The dramatic bond selloff that blindsided US equities less than 24 hours after Jerome Powell’s post-FOMC press conference suggested markets don’t yet view central banks’ tightening plans as aggressive enough given inflation realities.
That’s according to Nomura’s Charlie McElligott who, on Friday, wrote that the “currently indicated hiking path” for the Fed and the ECB isn’t “at the right place yet” from the market’s perspective.
He noted that at least one proxy for terminal rates has ratcheted dramatically higher over the past eight sessions, to 3.30% for the Fed and 1.50% for the ECB. That, McElligott wrote, “indicat[es] we have a considerable way to go in a short period of time on the policy rate side.”
Those expectations found expression in Thursday’s rates fireworks, documented here and recapped here. McElligott flagged the unit labor cost print and the extent to which it fanned fears of the very wage-price spiral Jerome Powell said the Fed doesn’t yet see evidence of.
“After the number was released, the bond murder” commenced, he wrote, flagging what, at one point, counted among the worst selloffs ever at the long-end. The figure (below) illustrates the peak of Thursday’s rout.
Charlie called that part and parcel of a burgeoning macro narrative centered around the notion that given the likely persistence of inflation, central banks aren’t yet hawkish enough. Note that the BoE’s projection for stagflation in the UK (including double-digit CPI later this year) set against internal dissent on the MPC didn’t help matters.
McElligott went on to detail two additional catalysts for the theatrics in rates which were, in part, “a story of legacy crowded flatteners being unwound” and a manifestation of a few “totally rational ‘truths'” associated with new lows in bond futures and STIRs.
That latter point has been key since the 75bps scare got underway. Late last month, the perception of policy panic prompted a flurry of bearish trades across the US rates complex, as the combination of Jim Bullard’s 75bps trial balloon, Powell’s endorsement of front-loaded hikes and remarks from Mary Daly played absolute havoc. The surge in demand for tail hedges suggested traders weren’t convinced the front-end selloff had run its course, nor were they convinced enough rate hike premium was built in.
Ostensibly, Powell put some of that speculation to bed on Wednesday when he repudiated the 75bps idea but, again, Thursday’s action in rates and bonds, and particularly the connection to the productivity data (i.e., the unit labor cost prints), suggested the market is still skeptical of the notion that a measured, predictable 50bps cadence followed by 25bps deescalations after July is going to cut it (no pun intended).
“This is the simple idea that as new lows are made in STIRs and UST futures, hedgers need to build positions at new lower strikes, which means there’s new open interest being created, and dealers then need to hedge out their associated ‘short gamma’ into an unstable market, adding further selling pressure into these downdrafts,” McElligott wrote Friday.
Meanwhile (and relatedly) the latest flows data betrayed large redemptions from bonds and credit, with the former seeing nine consecutive weeks of outflows and the latter 17.
Between them, bonds and credit funds have lost more than $200 billion YTD on EPFR’s data (figure above).
Finally, Charlie emphasized that Thursday’s “fixed-income disaster was a major input” in the accompanying stock rout, which he described as a “calamity.”
