Finesse

It’s perilous to trade in and out of markets at times like these.

Nobody is sure about much, marquee data is on deck and policymakers are queued up around the corner to weigh in publicly on the most vexing macro developments in a generation. As Nomura’s Charlie McElligott put it Monday, it’s “simply a massive week for markets.”

Any number of things could wrong on the way to catalyzing an extension of last week’s bond rout, but with the narrative (i.e., stocks are under pressure from surging real rates) now so heavily socialized, it’s not terribly difficult to imagine it all morphing into a sell the rumor (in bonds), buy the news (hot CPI and hawkish Fedspeak) dynamic.

Big-tech’s Monday reversal was something to behold. The Nasdaq 100 was down 2.7% at one juncture (nearly 9% from a record high hit in November), only to close slightly green (figure below).

There was certainly scope for a bounce after last week’s drubbing, but it would be a mistake to read too much into it. “[There’s] a mounting risk of a sharp counter-trend rally in the beaten-down Nasdaq, particularly considering the extreme magnitude of the Dealer ‘short Gamma’ profile in QQQ along with the shockingly ‘yikes’ scale of the net ‘negative Delta’ across strikes,” McElligott remarked, early in the session.

Rates were a mixed bag. Bear flattening was indicative of conviction around a March rate hike, with two-year yields the highest in 22 months. March liftoff is priced at ~88%. Goldman’s call seems to have cemented already hardened expectations.

With analysts now falling in line around four 2022 hikes and runoff starting by summer, it’s not clear what the catalyst would be for markets to price in additional hawkishness. That potentially opens the door to reversals, however fleeting, both in rates and equities expressions sensitive to higher long-end yields.

You could also argue that long-end outperformance was tantamount to bonds at least acknowledging the extension of the selloff in stocks. Another constructive takeaway (if that’s what you’re after) was the notion that, as BMO’s Ian Lyngen and Ben Jeffery wrote, “Monday’s price action [spoke] not only to investors’ confidence in the Committee to begin raising rates in Q1, but also the effectiveness of doing so on inflation and the real economy.”

All of that said, it was still an inauspicious start to a crucial week. Plainly, the most expensive corners of the US equity market are inclined to additional de-rating absent some sign from Fed officials that the market is ahead of itself on either the pace and number of rate hikes, the start date for balance sheet runoff or both.

JPMorgan sees QT starting in July. “We forecast initial runoff of $25 billion/month that will ramp to $100 billion/month by spring 2023,” the bank said, adding that although no decisions have been made, there are “a few” reasons the Fed could decide to be more aggressive this time around. “FOMC participants could be somewhat motivated by P&L considerations,” JPMorgan remarked, suggesting the Fed may begin to run a net operating loss if overnight rates rise to 2.25%. “This shouldn’t create operational problems for the conduct of monetary policy, but at the margin, we believe the related headlines would be a little embarrassing and the reputational costs could be notable,” the bank added.

As for stocks, BMO’s Lyngen and Jeffery summed up it all up in just a few words. “The purpose of QE was to push investors out the yield curve and down the credit curve – with equities (public and private) as the inevitable end,” they wrote, on Monday afternoon. “QT should serve to facilitate the opposite; it’s ultimately policy finesse from the Fed that will determine how dramatic any repricings in equities and credit become.”

At the risk of trafficking in obvious jokes, Jerome Powell isn’t known for “finesse.”