There’s a “light at the end of the tunnel.”
That’s according to Nomura’s Charlie McElligott, who on Tuesday flagged “obvious signs of capitulatory ‘panic’ and mounting destabilization forcing authorities and central banks to change the rules mid-game and push back against the impacts of ‘too much’ tightening.”
The notion that markets stop panicking when policymakers start panicking is now working in favor of risk sentiment as recent events suggest officials are indeed getting worried. “It’s now crystal clear” that authorities are alarmed by the deterioration across markets “due to the magnitude of financial conditions tightening,” McElligott said, noting that “market accidents have been increasingly large and destabilizing.”
Last week’s chaos in the UK LDI complex may, in hindsight, be viewed as a last straw of sorts. That certainly doesn’t mean it’ll be the last “event” (or “near miss,” if you like), but it was a wake up call. When considered in conjunction with FX turmoil and unfounded rumors of “imminent” SIFI failures, policymakers may be in the process of a pivot.
“As I always like to say, ‘The worse conditions get, the more asymmetric the policy response becomes thereafter,'” McElligott remarked.
In addition to the BoE’s intervention in long-dated gilts last week, Liz Truss folded to markets on Monday, scrapping an ill-conceived plan to abolish the top UK tax rate, and then, on Tuesday, the RBA surprised with a smaller-than-expected rate hike. Charlie cited both. UK fiscal profligacy “was forced to be partially amended, which then accordingly drove a massive global bond squeeze and relief rally that took risk assets along for the ride, and overnight, the central bank panic claim[ed] another victim [when] the RBA surpris[ed] the market with a dovish 25bps hike, slowing the pace of tightening, resetting market expectations in the process and becoming the first major central bank to slow its pace of tightening by communicating that its front-loaded monetary policy tightening was over.”
He also mentioned the contraction-territory print in the ISM manufacturing employment gauge, which I’d be on board with touting as incremental “plausible deniability” for any Fed officials inclined to downshift to 50bps hike increments were it not for the proximity of JOLTS and NFP, which could either validate the “jobs are rolling over” narrative or obliterate it. One thing’s for sure, though: The market read the tepid ISM report as bullish in true “bad news is good news” fashion.
For McElligott, you need two things for the market to begin front-running a Fed pivot: Job losses and a frozen credit market. Credit is cracking in the US, but in Europe, it’s freezing. Charlie noted that Europe’s public bond market just hit 40 “no-deal” days in 2022 (figure below), and a dozen in the past two months alone.
That’s more than the old no-deal record of 31 days in 2018, the last time the Fed embarked on double-barreled tightening. As Bloomberg wrote, borrowers are “struggl[ing] to raise debt in volatile markets while their costs continue to rise.”
So, what’s the takeaway? Well, the sense that policymakers are either panicking already or on the brink of panic is resulting in an “‘impulse easing’ of global financial conditions,” as Charlie put it, noting that macro trend trades tied to ever tighter policy are “seeing broad ‘stop-out’ and ‘unwind’ flows.”
The figure on the left (below), shows Fed expectations, which are leaking dovish again. Terminal rate pricing is down more than 30bps since the highs hit last month, while markets are pricing ~35bps of easing for next year.
The dollar, meanwhile, was down five sessions in a row, much to the relief of… well, to the relief of everything, really (figure on the right, above).
Barring a systemic event, any decisive Fed pivot still hangs largely on the data. What’s important is that the conditions are now such that any incremental relief on the data front would be more likely to prompt a pivot versus just a month ago.
“From here, markets can certainly keep running as the ‘trend trades’ are reversed out, but it’ll come down to the data, both the very jobs-centric rest of the week in the US, as well as the obviously critical next CPI print,” McElligott said.
“Misses or downside in both [would] add fuel to the dovish fire for bonds and equities short-squeezes,” he went on to write. On the other hand, any signs that wage growth and core inflation remain too hot and too “sticky” for comfort “would see all of this recent ‘dovish optic'” faded, in what would feel like a “painful resumption of the FCI tightening impulse.”