Although the bar for the Fed to slow the pace of rate hikes remains very high (and thus the odds of a “pause,” let alone an outright dovish pivot, very low), the reaction across markets to the Committee’s hawkish messaging may serve to reduce the sense of urgency among policymakers.
If that’s the case, the stage could be set for a reversal of recent trend trades, including shorts in rates and equities, as well as accompanying longs in commodities and the dollar.
That’s according to Nomura’s Charlie McElligott, who on Thursday flagged what he called a “critical” near-term inflection following the market’s painful, begrudging acquiescence to the Fed’s efforts to tighten financial conditions.
Nuance is key. McElligott on Wednesday suggested those hoping for a “Bostic pause” (as the media took to calling it) may be disappointed. But now that the Fed has successfully engineered i) a sizable correction in stock prices, ii) a material widening in credit spreads, iii) sharply higher mortgage rates, which are spilling over into the housing data, and iv) a slowdown in activity as measured by PMIs, the incentive for incremental hawkish escalations may have diminished.
“The Fed is getting almost everything they wanted,” McElligott said, noting that Nomura’s econ team, which previously called for consecutive 75bps hikes, now sees three 50bps hikes instead. “Recent trend reversals are telling you locally that” the market’s apparent “acceptance” of the Fed’s commitment to the inflation fight means “the near-term urgency to escalate has faded,” he added.
What does that mean? Well, among other things, it could potentially lead to re-leveraging/re-risking/re-allocating from the systematic crowd, where positioning in equities is still loitering in the single-digit percentiles for CTAs and vol control, and in just the 34%ile for risk parity.
CTAs have already seen buy-to-cover flows in excess of $16 billion over the past two weeks, Charlie said. Any additional rally would push spot closer to trigger levels, while risk parity could be in play contingent (by definition) on a decline in vol.
Even more compelling (potentially) is a reallocation from vol control, given sticky, but ultimately unsustainable, extremes in trailing realized (figure below).
One-month is coming down, and vol does tend to mean revert.
“There is enormous re-allocation flow energy here to buy back equities exposure over the coming days and weeks under almost any ‘daily change’ scenario,” McElligott wrote.
The figure (below) shows vol control would be buying in all but the most erratic scenarios.
Meanwhile, dealer gamma positioning is still negative, and thereby conducive to accelerant flows (i.e., selling into a hole or buying into rallies), but the situation isn’t as acute as it was just a week ago.
And, with so much negative delta strewn about, there’s ample scope for a domino-effect-style squeeze, assuming a spot rally.
Of course, all of this is tactical — it’s near-term. As McElligott put it, “we think there’s another ‘hawkish impulse’ left.” The bank’s econ team expects hot May inflation data “will underscore the scale of the problem policymakers face” over the summer.
US shares rallied sharply on Thursday, and the S&P was on track to snap its longest stretch of weekly losses in more than two decades.
I dont believe in technical analysis; having said that, I can’t help but notice that ETH looks like it will crash below key support levels any time now.
If BTC and ETH indeed crash, say next week, I doubt that there will not be spillover into stocks via the sentiment channel as per H’s recent article.
I believe 2 x 75 bps was not ever going to happen. Central Bankers just don’t work this way under almost any circumstance in developed markets- especially not in the currency of last resort. If you read reports on the ground, at the corporate level- margin pressure is here- and not just because of the supply side- they cannot pass on all their costs as demand is weakening. First on the fiscal side- the stimulus is gone. And monetary policy and financial conditions are is tightening. Just as the Fed did not have to buy that many corporate bonds during the 2020 pandemic crisis, just the signalling effect of saying they will tighten fast and hard makes it less necessary to do so. The financial markets are doing it for them. If the Fed is so late, why is the US$ index so high? Many financial indicators suggest we are near the end of the economic cycle. A good bet is that the terminal Fed funds rate this go around is going to be about 2%. That would suggest that 2 quick 50s will pretty much get us there. There may be another 25 or maybe 50 after that but that is all she wrote. The structure of the US economy is so different now than prior to the GFC. So much more leverage, and far more exposure to foreign trade and money flows. So you can throw all those models that look at time series for answers. The structure has just changed too much. 200 bps on mortgages just put the brakes on housing. Anyone care to bet which way mortgage rates are headed. My answer is lower…..
Feels right to me. Let’s see how this shakes out. Not selling.
I’m interested to see how everyone (FED + market participants) reacts when M-O-M Core CPI comes in 0.3, 0.3, 0.2, etc., but M-O-M Headline CPI comes in 0.7, 0.8, 0.8, etc. due to unrelenting Food and Energy prices. How long does the “ignore Food and Energy, those are highly volatile” concept hold water if those are the categories that wind up with the sticky inflation?
That’s my feeling as well. My wife and I recently purchased a house with a 7/1 ARM. She was looking at a doom and gloom article about “projected” mortgage rates going to 7% or 8% over the next 5 years. I had to explain to her how that is extremely unlikely for a variety of reasons and we’d have much bigger issues as a country if that happens. I can pretty much guarantee we’ll be able to refinance in the next few years at a much more attractive rate.
On the other side of the argument, I’m recommending friends to effectively buy the insurance of a fixed rate mortgage with the expectation to refinance in a few years if all goes well, instead of literally betting the house on wether inflation subsides or not.
With so many baby boomers retiring in the next few years, low immigration rates, low birth rates, conflict for the foreseeable future, 1980s inflation can’t be ruled out. Plus the Fed will not be buying MBS in a very long time: 5% might be the new floor for mortgage rates.
If we do have bigger issues as a country with higher rates in 5-10 years, recent buyers don’t want to see themselves forced to increase mortgage payments or sell.
Of course, I don’t know your circumstances so this is no judgement on your choice.
Yep, that’s very fair. We are fortunate enough to be in a position where we could probably pay down most of the house at that point and can afford to take the risk on rates potentially going up, but agreed that it is a major risk for many homeowners who might already be stretching their budget.
Literally just moved into my new house today. Went with a 5/1 ARM and same logic as you–can pay it all, or a good chunk of it, off if rates moon. I also live in an area that has seen growth, but not the exponential growth of the hottest housing markets.
The issue would be, if it’s that quick to stop then why wouldn’t it rise right back up just as fast?
Cash would just go back to buying homes and goods except we still don’t have clarity on China lockdown and growth to take pressure of supply so we would be right back where we are. We will see about Russia and drought issues already in place. The reported level of savings seems to hold to a degree after these months and add to that we are still adding jobs and not shaving many off.
COST on inflation
“For Q1, we estimate price inflation was in the 4.5% to 5% range. For Q2, we had estimated 6%-ish, if you will. And for Q3 and talking to our merchants, estimated price inflation was in the 7%-ish range.”