Obviously, the macro narrative is a train wreck.
The Trump administration’s apparently imminent offensive against Chinese surveillance companies only adds to the trade tensions. The odds of a near-term deal are essentially zero.
Steve Mnuchin on Wednesday morning said he currently has no plans to go to Beijing. Everyone’s base case will probably shift to include relatively high odds of Trump slapping tariffs on all Chinese imports next month.
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All of that is in addition to the increasingly dangerous standoff with Iran. Oh, and Italy is melting again too. And Turkey – oh, God. Don’t even look at Turkey.
Still, DM equities haven’t been summarily routed – or at least not in a way that conjures memories of February, October and December. Chip stocks have had a horrific go of it and there have, in fact, been some harrowing days this month (especially for mainland shares in China), but we haven’t had a panic selloff stateside just yet.
For Nomura’s Charlie McElligott, the relative resilience of equities is attributable to a number of identifiable factors, some of which serve as “flow catalysts for ‘rolling squeezes’ despite the deteriorating macro” picture.
McElligott elaborates. “The recent bulking-up of Shorts and reduction of Nets (1Y + lows) from Leveraged Funds act as potential ‘upside risk’ demand catalysts”, he writes in a Wednesday morning note. That’s “especially” the case given that his famous CTA models are “well within reach of COVERING levels [for] Global Equities in Russell, Eurostoxx, Nikkei, DAX, FTSE, CAC, Hang Seng / Hang Seng CH and KOSPI.” We’re getting close to re-leveraging levels on SPX and the Nasdaq too, he writes.
On aggregate, Charlie says CTA positioning is the most net short since just prior to the long pivot in early February. (I’m not sure how he derives the following chart – I tried to replicate it, but can’t – it looks like it’s based on Nomura’s QIS model).
“The danger”, then, is that shorts are covered on a gap higher as re-leveraging trigger levels are breached. (All it takes is one upbeat tweet to change the narrative.)
Meanwhile, McElligott also notes that according to Nomura’s risk parity model, exposure to US equities is sitting at a more than 2-year low. That means “there’s plenty of room to add from systematic / vol-sensitive buyers”, Charlie writes, adding that this comes just as “VIX roll-down strategies are again in position to sell vol with the term structure back neatly in contango”.
Throw in the return of systematic vol. sellers (put underwriters), and you’ve got a recipe for “pressure on vol”, Charlie concludes.
What does all of this mean? Well, it means that the complete breakdown of the trade talks (and the concurrent deterioration in the macro narrative more generally) may be offset by equity demand of a mechanical sort. With dealers’ gamma profile basically neutral, the conditions are in place for a macro-flows tug-of-war that leads to sideways “chop”.