Nomura’s McElligott: ‘Goldilocks’ ECB Sets Up ‘Smooth Fed Meeting’ That ‘Keeps The Dream Alive’

One popular narrative around the ECB statement and subsequent press conference was that Mario Draghi somehow wasn’t “dovish enough” or that, when taken together, the new statement and Draghi’s remarks failed to live up to expectations.

That was something of an odd interpretation. After all, the statement clearly telegraphed an easing package encompassing a rate cut, tiering, enhanced forward guidance and, likely, the restart of net asset purchases, to be unveiled in September.

It wasn’t likely that the ECB was going to pull the trigger on Thursday and besides, the euro dove to a two-year low and EZ yields plunged when the statement hit, so you’d be hard pressed to suggest that anyone was “disappointed” with the language or the forward guidance.

Read more: ECB Teases Rate Cuts, Tiering And A Restart To QE

The about face in the euro (and other assets) came during the presser and while you can point to whatever soundbite you like to justify that, Nomura’s Charlie McElligott has another explanation.

“The overly simplistic (and I believe misinterpretation) of yesterday’s post-ECB market price-action was that Draghi was ‘not dovish enough’ and left traders disappointed versus what had been rapidly building expectations following the ugly European PMIs”, he writes in a Friday note, before suggesting that what really happened “was simply a responsible monetization/’buy the spec, sell the news’ of CROWDED & WINNING ‘QE Trades’ particularly in ‘Long Bonds/Receiving Rates/Steepeners’, but also evidenced in ‘Long Equities’ and ‘Long Gold’ which traded backwards yesterday on speculative Discretionary Macro-/Leveraged- fund ‘profit-taking’.”

One of the things we noted on Thursday morning was that between the ECB statement and a string of poor data out of Europe this week (e.g., PMIs and Ifo), the dollar had scope to rally, much to the chagrin of Donald Trump. Imagine what might have happened with that setup had the ECB actually cut rates and/or had Draghi somehow come out even more dovish.

“Any sort of ECB ultra-dovish ‘shock’ yesterday would have put considerable pressure on the Fed to then fulfill even more dovish market expectations next week in order to avoid any sort of USD ‘rage rally’ as an implication of [being] relatively ‘less dovish’ versus the ECB”, McElligott goes on to say in his Friday missive. He then reiterates that such an outcome would “of course pose negative ramifications for US exporters while too drawing the ire of POTUS”.

The read-through, then, is that the Fed is actually in a better position to deliver, as Jerome Powell doesn’t have to try and out-dove Draghi for fear of accidentally sparking a sharp rally in the dollar.

You could argue that some of the pressure for a 50bp cut has now dissipated which, in turn, means the market is free to interpret a 25bp cut accompanied by an overtly dovish spin job as indicating the door is open to an actual easing cycle.

Charlie underscores that, noting that 25bp could actually be preferable “versus a heavier 50bps cut” as the larger move would have risked being interpreted by markets “more as a ONE-TIME ‘insurance’ cut, dictating an even more visceral unwind in the heavily-leveraged fixed-income ‘trend’ positions'”. Those positions are, of course, largely predicated on the idea that what we’ve seen in 2019 is a pivot back towards an extended period of easing. If the market were to get the idea that this is more one-off “insurance” and less “commitment to perpetual accommodation”, it “could turn sloppy without expected follow-up monetary policy support”, McElligott goes on to say.

In the short-term, Charlie says it’s “totally reasonable to expect some unwind in legacy trend ‘2019 QE Trades’ into [and] around the Fed which have made money if you’ve been there, particularly in the most leveraged/crowded areas”. He notes that EDZ9 is now “bleeding out” to lows last seen in May and is cleanly through the 50-DMA for the first time since November.

(BBG)

Over the medium-term, McElligott says a 25bp cut at the July meeting packaged in a sufficiently dovish wrapper that presages another cut by the end of the year “should help ‘keep the dream alive’ for the ‘commencement of easing cycle’ crowd”. That would then reduce the chances of catching folks offsides and mitigate the risk of a hawkish surprise, the worst case scenario.

So, if you’re wondering why implied equity vol. is so low headed into the July FOMC, Charlie suggests “expectations of slow, deliberate Fed ease” (as described above) could explain it.