“Are we really tightening policy into a global energy supply shock with an already fragile growth backdrop and credit liquidity knock-on concerns lingering?”
That question was posed by (or to and then by) Nomura’s Charlie McElligott on Friday afternoon, as US equities headed for a fourth straight weekly decline and rates convulsed.
As discussed in the new Weekly, the specter of rate hikes not only from the Bank of England and ECB, but perhaps even from the Fed, is bleeding risk sentiment in a way it wasn’t before.
It’s important to note — and McElligott did — that the juxtaposition between, on one hand, single (or “hierarchical” to use the technical term for price stability primacy) mandates at the BoE and ECB and, on the other, Europe’s status as a energy importer, explains the outsized reaction in front-end rates (and vol) across the pond.
The more vulnerable you are to the FX/energy pass-through effect in a supply shock, the more hawkish your central bank has to be. When the central bank’s operating on a single-mandate, that dynamic’s even more pronounced.
This gets really tangled, really fast because while the hawkish asymmetry at the BoE and ECB is a boon to sterling and the euro (see Thursday’s rally in both), the price action in non-USD rates can’t help but boomerang into Treasurys and the US front-end, where higher yields and rapid Fed repricing lend fundamental support to a greenback that was already bid, Thursday’s selloff (the flip side of the above-mentioned GBP and EUR rally) notwithstanding.
“This [is] a hot mess in a world that was heavily leveraged into, and positioned for, the ‘USD alternatives / de-dollarization’ narrative for the past six months,” Charlie wrote, adding that “most major ‘US alts’ are energy importers and / or single-inflation-mandate central banks, while too we’re not just seeing Fed cuts removed, but de facto Fed hike-pricing as stuff gets unwound.”
The figure above’s a proxy for the “short USD” unwind. It shows modeled gross CTA FX positioning, which went from 97%ile late last month to just 6%ile on Thursday.
It’s very difficult (if it’s possible at all) to determine what part of the front-end rates repricing is mechanical (i.e., levels breached, triggers triggered, stops hit, etc.) and what’s real trading based on perceptions of a shifting macro-policy zeitgeist. I think a good portion of it’s overdone, but I suppose that doesn’t matter for now.
It’s not just rates and bonds. As McElligott went on to say, longs in precious metals, small-caps (the Russell slipped into a correction on Friday), cyclicals and emerging market equities “are now getting deleveraged and tapped.”
“The obvious and primary issue,” he went on, is “the vicious global energy disruption” which has the potential to knock into an inflation shock, hence the “impulsive central bank rate-path repricing [and] rolling front-end VaR events” as the new market narrative turns “aggressively [against] the prior worldview.”
“Net net,” McElligott wrote, summarizing on Friday, it’s “just an ongoing, bleeding risk-management flow.”
It seems likely that our Emperor will soon issue a decree to stop US oil exports and cap domestic oil prices in order to placate to his base and backstep from this mess he’s created in the Middle East. I would expect that this will further reduce world supply and create a new shock to International oil prices and perhaps across the world economy. What hole will I need to crawl into in order to protect my happy little nut from this madness?
We’ll see. SPX 6500 and 10s 4.40% may not be the pain threshold. But let’s see how brave he is at 6000 and, say, 4.75%.
Big oil wouldn’t be happy about a move like this, but why not bite off the hand that feeds you? He’s gotten away with burning everything he touches do far. But what do I know, I thought he was dead when he said he could just grab ’em by the pussy.
Price controls on energy, WOW, why can’t that work ?
‘The Dow is at 50,000!”… Top
$50,000. She said $50,000.
So a four-year, end of term, Total Value target? No lie detected.
“single (or
After reading your piece on the ECB the other day I Googled to see if Ottmar Issing is still with us. He sure is and currently has a role at the ECB!
Correcting – it was your piece on the BOE where you informed/reminded us of the bank’s single mandate.
To explain the Issing reference, he was an ultra-hawk while at the Bundesbank. I used to claim that when he saw a headline about a company in Bremen adding ten employees he exploded: “That’s inflationary! We’ll put an end to that nonesense!”
What I see is rotational selling – sell this group down, then move to the next, with a whiff of “sell the profits you have”. Cyclical and small-cap and energy dependent names and regions got sold, of course, but also consumer staples, healthcare, other defensives. AI + big tech has been spared, maybe reflecting perceived insensitivity to oil and other molecules plus underperformance YTD, but some charts there are starting to round over. The SP500 has decisively broken its 200D. I’m not a chartist but next support looks around 6,000?
Oh and it was OPEX today, but I don’t know how that that played out.
Michael Hartnett’s B/B sell call in Feb looks a pretty good now.
I’m a UK based stir trader (sonia, euribor, estr and sofr) and the moves we have seen these past 3 weeks have been brutal (ice exchange has had 3 record volume days in this period). I never expected to be remodeling my theoretical interest rate curves this Saturday morning to include 4 hikes in Sonia and the bor (with a 50% chance of a cut in the following quarter after these hikes – nonsensical). I wholeheartedly agree that these moves are overdone but whilst the momentum funds have control, the dislocations in the markets are likely to continue until the straight of hormuz reopens, oil supply starts to increase and the price comes down. With president trumps rhetoric last night on the military decimation of Iran, and with the US 10yr swap spread nearing its pain threshold (bessent will be trumps kissinger), hopefully we’ll see an end to hostilities. Good luck all. Ad astra.
Thanks for this Stephen. Great insight.
Plus he brought us an honest usage of the word “whilst,” which is too rare on this side of the pond.
Agreed. But please (and I hate to be “that guy”), it’s Strait of Hormuz. I realize Spell Check is part of the problem.