElligott notes that easing bets are now back on the front burner, especially given the escalation in trade tensions.
“EDM9EDM0 [is] now implying 45.25bps of Fed cuts between now and June 2020 versus 38bps yesterday, a monster DoD change”, Charlie wrote Wednesday morning, adding that this marks a new “peak inversion” taking us through the highs seen during the late-March growth scare when a powerful DM bond rally rippled across markets.
Nomura is calling the Chinese data evidence of a “double-dip slowdown”. I’d call that bombastic were it not for the fact that Wednesday’s activity data comes on the heels of PMI misses, a renewed deceleration in exports and credit growth data that fell well short of estimates for April.
The good news is, you can expect more stimulus.
“We expect Beijing to significantly ramp up easing/stimulus measures to stabilize financial markets and bolster growth”, Nomura’s Ting Lu wrote Wednesday. “We also expect Beijing to especially push forward its non-conventional policy easing measures, such as providing special support to the private sector, cutting taxes and deregulating the property markets in big cities.”
So, basically, if China can do it without ruffling any feathers or stoking concerns about flooding the market with liquidity (potentially exacerbating the frothy equity market), they’re going to do it. That was clearly the expectation from markets on Wednesday, as Mainland shares surged, led by consumer names.
The problem is that in a world where the narrative has again flipped back to centering on growth concerns and, by extension, disinflation (if not outright deflation), crowded positioning means an upside inflation surprise is a disconcerting tail risk or, as McElligott puts it, “the largest cross-asset volatility risk.”
This comes just as Donald Trump looks set to go “all-in” on the tariffs, which could well push up inflation. Here’s McElligott to explain the problem:
The “new” Chinese double-dip into weakening US inflation trajectory and uptick in trade war breakdown risk has built [a] massive UST / Rates “Long” at a time when 1) China is again going to be forced to escalate easing- and stimulus-, while too 2) we see the market utterly cynical on the stickiness of US inflation upside risk as per the enormous “Bond Long” and “Slow-flation” in Equities just as 3) we are about to escalate Tariffs (which will drive domestic prices HIGHER) and 4) ANOTHER acceleration of “pull forward” ordering ahead of additional tariffs (which could again temporarily stimulate global data similar to the March releases) should really put the Fed between a rock and a hard place…and too likely means more performance-pain inducing “unwind / rebalancing” in coming-months.
Again, positioning across rates is predicated on growth worries and easing bets, and that comes at a time when a multitude of factors are conspiring to create the conditions for a possible upside inflation surprise, however unlikely and/or far-fetched that might seem. For CTAs, bonds are still in-trend – on Nomura’s QIS model, the 100% Long signal holds.
We’re nowhere near de-leveraging triggers for UST futures.
For risk parity, Charlie’s model shows DM positioning has seen “enormous exposure growth” year-on-year.
So, fear the “rogue” inflation upside surprise, one supposes, as it would catch everyone woefully wrong-footed, presumably triggering a spike in cross-asset vol. starting in the rates space. Meanwhile, the fact that the “growth scare”/”easing bets” trade remains so “consensus” probably shouldn’t be a source of comfort, no matter how much you love central bank stimulus.
Finally, remember that an all-out trade war is in many ways the worst of all possible worlds, as it has the potential to both lift inflation and depress growth, leaving central banks with a kind of Sophie’s choice.
On that note, we’ll leave you with a quick passage from the latest note by Deutsche Bank’s Aleksandar Kocic:
If the currency does not offset the effect of tariffs, then the imported goods become more expensive and the US consumers and production process carry the burden. In general, both output and inflation are affected –the effect is bearish for growth and supportive of higher price levels. In the long run, this is a steeper curve, most likely bearish, which requires a difficult decision making by the central banks. It is a risky outcome given the markets’ positioning and a considerable negative convexity exposure in credit due to redistribution of leverage from financial to corporate sector, which becomes vulnerable to bearish spread wideners, a likely outcome in this case.