$35 Trillion Was Enough (Pivot Point)

A year ago last month, the Norges Bank became the first central bank to raise rates in the pandemic era among countries with the 10 most-traded currencies.

The frantic hawkish procession that followed found developed market policymakers in unfamiliar territory: Raising rates in very large increments to catch runaway inflation. 2022 marked an unceremonious end to the four-decade bond bull market. “The Great Moderation” was over. The economic legacy of the pandemic, alongside the macro shockwaves and geostrategic jostling brought about by the war in Ukraine, conspired to usher in a new, inflationary paradigm.

Since August of last year, central banks have delivered 295 rate hikes, according to BofA, compared to 1,302 rate cuts since Lehman. At the same time, markets have seen more than $3 trillion in QT over just seven months. USD M2 growth has turned negative across the world’s four largest economies. The result: An across-the-board selloff that spared no asset.

The value destruction across global equities and bonds exceeded $35 trillion in just nine months. It was the largest value destruction event in modern history (figure above).

I’ve variously suggested markets (and economies) reached a breaking point last month. Between the yen’s collapse, the PBoC’s increasingly forceful efforts to slow the pace of yuan depreciation and, finally, the Bank of England’s intervention to prevent an overnight financial crisis in the UK, it’s obvious that markets are on the brink. Wild speculation about Credit Suisse is yet another sign that policymakers are losing control of the narrative — not that they ever had control in the first place.

This week may be remembered as the pivot point. The RBA’s smaller-than-expected rate hike on Tuesday and (arguably) dovish statement was written off by some as idiosyncratic, but the same was said of the BoE’s intervention in long-dated gilts last week. So, that’s two idiosyncrasies in five days.

I’m not suggesting deliberate coordination. Rather, I’m suggesting that conditions are deteriorating such that things are either breaking or are on the verge of breaking across locales, which is prompting a mini-panic. If policymakers turn incrementally dovish and begin intervening simultaneously, it scarcely matters whether it was planned or forced — “accidentally synchronous” feels like an oxymoron, but it also feels like an apt description of the burgeoning policy panic.

When combined with cooperative data, which on Tuesday meant a welcome drop in US job openings, the stage was (and still is) set for a powerful reversal in this year’s macro trend trades. Five-year yields in the US are down 22bps this week already. Five-year reals are 36bps lower (figure below).

That’s a powerful FCI easing impulse. Although Treasurys ended well off their best levels Tuesday, US two-year yields fell below 4% for the first time in weeks at one juncture. Short covering is likely in play, as are mechanical buy-to-cover flows (e.g., from CTA trend).

“Treasurys continued to rally on Tuesday, a move that has increasingly brought into question investors’ perception of the Fed’s commitment to following through on its hiking campaign and realizing the 4.6% terminal projection in the wake of the ‘dovish’ RBA hike of just 25bps versus the consensus call for +50bps,” BMO’s Ian Lyngen and Ben Jeffery wrote. “When combined with the upheaval in the gilt market and the BoE’s purchase of long-dated UK bonds, there’s a growing sense that financial markets are showing sufficient stress as to warrant a collective pivot away from the global trend toward tighter policy,” they added.

The dollar was sharply lower Tuesday. That too is a risk-on green light and represents easier financial conditions. Weakness in equities which saw US stocks give back the summer rally was directly attributable to an inexorably stronger dollar, a rapid move higher in US real yields and higher US terminal rate pricing. All of that slammed into reverse early this week. The two-day rally on the S&P was the largest since the volatile days of the original pandemic crash (figure below).

The setup was fortuitous. “I said [this] past Friday that we were likely to see a final-day-of-the-month- / quarter-end US equities selloff, with a particularly ugly market-on-close due to the infamous ‘Put Spread Collar’ trade that has so often marked local pivot points in equities, but which would then afford a ‘buy the dip’ on the MOC opportunity playing for a relief rally thereafter, with high absolute levels of iVol at the time (an attractive level for opportunistic vol-sellers), plus a low entry point from a spot perspective, providing a great location to get long ahead of painful ‘squeeze-able’ conditions,” Nomura’s Charlie McElligott wrote.

“The largely options-driven rally phenomenon then spun-off a number of second-order flow impacts which absolutely lit legacy downside and shorts on fire,” Charlie went on to say, referencing Monday’s trade. One certainly imagines some of the same second-order flows were in play during Tuesday’s rollicking session.

But, as Charlie was keen to emphasize, “without question the flows and the setup benefitted massively from two absolutely critical fresh macro catalysts which have changed the calculus.” Those catalysts are i) signs of panic from policymakers and ii) cooler US data.

“In less than two weeks, the US equity market priced in fears related to the hawkish outlook the FOMC provided at the September meeting and has all but fully erased the declines,” JonesTrading’s Mike O’Rourke said, on Tuesday evening, adding that,

There have been multiple catalysts for the sharp two-day relief rally. Over the past two days, markets received a global boost. Yesterday, the UK government reversed course on a key tax cut in its “growth” plan that roiled financial markets. A significant portion of today’s push higher for global equities was catalyzed by the RBA delivering a dovish surprise. US equity markets have taken solace from a couple of minor economic misses. Stock, bond and currency markets are making a concerted effort to undo the recent necessary tightening of financial conditions. Commodity markets are making their best effort to start undoing progress on the inflation front.

Note O’Rourke’s use of the term “necessary” to describe tighter financial conditions. As ever, there’s a very real sense in which the relief rally is counterproductive. The title of O’Rourke’s missive was “Old Habits Die Hard.”

Whether we’re currently witnessing an epochal shift in policy is obviously up for debate. October’s early theatrics may well be remembered as nothing more than a fleeting fireworks show to the extent they’re remembered at all. But, coming full circle, if this is “a moment,” so to speak, it comes on the one-year anniversary of the first G10 rate hike. And not a moment too soon for stocks and bonds.