Bonds are pricing in armageddon or, if hyperbole isn’t your thing, you can just say that if you go by developed market yields, the recession started months ago.
The relentless duration grab sent the “wrong” signal to stocks, which plunged out of the gate on Wall Street, as nervous investors fret over the next wave of selling.
And to think, we haven’t even seen another serious escalation out of China yet. The yuan fix on Wednesday was perilously close to 7, which means the PBoC can send a powerful signal over the next couple of days.
“Bonds [are] indicative of outright central bank policy error/ recession pricing, and this grab into duration is correlating with higher rates vol and freakish ‘short gamma’ flows in both rates and equities”, Nomura’s Charlie McElligott wrote, in his latest daily hot take, which underscores some of the color on rates from the linked post above and also serves as a reminder that one of the key local risk factors for stocks is still in play.
Going over the “stunning bid” for the long end, McElligott calls it “investor capitulation into an outright Global Recession stance”. As far as the underlying dynamics exacerbating the moves, Charlie flags “very directional correlation between duration and rate vol, with large moves in realized reflecting ‘short gamma’ receiving and force-ins from rate vol desks (in 30Y) and convexity hedgers (in 5s through 10s)”. Again, that’s a familiar story.
As far as equities go, Tuesday might have been a false dawn.
“‘Turnaround Tuesday’… was largely driven by forced-covering of dynamic hedging in futures from leveraged funds, following what optically look like systematic selling from CTA Trend after our estimated 2830 ‘deleveraging trigger’ level was cracked Monday night after hours on the reopen”, McElligott writes.
On Tuesday evening, we gently suggested that “some of the systematic selling likely hasn’t run its course”. Charlie has a nuanced take on that. To wit:
Systematic Trend likely “shaken but not stirred”—our CTA Trend model estimated that the S&P futures position price-signal went from -65% following Monday back to +63% yesterday by end yesterday,with potential additional covering now at the 2888 level to chase back into outright +100%. However it should be noted that “smoothing” techniques would likely be applied to avoid these shock flips, ESPECIALLY as that 2830 “sell” level only traded “after hours”…which gives me low conviction in saying that the CTA deleveraging flow has already cleared, and thus remains a risk—thus our model shows SELLING at 2835 to get back to “SHORT”.
That’s a technical way of saying “don’t get too comfortable”.
Finally, he continues to describe the VIX complex as being “wound very tight, due to the ongoing impact of the ’50 Cent’ VIX Call flows with upside convexity being ‘extreme’ due to implied dealer positioning”.
What does that mean? Well, it means pricing continues to reflect expectations of binary outcomes – and “violent” ones, to quote Charlie, at that.