For the better part of two months, Nomura’s Charlie McElligott has been keen to press the idea that barring a truly epochal shift in American politics accompanied by protracted, widespread social unrest, the market would have a difficult time “realizing” (and there’s a double entendre in there if you look hard enough) the kind of outcomes reflected in some pre-election hedges.
Equities, McElligott variously suggested, could be “slingshot” higher post-election absent a worst-case scenario, while vaccine readouts, pro-cyclical seasonality, and a latent, mechanical bid from vol-sensitive investor cohorts which would re-leverage on realized vol compression, could provide a tailwind into year-end. That’s one sequencing thesis.
There was some scope for things to get sloppy post-Op-Ex, but as Charlie wrote in a Tuesday note, vols are continuing to collapse, and at a speed “beyond anything I could have anticipated.” “Look at this destruction,” he marveled, referencing Monday. He described the vol selling in the front-end as “capitulatory.”
Obviously, one catalyst on Monday afternoon (and into Tuesday) was news that Janet Yellen will be Joe Biden’s Treasury Secretary.
That’s bullish for all the usual reasons (e.g., fond memories of the low vol bubble she presided over, which unfortunately burst the very same day Jerome Powell was sworn in to replace her), but also a few new ones.
The assumption is that Yellen will work to ensure that the recovery from the pandemic is not hamstrung by a lackluster fiscal impulse. In the same vein, Yellen is expected to coordinate closely with Powell in just the kind of monetary-fiscal “partnerships” seen as necessary to bring about more robust, real economic outcomes that matter for Main Street (as opposed to the asset price inflation engendered by monetary policy working in isolation, as it did for most of the post-GFC era).
McElligott emphasized all of that. “The announcement of Yellen as Biden’s Treasury Secretary effectively greenlights 1) ‘lower forever” policy support, 2) big fiscal advocacy, even though the magnitude of that is dependent on the Senate, and 3) quasi-debt monetization, as the Fed and Treasury evolve closer to one, like-minded entity.”
All of that is spot-on. And although Charlie doesn’t go this far, I will. There’s a sense in which Yellen and some of her former colleagues probably feel like she’s (still) the rightful Fed Chair. As Treasury Secretary at a time when the Fed and Treasury are poised to function as “one, like-minded entity” (to quote McElligott), I’d venture that Yellen will be de facto Fed Chair too. It is inconceivable to me that Treasury Secretary Yellen would be rebuffed by Fed Chair Powell in the event they disagreed on the proper course for policy — any policy.
Obviously, those “behind-closed-doors” dynamics will be much more airtight under Biden than they were during Trump’s leaky sieve, gossip factory.
As far as equities into year-end, McElligott reiterated that vol destruction “will continue to feed into an expected mechanical escalation of second-order vol-control re-leveraging in [the] coming weeks, as the position size is inversely proportional to the instrument’s vol.” Volatility is “your exposure toggle,” as Charlie loves to say.
Looking out through December, McElligott said “the feedback from clients is universally bullish into year-end, where any sort of corrective move would be a dip to buy.”