“Yesterday’s monster cross-asset ‘momentum’ reversal saw the first real drawdown in ‘trend trades’ in months”, Nomura’s Charlie McElligott wrote Friday, looking back on an eventful Thursday session that saw bonds summarily routed just days after US government debt wrapped up the best month since 2008.
“Patient-zero was the US Rates / Duration space”, Charlie notes, underscoring the point, calling the bond selloff “death by thousand paper cuts”.
We enumerated those on Thursday, and McElligott lists them all, from “calming macro left tails” (i.e., Brexit risk dissipating on Boris’s blunders; expectations that there will eventually be some resolution in Hong Kong after Carrie Lam formally yanked the extradition bill; and scheduled trade talks between the US and China) to US data surprises to the deluge of IG issuance which led to “heavy swapping and rate-lock hedging”.
Charlie goes on to say that the “final cherry on top of the selloff was a technical glitch that postponed Thursday’s POMO, which meant $2.25B of 20-30 year coupon purchases didn’t occur as planned”.
Hence, the biggest jump in 10-year yields since January 4 and one of the worst days for TLT since Trump’s election:
If you’ve been following McElligott’s running commentary of late, you’ve probably surmised that he generally got the equities move correct, something he underscores on Friday.
“Looking at the overall US Equities trade yesterday, I’d say we nailed it”, he writes, adding that the ‘”Gamma Gravity’ pin-job between the two massive $Gamma strikes (2950 & 3000) looks to be ‘bang on'”.
One of the cornerstones of Charlie’s sequencing thesis for September (risk-on into mid-month, and then fade thereafter) involves overwriters rolling in-the-money calls and corporates getting in some buybacks ahead of the blackout. Both of those were in play on Thursday, he says.
“[There was] clear evidence of ‘buy-writers’ buying back their overwrites and rolling—e.g. Sep6th 2875 Oct 2975 CS paper pays 42.00 for Sep6th 4000 x’s, created $500mm in delta to buy”, he says, before flagging “evidence of an aggressive corporate share repurchase bid in the market [with] the Nomura-Instinet ‘Buyback’ factor finish[ing] +1.6% on the day, an enormous +3.2 z-score move (1Y rel)”.
All of that played out against “bigly” (sorry) “under-the-hood” action, something McElligott spends quite a bit of time on.
“As I have highlighted for months, any sort of reversal in the ‘duration grab’ would risk presenting large performance shock risk into US Equities, where ‘pure’ momentum has been ‘long secular growth and defensives / min vol (positively correlated to lower yields) versus short cyclicals (negatively correlated to lower yields)”, he reminds you.
Then he quotes himself. To wit (because you really need the verbatim here to get the requisite chuckles):
Allow myself to quote…myself: “On any bond sell-off, you’re gonna get a really convex move in all the things people are really underweight.” Me, RealVision interview 8/29/19
And so it was, with Thursday witnessing a “violent factor reversal” as 1Y Price Momentum suffered to the tune of -3% (a -3.4 z-score move, Charlie observes) while a half-dozen of Nomura’s Value factors enjoyed larger than +2 z-score moves on the day.
Critically, though, Thursday likely didn’t mark any kind of epochal shift. Rather, it was just a predictable position cleanse catalyzed by the bond rout.
“[This isn’t] indicative of a ‘sea-change’ rotation from US Equities investors into Value, with Sec Growth / Min Vol as ‘source of funds'”, Charlie says.
What would it take to get that kind of serious, long-lasting shift? Well, the macro backdrop would have to stabilize, for one. That would require meaningful progress on Sino-US relations which could then, in turn, give central banks some scope to pivot less dovish, potentially shaking out weak hands (i.e., the johnny-come-latelies to the duration infatuation trade).
Beyond that, we would need to see fiscal stimulus.
“From a secular perspective, the only catalyst I can see on the horizon to turn the tide of perpetually lower / negative rates would be widespread global pursuit of fiscal stimulus, in the potential form of US MMT (i.e. a Democrat wins the US election next year)”, McElligott says.