Three Things That Can ‘Make It All Go Right Again’

How do things calm down? That’s the main question on traders’ minds this week.

The simplistic answer is straightforward: Rates need to stop “raging,” as it were.

And folks need to stop speculating about “early” Fed tightening. And real yields need to stop rising. Because conceptually, real yields are the opportunity cost of doing anything other than sitting in a risk-free bond. If that opportunity cost rises, or even if the cost of choosing inflation-adjusted certainty becomes less punitive (i.e., less negative), then all the things priced off those rates (so, basically everything) have to reprice.

That’s where we were at the beginning of March.

In a Monday note, Nomura’s Charlie McElligott enumerated a trio of catalysts which he said “could accelerate some semblance of ‘vol normalization’ this week.” In layman’s terms, he provided a kind of roadmap for how “it could all go ‘right’ again,” as he put it.

First, profit-taking in short-term VIX ETN longs could help. Charlie flagged a weekly drop in net vega, and noted that as longs monetize, the market could “see fwd iVol soften.”

Second, there’s quite a bit of Fedspeak on the calendar ahead of the pre-FOMC quiet period. As discussed at length here over the weekend, this provides officials with an opportunity to jawbone the market and otherwise align the message with that being sent by global counterparts who have been busy attempting to beat back the vigilantes at the gates. The Fed could “push back against the rates move with enhanced forward guidance, under the guise of ‘tightening in financial conditions,'” McElligott wrote, suggesting that they might even try to float an Operation Twist trial balloon.

Third, the market is looking for something on SLR. An extension of pandemic emergency exemptions (the linked article below can serve as a refresher for anyone who may need it) is ideal and, I imagine, expected at some level. But anything besides ongoing silence would be useful.

Read more: Fed Effectively Tells Banks To Increase Leverage With Rule Upping Exposure Capacity By $1.6 Trillion

“The Fed need[s] to clarify to the market whether the SLR relief is going to be extended, while at the same time state whether Treasurys, reserves, or both will be exempted again,” McElligott remarked.

The worry, in essence, is just that the Fed’s silence on the matter is tantamount to brinksmanship, only without any readily discernible purpose. Brinksmanship is almost always undesirable. Brinksmanship in the service of furthering a policy objective is sometimes necessary, but still generally undesirable. Brinksmanship without any obvious rationale (where the Fed was as of Monday) risks being viewed as a manifestation of incompetence — you don’t want that.

“[The] shocking lack of ‘market feel’ from the Fed is contributing to the Treasury selloff, as banks lack visibility [on] whether they can continue to expand their balance sheets with purchases of Treasurys or, conversely, need to shed balance-sheet, deposits and USTs,” McElligott said Monday, noting that an announcement on this has the potential to help stabilize the market depending, of course, on what the decision turns out to be.

So, those are the three factors with the potential to turn things around and make it “all go right again,” as Charlie put it Monday.

“If bonds can be stabilized, then equity vol likely is stabilized, which then would see Nasdaq and Tech Momentum stabilized,” he said. At that point, we could continue down “the road to 4,000-4,200 SPX.” Or up the road. Whichever.