It all hinges on the evolution of the data, of course, but absent an inflation re-escalation or evidence to suggest the lingering mismatch between labor supply and demand supporting jobs growth poses a wage-price spiral threat, the Fed looks inclined to dial down the hawkish rhetoric. That, in turn, could beget a durable duration bid and, ultimately a “Santa rally.”

Famous last words, I know. But the Fed “rhetoric shift” talking point isn’t just wishful thinking. Indeed, you’d be obtuse not to recognize it after Wednesday, when Christopher Waller became the most recent official to suggest the recent increase in yields, and particularly the term premium repricing and attendant surge in real rates, could stand in for a rate hike.

Although Waller described the US economy as “really booming,” he also said the Fed’s now in a position “where we kind of watch and see what happens.”  “Financial markets are tightening up and they are going to do some of the work for us,” he added, during a panel discussion in Utah moderated by Paul Ryan, living embodiment of the phrase “get while the gettin’s good.”

Waller was very explicit in his remarks on inflation. The Fed is “finally” seeing good numbers, he said. “If this continues, we’re pretty much back to our target.”

Again, you’d have to be obtuse not to observe the shift in the rhetoric. This is a Fed on the verge of being satisfied not necessarily that inflation is right now, as we speak, on a sustainable path to target, but at least that policy, with a kicker from the latest leg higher in long-end yields, is “sufficiently restrictive” to put inflation on that path soon enough.

If that’s the correct read and if earnings season comes and goes without any major incidents, the odds of a year-end equity rally could be described as favorable. Nomura’s Charlie McElligott on Wednesday sketched the “Santa Rally” setup.

“This Fed ‘messaging evolution’ onslaught lays the groundwork for further duration stabilization, which [could] provide the conditions for a cross-asset rally, particularly in equities,” he wrote.

Below, from McElligott, are four steps to a holly jolly Christmas. Note that this is predicated in no small part on stable rates, which is to say a US long-end that doesn’t resume a violent bear steepener — so I suppose it’s actually five steps.

1. Massive Index weighting from ‘secular growth’ mega-cap tech-type names, all of which are equities duration proxies, and makes further drawdown due to macro variables almost impossible if bonds stay stable and/or rally further, on P/E multiple expansion (relief from the recent multiple contraction of the violent rates selloff);
2. Multi-decade bullish ‘risk-on’ thematic / sector / industry / cross-asset seasonality from October into year-end;
3. Constructive ‘demand over supply’ reversal from the past month’s dynamics (e.g. enormous Federal tax liquidity drain in the back part of September), with both fund flows seasonality being traditionally strong for equities inflows in late Q4, as well as the eventual resumption of corporate buyback flows on the move through EPS season and into November;
4. Recent equities exposure purge from systematic universe (CTAs sold -$16.4 billion of US equities over the past three months, vol control -$32.9 billion of US equities over same period), which now then tilts them back into a position where the need to ‘buy to reallocate (vol control) / cover or even flip back long’ (CTA) into index rallies, acting as an accelerant or ‘synthetic short gamma’ flow to the upside