Many investors (I dare say a preponderance or at least a plurality assuming the existence of several competing macro narratives) came into 2023 assuming a US economic slowdown was imminent.

Monetary policy acts on a lag, after all, and while the timing varies from cycle to cycle, it’d be 12 months come March and the rapidity and scope of the rate-hike blitz was generally seen as an argument for faster transmission.

In one sense, such predictions were borne out. There was a banking crisis 12 months on from the first rate hike. But the real economy seemed immune. Indeed, just 24 hours before SVB’s troubles became front-page news, Jerome Powell was sitting in front of US lawmakers explaining why the Fed would likely need to raise rates further than previously anticipated. The incoming data suggested the US economy was off to a blistering start, and terminal rate expectations peaked on the eve of SVB’s spectacular implosion.

Not only did the banking crisis not trigger a slowdown, the response to the turmoil (a new Fed facility and a depositor bailout) conveyed to the market that even if the Fed kept hiking rates, the policy put wasn’t dead after all. Between that, the optics of a Fed balance sheet that was suddenly “growing” again and the impact of dispersion and collapsing correlations on vol, stocks embarked on a push into bull market territory.

As the second half wound down, the data began to reaccelerate — notwithstanding a lackluster read on personal spending, which was anyway welcomed by markets given fears the economy was outperforming to such an extent that the Fed might find cause to make good on the “threat” posed by the June dot plot.

In a note published just before the US holiday (July 4 on a Tuesday means this is effectively a four-day weekend for US traders), Nomura’s Charlie McElligott recounted the above from the perspective of wrong-footed (and by now thoroughly frustrated) market participants.

“Macros began the year in a PNL hole on the ‘end of Fed tightening’ / ‘recession’ view, which put them into ‘short USD’ trades that were blown out by the US economic resiliency shown in January and February,” he wrote, on the way to reiterating that the monetary policy transmission channel in the US may be impaired currently by the combination of a still-bloated Fed balance sheet, the legacy of pandemic savings buffers and very hot nominal growth which, when juxtaposed with the regional banking drama, looks like proof that we are in fact living in an “r-star > r-double-star” reality.

Charlie went on. “With no performance to work with, theta bills across assets have been killing everybody for their forward ‘recession’ / ‘long vol’ / ‘gamma’ expressions with negative carry ever since,” he wrote, noting that although “owning vol at a seemingly low absolute level feels comfortable at first, persistently resilient US growth is bleeding your view — and your capital, as vols get bled-out, and as more capital chases ‘short vol’ / ‘gamma’ / ‘correlation’ performance.”

The insult-to-injury corollary: “All while simple ‘lazy long’ equities and short vol trades just keep working,” even as their ongoing performance sows the seeds of an accident.

That latter bit (about accident risk) is likewise a source of frustration. Knowing that stability breeds instability, it’s tempting to double down on the bane of your own existence. As McElligott put it, the growing threat of a Thanksgiving turkey moment for the short vol trade “rationally perpetuat[es] the desire to own gamma, which keeps PNL bleeding!”