If you’re a Fed official and your “higher for longer” message is already resonating, it’s not obvious why you’d go out of your way to posit a kind of worst-case scenario wherein rates need to be raised significantly higher on top of what already counts as the most aggressive rate-hiking campaign in modern history.

Public Fed pontification rarely accomplishes anything, and more often than not it’s counterproductive. It wasn’t obvious, to me anyway, what Neel Kashkari had in mind on Tuesday when he decided to publish a lengthy essay called “Policy Has Tightened a Lot. Is It Enough?” The piece was a sequel to a May essay in which Kashkari carried on about the many virtues of focusing on long-term real rates when assessing the “overall stance” of monetary policy.

Kashkari must’ve known (and if he didn’t, he’s oblivious) that markets and the financial media would summarily ignore the finer analytical points in favor of the subjective odds he placed on a “High-pressure equilibrium” scenario, defined by a soft landing and 3% inflation, which he helpfully distinguished from 2%, the Committee’s goal. In that scenario, households might “feel more confident about their economic futures and spend more than prior to the pandemic, keeping consumer demand strong and the economic flywheel spinning.” Were that to play out, Kashkari said the Fed “would have to raise rates further, potentially going significantly higher to push inflation back down.”

In the same section, he effectively conceded that monetary policy (i.e., rate hikes) have had little, if anything at all, to do with moderating inflation so far. “The case supporting this scenario is that most of the disinflationary gains we have observed to date have been due to supply-side factors,” Kashkari wrote, noting that “the sectors of the economy that are typically most sensitive to interest rates have proven surprisingly resilient.” How, he wondered, is that possible “if policy were truly tight”?

Ultimately, he put 40% subjective odds on a scenario in which services inflation doesn’t moderate sufficient to bring overall inflation all the way back down, and the Fed is compelled to “push the federal funds rate higher, potentially meaningfully higher.”

So, basically, Kashkari said it’s a coin toss whether terminal as currently priced by markets will actually be the peak, or whether we end up in Jamie Dimon’s “worst case,” with Fed funds at 7%. (Kashkari didn’t say 7%, but “meaningfully higher” pretty much has to mean at least 6% given where rates already are.)

To be clear, I don’t think Kashkari’s essay was a big contributor to Tuesday’s extension of September’s equity selloff, but it certainly underscored the notion that the Fed sees a material risk of a Dimon-esque, left-tail (or right-tail, depending on how you want to look at it) escalation. Indeed, Kashkari’s probability assignment suggested 6% Fed funds isn’t properly a “tail” at all.

We’re now getting some pretty meaningful movement in spot equities. Tuesday was the second-worst day for the S&P since April. Coming off the worst week since March. And on the way to what’s now all but guaranteed to be the worst month since December.

The distribution of daily outcomes is widening out a bit. If you squint at the figure above, you can see realized vol perking up on the right-hand side amid escalating daily losses for the index. That’s a risk. If you want to avoid additional systematic de-leveraging on top of what we saw last week, you really need stabilization in spot. Outsized moves are oxygen for a nascent vol fire that needs to be fed lest it should mean-revert.

At the beginning of this week, daily 100bps SPX changes would’ve dictated around $16 billion of new selling from vol control cohorts over the next one-week period and some $41 billion in selling if sustained over two weeks, according to Nomura’s models. Note that peak short gamma was somewhere around 4300 SPX as of Monday. We were obviously well through that on Tuesday afternoon.

That the long-end of the Treasury curve couldn’t catch (or sustain) a bid despite the risk-off tone for equities was notable. “Those seeking safe haven flows were left wanting,” BMO’s Ian Lyngen and Ben Jeffery remarked, adding that “as the quarter comes to a close, equity investors are apparently unwilling to push valuations higher, a dynamic that can surely track part of its foundation to the elevated level of yields.”

It’s tempting to blame September’s cruel seasonal for the selloff, but it’s probably more accurate to say, as I did in the Weekly+, that rates finally caught up to stocks.

The figure above (also from the Weekly) underscores the point. Big tech defied gravity all year. The recent leg higher for reals was just too much.

The fact that benchmarks are dominated by rate-sensitive, long-duration stocks makes this situation worse. “The MSCI World is still up 10% YTD or 12% in total return terms, but performance continues to be flattered by the performance of just a few stocks,” SocGen’s Andrew Lapthorne wrote, in his latest, calling the combination of large size and performance “a major headache for those with a tracking error constraint.”

The charts speak for themselves, but Lapthorne elaborated. “For some, not participating in the top ten is too risky [and] this need to keep up with just ten stocks is frustrating, as it can limit what many investors are prepared to do at a time when there is significant valuation dispersion, and rising bond yields continue to negatively impact the most expensive part of the equity market.”

Note from the visual on the right that the biggest 10 stocks’ correlation to 10-year yields is materially negative. So, if bond yields are rising, those 10 stocks are generally falling. And so go those 10 stocks, so goes the market.

Remember: Cap-weighted equity benchmarks, dominated as they are by mega-cap tech shares, are just a giant, leveraged long-duration bet. And duration is trading like death.

Regardless of the catalyst, September is living up to its nefarious reputation as a cruel month for equities.

The rub: Stocks are still up handily for the year, which means folks like Kashkari have no incentive whatsoever to dial back the hawkish pontificating.

“Stocks are off the peaks but the S&P 500 remains up ~11% on the year,” BMO’s Lyngen and Jeffery went on. That, they dryly remarked, is “a backdrop that offers nothing to derail the Fed from adhering to the higher-for-longer mantra indefinitely.”