As August Melts Into September…

I mentioned there were two key macro narratives on Tuesday, and they’ll stay relevant even as the US labor market takes center stage later this week.

One is the unfolding drama in China, where a societal overhaul disguised as a regulatory crackdown is playing out against a burgeoning economic slowdown. The other is the prospect that the ECB might soon begin to trim asset purchases under its pandemic QE program.

Nomura’s Charlie McElligott weighed in on both while delivering a wide-ranging survey of markets as August melts into September.

In brief remarks on Robert Holzmann’s stimulus comments, McElligott noted that short-term CTA trend could be a “deleveraging risk” for bunds, as net exposure was very long on Nomura’s model.

His remarks on China were more extensive. Clients, he said, want to know when Beijing will “hit the panic button,” where that means “scrambling to ease.” Remember, policy rates haven’t been cut in 16 months (figure below). And last month’s RRR cut was generally seen as a precursor to at least one more move by year-end.

“We expect Beijing to up their bond issuance and fiscal spending alongside the PBoC increasing liquidity via targeted RRR cuts and various lending facilities in an attempt to offset these slowdown pressures over the coming months,” Charlie wrote, but noted that according to colleague Ting Lu, it won’t be enough.

Nomura sees growth in China “drop[ping] significantly, driven by the latest wave of COVID-19, slowing exports, property tightening and the campaign to reduce carbon emissions.” Investors, the bank said, “should be prepared for what could be a much worse-than-expected growth slowdown, more loan and bond defaults and potential stock market turmoil.”

As a reminder, more than three-quarters of those surveyed for the August vintage of BofA’s Global Fund Manager survey expect China to ease over the next several months (figure below).

A multitude of banks cut their outlook for China recently, including JPMorgan and Goldman.

Needless to say, the never-ending deluge of decrees and threats emanating from Beijing won’t help market sentiment in the event the economy continues to decelerate. The services sector contracted this month for the first time since February of 2020.

Read more: The Writing On The Wall

Meanwhile, in US equities, the story remains the same. The vol complex is broken or distorted or whatever adjective you prefer to describe the extremes shown in the table (below, from McElligott).

That makes for quite the contrast with depressed realized vol. And that’s making some folks uncomfortable. “Term structure metrics [are] all uber-extreme, juxtaposed against the ‘gamma hammer’ flows reinforcing the market’s low rVol tight-range strangulation,” Charlie wrote. “In conjunction with implied vols holding flat-to-up, it just doesn’t engender ‘good vibes.'”

Despite the melt-up in the benchmarks (e.g., S&P making a dozen new highs), McElligott noted that “the seasonals for the next two weeks are not particularly bullish.”

Buybacks may slow as earnings season approaches, and when it comes to the September Fed meeting, the dots and SEP still matter, notwithstanding what’s sure to be a concerted effort on Jerome Powell’s part to drive home the notion that the market shouldn’t attempt to divine anything about liftoff from the taper schedule, whenever it’s unveiled (likely in November).

The “stability breeds instability” setup is still in place, by the way. “The big upside strikes in SPX and QQQ options continue picking up a ton of Delta as we print all-time highs every other day, while recent Call overwrite flows have had to reset as we trade through strikes on the low realized volatility melt-up,” McElligott said, noting the upcoming “monster quarterly / serial Op-Ex” and the “coiled spring” that is the vol control universe after months of mechanical accumulation left exposure in the 90th%ile.