This Is ‘The Most Critical Level In Global Markets’

If you had to choose just one level to watch across the entire global markets universe, what would it be?

One candidate, according to Nomura’s Charlie McElligott, is 127 on 10-year Treasury futures. “The Street is short just a massive amount of downside struck there in TYH2 Puts, with 321,729 of OI,” he wrote Tuesday, as US market participants came back from a long weekend to more rates-related turmoil.

Although 10-year yields initially receded after hitting 1.85% (as expectations for aggressive Fed tightening seen at the front-end ultimately couldn’t be squared with higher long-end yields given the read-through for growth), they promptly started rising again and McElligott noted that we’ve “continue[d] blowing through downside strikes of all levels.”

If 127 goes, he said, “the potential for a ‘short gamma / negative convexity’ event grows substantially on Dealer hedging ‘accelerant’ flows.”

Charlie went on to suggest he was “very wrong” last week to say the Fed was fully priced, but really that depends on one’s lens. Markets are pricing an additional ~50bps of tightening for 2022, but from a kind of 30,000-foot perspective, I’d argue it’ll still take a meaningful “surprise” in top-tier data to move consensus on board with any iteration of policy “panic.”

Additionally, market pricing for the trajectory of rates needs to incorporate not just the possibility that the Fed will substitute the onset of balance sheet runoff for one 25bps hike this year, but also when and how. So, for example, they could hike in March then skip a meeting when they announce QT. Or they could pair an announcement of the associated caps with a 25bps hike instead of resorting to 50bps at one meeting. And so on. There are endless permutations.

In any event, McElligott wrote Tuesday that “the Rates Vigilantes are at the gates and are now pushing through” with four hikes priced and more folks willing to bet on 50bps at the March meeting. As I put it over the weekend, it’s not just Bill Ackman.

“If the Eurodollar market were to go ahead and price… a 50bps ‘rage liftoff’ at the March meeting, the Fed will simply ‘have to’ take what the market is dictating to them,” even if they may not like it, McElligott remarked.

The bank’s CTA model shows “‘-100% Short’ signals across every G10 Bond and MM Rate,” he added, on the way to noting that the aggregate notional position “of the G10 DM Bond ‘short’… is > -2 z-score dating back to 2002.” CTAs, McElligott said, “keep winning on this Rates / Bond momentum.”

Something tells me trend-following strats aren’t “tired of winning” just yet. And it’s possible the rates vigilantes won’t be satisfied with the gates. They may start scaling the walls soon.