“Stuff is breaking,” macro assets are chaotic and “burning,” but “goofy-ol'” stocks continue to press higher.
That was the overarching message from Nomura’s Charlie McElligott who, in a rollicking Tuesday note, editorialized around various manifestations of macro instability catalyzed by central banks and the war, before explaining buoyant equities.
As for what’s broken, there’s the yen, which is beset by two very simple dynamics. First, Japan imports raw materials, the price of which is soaring and volatile. Second, because the BoJ isn’t facing the same inflation panic as its counterparts, Kuroda is free to stick to the easing script, a dovish bent that’s now wholly anomalous. The bank’s decision to defend the cap on JGB yields this week spoke to a widening policy divergence, pushing USDJPY past 125 for the first time in seven years.
The yen is hardly alone in experiencing dramatic moves. US cash curves are now inverting, and twos look like a crypto chart. On the grid, there’s some “very fine” volatility on “both sides,” to channel a former US president. Incessant hawkish rhetoric and expectations for 50bps increments from the Fed in May and June are supporting left-side vol, while recession worries and the possibility that inflation expectations might come unmoored are in play on the right.
“There are outrageous absolute levels in the upper left side of the USD rate vol surface, with obvious signs of dealer ‘short gamma’ problems, and with little offsetting gamma ‘supply’ as systematic vol shorts pull back after being repeatedly burned,” McElligott said Tuesday, before pointing to EU rates, where it’s “ground zero for a war de-escalation, which [could] stimulate risk appetite, allow[ing] for the resumption of ECB hawkishness.” He flagged a five-sigma move in the ERU 5th contract.
On Tuesday, the ECB’s Pablo Hernandez De Cos warned of “an additional increase in inflationary tensions” tied to energy volatility. “The data for March are going to be particularly negative,” he said, adding that energy prices may stay elevated.
Speaking of energy, McElligott touched on that too, noting “sustained bouts of massive volatility” in commodities.
On Tuesday morning I suggested crude is nearly untradable. Brent’s Monday rout was the third largest ever in dollar terms, and Charlie noted that May 25d puts for WTI are at a 74 vol.
Tuesday was shaping up to be another anomalous session for crude. Anytime you find yourself using the word “another” in conjunction with the word “anomalous,” it means something’s amiss. That’s a contradiction in terms.
“With the market as it is today, you need to put up a lot of money to trade,” Bloomberg’s Alaric Nightingale remarked. “That’s probably why it’s become relatively rare these days for oil not to shift by more than $5 a barrel on any given day.”
So, what about stocks? Why the rally? Well, it’s a flows story or, as Charlie put it, stocks are “doing their ‘flows > macro’ thing.”
Any number of benefits come along with receding vol. Most obviously, vol compression is conducive to re-leveraging from a systematic universe that was substantially purged.
Between them, CTAs, risk parity and vol control dialed up global equities exposure by almost $25 billion over the past week, and by some $60 billion over the past month on Nomura’s models (the figure above doesn’t include vol control).
In addition, McElligott flagged the resumption of positive gamma and positive delta in dealer positioning. Note that the swing in SPX/SPY delta from mid-month through Monday was a net +$817 billion (figure on the left, below).
He called that “astounding,” and noted that the rally in equities simply wouldn’t “have been possible” absent a return to a long gamma, positive delta regime across major US equities index and ETF options. He also quantified the swing in QQQ $Delta, which went from a 0.0%ile rank two weeks ago to a 91%ile rank Monday.
There’s also a “YOLO” kicker, which I’ll get to shortly, but suffice to say that between a dramatic “regime change” (no geopolitical pun intended) in dealer options positioning, systematic re-leveraging on the heels of a “biblical” purge over the past six months and an apparently reinvigorated retail crowd, “equities are just winning on all fronts,” as McElligott put it.
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