Tail Risks Of The Reconstruction: Nomura’s McElligott, BMO, Goldman Talk Rates, Stimulus, Election Nexus

Tail Risks Of The Reconstruction: Nomura’s McElligott, BMO, Goldman Talk Rates, Stimulus, Election Nexus

If everyone else zigs, you may want to zag — at least for a hedge.

With long-end yields stateside having pressed to multi-month highs on the assumption that stimulus is coming (if not pre-election, then in the lame duck session, and if not by year-end, surely by March), and as market participants increasingly view a Democratic sweep as the most likely election outcome, Nomura’s Charlie McElligott wonders if it might be prudent to hedge the tail risks associated with “alternative facts,” if you will.

“I am beginning to believe that as what feels like the majority… is now approaching ‘priced-in’ status on a shared view of [an] ‘imminent’ stimulus deal [and] ‘Blue Wave’ thereafter, this may mean that perhaps the best trade might be to look at expressions of Duration outperformance as hedges,” he said in a Wednesday note.

More comments from Mark Meadows and Nancy Pelosi suggested The White House and Democrats are indeed targeting a deal within 48 hours. That pressured Treasurys lower, steepened the 2s10s, and pushed 10-year yields up to ~83bps. As a reminder, this is where we are:

It’s been a reluctant move higher/wider as the market is skeptical on any number of fronts, including near-term concerns about the Senate’s reluctance to go along with comprehensive virus relief and longer-term considerations tied to the lingering disinflationary drag from the pandemic and the extent to which that exacerbates the well-known, structural deflationary dynamics behind the “slow-flation” macro backdrop that’s dominated for years.

“In 10s, the June peak of 95.5bp represents key support in the event of another meaningful round of bearishness during the latter part of the fourth quarter,” BMO’s Ian Lyngen, Ben Jeffery, and Jon Hill said Wednesday. “While we’re certainly on board with a repricing toward higher yields into year-end… our bearishness is in the confines of the realities of an overarching low rate environment, easy monetary policy stance, and a global pandemic,” they added.

As ever, Lyngen, Hill, and Jeffery are incisive, especially considering the volume of analysis they produce.

Getting back to McElligott, he cautions that eventually, the Fed may need to go ahead with the long-rumored WAM extension in order to offset any undesirable upward pressure on long-end yields tied to stimulus-linked supply (note that I’m trying to couch things in terms that avoid referring to Treasurys as “debt” issued to “fund” stimulus, because that kind of language perpetuates unfortunate misconceptions — it’s not “debt”).

“The point here is that if folks are generally consensually positioned for STEEPENING / Duration sell-off, then you need to hedge the tail-risk of actual FLATTENING”, Charlie wrote Wednesday, citing the potential for no Democratic sweep or (gasp) the return of actual, real inflation.

“A Republican Senate [may] spend the next four years acting as the Trump-free line of last defense against Democrats in the White House and Congress, and will simply mean bogged-down fiscal policy,” he wrote, adding that a “waaaaay ‘tail-ier’ outcome” would find inflation developing “much faster than the market anticipated,” catching the Fed behind the curve (figuratively and literally) and thus “need[ing] to hike sooner than the market previously believed possible.”

Meanwhile, Goldman said Wednesday that “under a status quo result, it seems likely that the bill currently being negotiated could pass in a lame-duck session of Congress in November or December.”

However, the calculus changes if Democrats prevail in the election. “If Democrats win the White House or the Senate, the odds of a stimulus passing in the lame-duck session would be much lower, as Senate Republicans would likely object to a large package, and congressional Democrats would have little incentive to pass a scaled-down bill when they could pass a much larger bill in early 2021,” the bank noted.

As far as getting something done in the next two weeks, Goldman’s Alec Philips thinks you can probably forget it. “Despite an optimistic tone and a slight narrowing of differences, the odds of pre-election fiscal stimulus continue to look very low,” he wrote.


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