‘Violent’ Rates Shock Is ‘Gut Punch’ To Staggering Stocks

When you think high drama, you don’t generally think data-less Friday in April.

But these times of ours are unique. They’re also trying.

The final session of a vexing week was a minefield, as all 11 S&P groups retreated amid a few earnings mishaps and what I think it’s fair to describe as policy panic — among market participants, yes, but also among policymakers themselves.

Days of aggressively hawkish rhetoric from US officials compelled at least one bank to adopt twin 75bps rate hikes as their base case, a testament to the notion that the Fed’s message is getting through. Investor psychology is accordingly bleak. US shares notched another weekly decline (simple figure below) after closing on the lows.

“In a more traditional environment, a data-less Friday in the US rates market would suggest little was in the offing that could materially impact the overall trajectory of yields,” BMO’s Ben Jeffery and Ian Lyngen said. “Alas, the current high-volatility regime means that the price action itself holds the potential to reveal critical information on the current reaction function among market participants.”

That applies to stocks too. Although steep declines for equities helped bonds trim losses, there was little in the way of evidence to suggest rates are keen to fade the Fed. Yields were essentially flat into the afternoon. During the US morning, the long-end was richer and 2s cheaper, underscoring “sticky” Fed worries on the back of Thursday’s bloodbath across the rates complex, both stateside and across the pond.

“The risk now is that as markets have so violently and so quickly re-priced rates (with the front-end impulse lower seeing upper left vols squeeze again on a wider potential distribution of outcomes in a shorter period), we’re making fresh lows in STIRS and UST futs to such an extent that there is no real OI at these new levels,” Nomura’s Charlie McElligott said.

That’s potentially problematic, as the trek into uncharted water creates demand for protection. “As such, we’re seeing impulsive new downside grabbing that further risks dealer ‘short gamma’ hedging flows, in addition to enhanced hedging from the convexity crowd as we break down to fresh lows,” McElligott went on to write.

In equities, Verizon blighted a tape that would’ve been ugly enough on its own. The shares fell 6% as investors indicted the carrier’s guidance (figure below).

The analyst commentary on Verizon was amusingly blunt. “This is disappointing,” someone said.

Again, though, the story is rates. Stocks are exceptionally sensitive to volatility tied to Fed hike escalations, which hit equities on two fronts. There’s the mechanical drag from higher yields and the read-through for the economy of aggressive tightening aimed at reining in inflation even if that means engineering demand destruction.

Now that some (read: many) of these US rates expressions are exploring new territory, the odds of disorderly price action have increased.

McElligott drove it home. “It’s likely we begin seeing a new string of STIRS / UST downside optionality trades brewing for protection purposes… which then means likely ‘accelerant’ flow risk from dealers hedging their short gamma as we push into new lows in ED$, SOFR and UST futs,” he wrote, calling this “a gut punch to markets and sentiment.”