Over the past two weeks (give or take), I’ve argued that markets were teetering precariously on the edge of a “false optic” growth scare.
Positioning unwinds and stop-outs accelerated a burgeoning bond rally, which began to feed on itself. Lackluster summer liquidity appeared to exacerbate the situation.
By this week, the risk was clear: Falling yields could be seen as “validation” (from the market) that worries about peak growth were justified. “Delta” variant concerns were fuel on the fire.
Read more: The Danger Of False Optics
On Thursday, this conjuncture looked poised to tip over, as equities wavered and bonds extended gains.
30-year US yields dropped below 1.90%, while 10-year yields fell to ~1.25%, more than 50bps below the mini-tantrum peak, and the lowest since February 16 (figure below).
Meanwhile, bund yields touched a three-month low on the heels of news that the ECB will lift its inflation target to 2% (from “below, but close to 2%”) and allow modest overshoots if necessary. That opens the door to prolonged easing in Europe, although I suppose I’d just state the obvious: ECB accommodation is already prolonged.
“Our working theory is that we’re in the middle of a modest global growth scare,” DataTrek Research’s Nicholas Colas and Jessica Rabe wrote.
That’s correct. But, again, I’d reiterate that this is something of a false optic — a Fata Morgana. Peak earnings growth and peak expansion are behind us in rate of change terms, but the global economy is poised for robust growth in 2021.
One concern is that the Fed may have pivoted (hawkish) too quickly. That may seem absurd (and it is) considering the “momentous” pivot involved little more than a mark-to-market exercise in near-term inflation projections and a shift up in the dot plot. But the June FOMC also underscored the idea that when push comes to shove (i.e., when realized inflation actually overshoots), policymakers will get weak knees. That, in turn, prompted bull-flattening in the curve (figure below).
The 5s30s is now back near levels seen just after the June FOMC. Again: This sends the “wrong” message about growth.
“Much has been made of the divergence between the performance of the US real economy and the summertime rally that has defied the bond bears’ expectations for the cheaper and steeper narrative to persist beyond Q1,” BMO’s Ian Lyngen and Ben Jeffery said Thursday. “We’re certainly on board with the rally and wouldn’t look to fade it in any meaningful size just yet – acknowledging the risk of a period of consolidation, if nothing else,” they added, noting that “the steady grinding nature of the bid suggests any retracement will be shallow, while drifting toward even lower yields remains the path of least resistance.”
There’s a very real sense in which this entire dynamic amounts to market participants being scared of their own reflection. And it’s very difficult to get a clean read on things during the summer months. For now, though, “reflation” (the trade and the narrative) look to be in jeopardy.
“The unraveling of the reflation trade has accelerated over the past week,” SocGen’s Albert Edwards wrote Thursday, adding that with US 10-year yields having broken a key technical level, the rally could “accelerate sharply, and with it, the continued unraveling of cyclicals and commodities.”
A few of us, unbeholden to ancient economic theories, have believed that, until this week, we’ve been in the midst of an inflation scare rather than a growth scare.
If we are wrong, asset prices will suffer as the Fed overreacts. It looks like a lose-lose to me.
But what do I know?
John Authers of Bloomberg, had a really good summation of the possible issues related to the growth scare. There is not usually one explanation- a further one is that sentiment has shifted. I give a lot of credit to fears of covid variants. One analyst Marko Kalonovic (JPM) has suggested this fear is overblown. However, I do not think anyone, short of g-d really knows whether or not this will be a major factor- it is an attempt to model a random event (virus mutation) which cannot possibly be modeled. To the extent that affects sentiment- at least- it is a factor. A bull flattening curve more than level of interest rates is concerning.
Tody’s price is tomorrow’s news….I think the moves are getting bigger and shorter in time…This is what happens in relatively high volatility periods..I try not to read too much into it…An extremme example is lumber in the last couple of months
We have inflation so long as we have demand, we have demand so long as we have cheap debt and government stimulus, we have those so long as things are bad… so as soon as things start to go good they’ll go bad faster than the things holding it together can catch it. You need the stimulus and the accommodation until supply catches up with demand… not just until demand begins to hit supply challenges. You don’t drive a car by constantly keeping it so fuel starved it constantly is on the verge of stalling then attempt to recover it again. You want the acceleration to kick in and get to a desired speed before cutting fuel flow.