‘The Worst Whipsaw Of All’

“Who had bull-steepening on their bingo card?”, Nomura’s Charlie McElligott asked, playfully, in a Tuesday note.

One paradoxical read-through from the RBA’s closely-watched policy decision was that Philip Lowe’s explicit pushback against aggressive market pricing for rate hikes could end up anchoring the front-end, even as the bank did away with an increasingly asinine target for the April 2024 YCC note.

With the Fed on deck and, more importantly for the near-term rates narrative, the BoE set to reveal whether the MPC coin toss resulted in heads or tails, it’s probably a mistake to extrapolate too much from the RBA, especially considering Lowe’s emphasis on Australia being “different.”

That said, Lowe’s almost explicit ruling out of a 2022 rate hike (let alone multiple hikes) does at least suggest that after weeks of tumult, the front-end fireworks, flattening fracas and “policy error” pricing may have gone too far.

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“This ‘relief’ outcome is perhaps the largest ‘reversal’ danger for global fixed income’s recent flattening spasm,” McElligott remarked, referencing Lowe’s comments.

Remember, episodic spasms in rates tend to be multi-faceted and self-perpetuating. This one was no different. Markets rushed to add hikes at the front-end as the BoE seemed increasingly prone to break with post-GFC precedent on the way to deploying preemptive tightening in the face of inflation. That was exacerbated by the BoC’s hawkish lean and abrupt end to QE. As the situation escalated, stop-outs did too, while the long-end voiced its concerns about the likely effect of preemptive hikes on growth by rallying, adding to the flattening impulse, which was further amplified by expectations of slower issuance (less supply).

“The risk [is] that we made the flats, and are now biased again to steepening from here,” McElligott went on to say. “Gasp — even BULL steepening.”

Again, it’s early. And it’s by no means clear that Lowe’s dovish remarks were indicative of some newly-formed consensus among central banks that after last week, it’s time to discourage markets from getting too far ahead of themselves when it comes to pricing the rapid normalization of policy.

But, as Charlie wrote Tuesday, central banks “could push back on market implied hikes with more ‘dovish-y / less hawkish’ commentary this week à la the RBA, which stops the beatdown in the front-end.”

If that were set against still-sticky inflation and a snap back at the long-end, curves could re-steepen.

That’s a kind of melding of a near-term policy dynamic (i.e., central banks dialing back the hawkish rhetoric even as they gingerly proceed with incremental normalization) with a medium-term view on inflation dynamics (e.g., price pressures continue to manifest in PMI anecdotes and PPI, while the surge in home prices starts to “realize” in CPI). It’s a thought experiment of sorts.

An additional input will be October payrolls stateside. If you enjoy seeing markets whipsawed, you might be in for a show.

“Now say we were to get further extension of this new knee-jerk bull-steepening trade this week thanks to less hawkish central bank commentary after the painful stop-outs cleansed steepeners over the last few weeks, and against still very crowded ‘bearish bonds’ positioning,” McElligott wrote, setting up a dramatic hypothetical.

“But then, we print a +1 million payrolls Friday, and proceed to see upticks in CPI, PPI and wages next week,” he continued.

“That whipsaw would be the worst of all,” he said. “From the shock bear-flattening of the past few weeks, then potentially a sudden bull-steepening this week, but then again into another spasmic bear-flattening thereafter,” and all “awkwardly coinciding” with the taper unveil.