For beleaguered stocks to stage a durable rally, incoming inflation data needs to be amenable to constructive interpretation.
This week’s early bull steepener suggested the market is open to repricing the Fed path if given an excuse. At the least, some of the risk premium is migrating to the long-end which, while potentially perilous from a big-picture perspective, could spell short-lived relief for risk assets assuming it’s synonymous with a diminution of the near-term, 75bps hike left-tail risk.
“The market is walking back their prior ‘most hawkish’ expectations and monetizing downside expressions in USTs and STIR futures as well as unwinding flatteners,” Nomura’s Charlie McElligott said Tuesday. “For stocks to get legs, it will likely require a second consecutive CPI miss, which then leads to softer Fed rhetoric,” he added, noting that in such a scenario, the market could continue to refine its expectations for the policy path, “dialing back expectations for multiple 50bps hikes beyond July” or even “downshift Fed pricing towards a post-July ‘pause.'”
In the meantime, equities are stranded in what Charlie called, “an awkward ‘no man’s land.'” Stocks are a “tough own,” he said, “which makes this… look like a ‘buyers’ strike,'” in anticipation of a guaranteed 50bps hike in June.
Recent de-risking has seen exposure drop to extreme lows. McElligott cited Nomura’s vol control model as a “dirty proxy for the VaR-down,” noting that it currently sits in just the 5.5%ile (figure on the left, below).
The net global equities exposure rank for CTA Trend is just 2.3%ile on the heels of an estimated $55 billion in selling over the past month (figure on the right, above).
At the same time, there’s scant new demand for crash protection. In fact, McElligott observed, more market participants are worried about missing a rally. “Call Skew is looking borderline frothy,” he said.
But it all hangs on a deescalation from the Fed which, in turn, depends on the evolution of the incoming inflation data. Until there’s concrete evidence to support the “peak inflation” talking point, equities are effectively “capped” by a familiar dynamic.
“Rallies in risk ease financial conditions, which is counterproductive to their efforts to kill demand-side inflationary pressure [and] that’s why equities now look more like a buyers’ strike,” McElligott said Tuesday.
“We’re still held hostage by the fact that the Fed has to get 50bps in June done at the very least [but] the moment the Fed tilts the broader messaging towards downgrading hikes… to something that looks closer to a series of 25bps [moves], things could get a little weird because that’s almost a de facto directional ‘easing’ versus what’s been priced,” he added.
H-Man, the world is being pummeled by inflation. This is not going to end well.