‘Abundant, Wide’ Market Dislocations ‘Unlikely To Disappear’: Kocic

These are unprecedented times.

I’m immediately compelled to roll out two caveats that frustrate some readers. All times are “unprecedented,” by definition. Just like every day is “history,” by definition.

Asinine? Maybe. But grandiose declarations become nebulous clichés through overuse. At that point, they’re no good to us. They’re not available when we need them. And make no mistake, we need the “unprecedented times” and “we’re witnessing history” declarations in 2022. This isn’t a drill. These times of ours really are unprecedented, in the grandiose sense. And we really are witnessing history, in the textbook sense.

That’s not lost on markets, and especially not on rates. “In contrast to previous history, this year’s vol in rates has been at crisis levels, significantly higher than in any other tightening cycle post-1990, contested only by the spikes during the peaks of LTCM and the 2008 GFC,” Deutsche Bank’s Aleksandar Kocic said, calling vol “high” and dislocations “abundant, wide and persistent.”

If you ask Aleks, this state of affairs isn’t set to dissipate anytime soon. In fact, he wrote, it may “become even more extreme in some cases” given that “confidence has eroded” in the face of “multiple dimensions of risk, as well as the ambiguities regarding the rates path and its long-term consequences.”

He reiterated the familiar notion that long-end rates have seemingly achieved something like total independence from underlying economic realities — “the fundamentals,” if you prefer. That’s best illustrated by the scatter plot (below). The red squares represent recent history.

We’re not in Kansas anymore, as Dorothy would say. Kocic explains the disconnect by way of ambiguity around the longer run outlook. “The market seems to have abdicated on its attempts to forecast the long-term and has remained focused on monetary policy as the only manageable risk at the moment,” he said.

But even that risk is hard to manage. The pace of this year’s rate hikes is unheard of (for this point in the cycle, anyway) and when juxtaposed with the very gradual hikes observed in the last cycle, appears even more pronounced.

“In the first stages of the cycle, the Old Fed (before the current) had been remarkably consistent in its pace, regardless of the period and the Chairperson,” Kocic said. By contrast, the current Fed “has been outside that range rather decisively on both sides, from super-slow to super-fast,” he continued, noting that Powell “has removed the speed limit” in 2022, hiking between seven and eight times faster than the last cycle and at least twice as fast as prior cycles (figure on the left below).

At the same time, the real rates curve is the most inverted in history using Kocic’s preferred proxies for terminal and neutral (figure on the right, above). Policy is thus very restrictive — the curve “has never been this negative,” he observed, adding that typically, inversion doesn’t occur until the end of the cycle, while in 2018, it didn’t occur at all.

If you overlay reals with stocks and high-grade credit, they’re almost lockstep. Rising real rates are driving the selloff across equities and IG. “This narrative of higher real rates has overpowered all other considerations and continues to be the dominant driver of markets in 2022,” Kocic wrote.

As for when this might resolve, it’s all down to inflation and, more to the point, how long inflation “remains resistant to rate hikes,” as Kocic put it.

That gets to the heart of the matter. I’ve posed it as a question: Can rate hikes bring down inflation and restore faith in the notion of price growth as a phenomenon over which can exert some semblance of control? Or do geopolitical realities and strategic realignments mean inflation is stochastic now, at least at the headline level?