‘Full-Blown, Front-End VaR Shock’ Underway

Amid a never-ending tsunami of terrifying war headlines out of eastern Europe, traders priced out any chance of a 50bps Fed liftoff at this month’s policy meeting. In fact, swaps priced just 24.5bps for the gathering.

So, even as a hike was still seen as a near certainty, the fact that we’ve gone from pricing high odds of a 50bps move to suggesting that a regular, 25bps hike isn’t a total, 100% lock, is remarkable.

“Massive front-end short positioning is being VaR-shocked in full-blown stop-out fashion,” Nomura’s Charlie McElligott said Tuesday, noting that market pricing for the first full ECB hike has now been pushed into next year, while “Fed implied liftoff is now under a full hike in March.”

Again, consider the scope of the roundtrip. As Charlie put it, making the same point I made here at the outset, “the debate has turned from ’25 or 50?’ to now ‘0 or 25?’.” As for the full year, we’re now below five full hikes from seven following January’s foreboding CPI report.

This is a combination of an exogenous shock (Ukraine) forcing a rethink around positioning that was very crowded. The result: A black swan-ish squeeze (figure below).

“The scale of the move was of course too due to the enormous crowding / asymmetry in ‘hawkish’ front-end shorts,” McElligott went on to say, noting that on Nomura’s models, Eurodollar and Euribor futs signals “have both been ‘-100% Short’ since October, and most importantly, had accumulated into the two largest exposures across the entire CTA Trend model.”

Now, some of that short is being force-covered, “kicking off a very large implied $notional buying / squeeze,” as Charlie wrote. Amusingly, more cover/ trigger levels are close, which means additional stop-outs could actually flip the signals long, exacerbating the situation.

Worse, it’s impossible to “play” or “game” or otherwise read due to the sheer ambiguity inherent in all geopolitics, not to mention the dense fog of this particular war and rumors that Vladimir Putin’s “madman theory” approach to the conflict may be more “madman” and less “theory.”

“The risk of slowing growth against persistently higher inflation is very much real, as are risks of ‘worst case’ war outcomes in the worst kind of ‘risk-off’ fashion,” McElligott remarked, summing up. “So this ‘hawkish Rates’ trade and ensuing risk-off ‘dovish stop-out’ remains utterly binary from a macro catalyst- and price-signal- perspective, and could continue to ‘chop’ again, particularly into next week’s potentially ‘still hot’ US CPI print.”