Nomura’s Charlie McElligott didn’t mince words when it came to describing the last couple of days.
“Well that was one of the most manic 36 hours of trading I have ever witnessed in my 18 year career”, he remarked, in a Friday note.
Obviously, Donald Trump’s decision to escalate the trade conflict with China changes the game when it comes to Fed prognosticating. Goldman, for example, quickly raised their subjective odds for a September cut from 60% to 80% on Thursday evening in light of the president’s tweets.
For McElligott, Trump’s latest (and, the president would say, “greatest”) trade broadside renders a fledgling long dollar/short duration trade idea null and void. “I was ready to enter a tactical ‘long USD’ + ‘short duration’ position into August’s seasonal volatility and high likelihood of Fed disappointment in September as per the Powell commentary”, he writes, while simultaneously noting how “laughable” that idea now seems after yet another out-of-the-blue Twitter declaration from the commander-in-chief.
“President Trump has again changed the market calculus and thus investors are now forced to adjust their views on the monetary policy path from here, as this re-escalation of the China trade war likely forces the Fed (and ‘competing’ Central Banks in beggar-thy-neighbor currency devaluation fashion) to once again ‘bend the knee’ in a preemptive strike against the negative forward growth implications”, Charlie says.
And so, a September cut is fully priced (versus almost a coin flip following the Fed meeting). Between the renewed trade tensions (which are now “boiling over”, not just “simmering” to employ Powell’s vernacular from the press conference) and fresh evidence that the global manufacturing slump is finally making landfall stateside, the idea of crowded cross-asset macro positioning being grossed down “has been conceptually ‘stopped-out’ dead in its tracks”, McElligott declares, citing (among other things) the “fresh wave of stop-ins’ to all things Duration- and Rates- linked” including a multi-standard deviation move in reds on Thursday.
He goes on to cite the following reinvigorated duration grab expressions:
- Real Money—both foreign and domestic—have been driving the demand seen on our desk for weeks, and that continued yday
- Overnight there was talk of Asian Real $ flatteners going-through, as well as outright long-end buying
- Suffice to say that on any breakout to new levels (in this case, fresh multi-year levels), you are likely going to see (negative) convexity hedgers active—which from the looks of the trade in swaps yday, we got that in the form of new Receiving flows
- Also too then it’s likely that there are fresh duration buys in the long-end originated from Vol Dealer desks, who too are being forced-in as per Gamma hedging requirements from the incessant Receiver demand
As far as equities go, McElligott quips that he “certainly got [his] anticipated August ‘Vol Spike’ call correct, with US Equities ‘vol of vol’ seeing a 9.2 vols move yesterday alone and indicating a massive grab for tails, as the whole curve was lifted”.
Clearly, the door is open for a correction and as we highlighted on Thursday afternoon (citing Charlie’s Wednesday note), dealers are now short gamma after yesterday’s selloff.
That’s one local risk realized. In addition, McElligott flags “bulk” dealer vol. shorts and recent reengagement (in “significant size”) from systematic VIX roll-down players, who will now have to hedge. Then there’s VIX seasonality, and the prospect of a sustained vol. spike pulling up trailing realized and thereby forcing de-leveraging from the vol.-control crowd. As far as CTAs go, the QIS model shows de-leveraging under 2,916 SPX.
For what it’s worth, the VIX is on track for its longest stretch of daily gains since October.
Of course, the irony in all of this is that the crazier things get, the more inclined the Fed will be to ease. Indeed, it seems entirely likely that Trump is angling to engineer just that outcome.
As Charlie puts it, “these market shock events only firm the case for more investor-conditioned ‘buy the escalated Fed easing case’, as external risks to growth further percolate”.