The market is caught between two poles. At one end are declining yields and lengthening duration which favours growth stocks. At the other end is a recession that has barely started and has not yet hit the earnings outlook hard enough. In the middle is the Fed.
Charlie McElligott at Nomura:
The Fed “got the memo” in a big way it seems, as Committee speakers yesterday grabbed the Rates market by the scruff of their neck and slapped some “inflation hawk” sense into them, with the front-end and UST Yields experiencing a shockreversal due likely “stop-outs” in late-comer “dovish / recession” Longs (largest 1d move in 10Y Treasury Yields in 5 years, ex 2 days at peak of COVID lockdown), all due to a circling of the wagons on the punitive inflation- and labor- backdrop realities making the prior market delusions about big Fed EASING as early as Q1 next year see sharp “come to
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Typically “Uber-Dovish” Kashkari started the “Hawkish repricing” ball rolling over the weekend…but then yday, Daly, Evans and Mester minced no words when reiterating the Fed’s inflation “single-mandate” trumps all current “growth” concerns (and misperceived return of “Fed Put”) for markets, and 1) not only built real delta back into Sep seeing a 75bps potential hike again (now just a touch below “even money”)..but most critical to my message in the past week +, saw both 2) Fed “terminal rate” repriced meaningfully higher again (Feb ’23 FF fut was implying down to 3.25% yday, but now back up to 3.44% implied terminal last), which then too meant that 3) ’23 implied Fed “easing” (as per EDZ2-Z3) was also then reset sharply lower, as I expected—from -77.5bps on Monday to the earlier -60bps made today, removing 70% of a full rate “cut” in one fell swoop!
And even though Bullard’s comments on his high confidence that the US avoids recession helped calmed markets off th precipice earlier overnight, that was again “mutually exclusive” from his repeated statements that we have to run policy into “more restrictive” territory, and that he would “…like to see the policy rate get to 3.75%-4% this year”—his same message on “above consensus” terminal, and in short-order at that, bc soft landing does not necessarily require gradualism
And not for nuthin’, but it’s like Bullard reads my note, stating that interest rates will need to be “higher for longer” if inflation does not recede
Again, the realities are that despite slowing activity data (ummm that’s the point!), the labor market’s continued strength as per robust ongoing monthly job adds, record-low U-rate and still growing monthly average hourly earnings / record high wage growth all conspires against their “inflation killing” goal—they need to create “demand destruction”
Yet as evidenced yday looking at our Quadrant analysis, this absurd recent overshoot in actual financial conditions “easing” seen in July on market reflexivity of higher recession odds perceived as increasing probability of a “dovish” Fed (part this “bad take” on Powell’s poor “Neutral” commentary and softer fwd Prices / Goods / Commods inputs—but admittedly too, also reflecting a “stop-out” of outsized shorts in Bonds / Rates / Equities) then actually allowed for high frequency US growth and inflation data to somewhat stabilize over the past month, versus the prior sharp trajectory into the “Contraction” quadrant—i.e., the July FCI easing actually reduced the odds of a hard recession, but at the same time that the “hard landing” story was such a large part of the “Long Duration” trade momentum in the first place!
And let’s get real here: the ridiculous misconception that Powell “dropping” forward guidance was some sort of “dovish signal” is / was ludicrous they dropped the fwd guidance “game” bc they’re horrible at it, as has been seen on repeat time-and-time again, per the total fail on guiding us to June & July 50bps hikes…which was so mis-managed that days before the meeting and in blackout, they had to leak a 75bps hike through the press, and follow with another 75bps hike the following month
And that’s because Inflation Volatility is a hell of a drug—and despite “Goods” inflation moving lower, Services and Rent show that inflation is now embedding into the “sticky” components of CPI—so yes, we can move down to 4-5-6% inflation in-due-time, but getting back to a 2% target looks to be a pipe-dream, unless we start printing negative CPI monthlies along with negative jobs- and wage- prints!
This is a big deal though: One additional element of the Rates spasm yday that I also believe was lost in the wash of the remarkable Fed messaging yesterday, however, was the Treasury Dept’s announcement Monday which saw their estimated Fed borrowing estimate EXPLODE higher, as they boosted the quarterly borrowing estimate by ~$262B (now expecting to borrow $444B in July through Sept vs original est of $182B)—bc the May estimate left-out assumptions on Fed runoff which began in June, while also, Fed revenues dropped sharply post tax season, with a decline in receipts vs uptick in spending
Final notes for Equities: to my point on this nascent (and recently v “rare”) Vol outperformance vs Spot seen over the past few days, yesterday saw Downside go “bid” again, with SPX 1m iVol trading up over 70bps, with 25d Put/Call Skew also continuing its grind higher, as Upside comes off the boil at same time that Puts are finally firming and hedgers are seeing some “value” return in outright Puts…and mind you, also seeing “vol of vol” with a meaningful 2 day move higher as well, showing signs of life in “tails” for the first time in ages
The resumption of hedging for Downside and a pick-up in iVol then saw Dealer “Gamma vs Spot” position move down and within shouting distance of the “flip line” for SPX / SPY at 4044…where any further Spot selloff would be exacerbated below that as a potential “acceleration point” on Dealer hedging
The Market Ear picks up the same theme:
NASDAQ – huge levels watch NASDAQ is back to the 100 day moving average. As Bear Traps notes, this has been the longest period of tech trading below the 100 day moving average since Lehman. 13000/13200 is a huge resistance area to watch. Why not a flag here, another push higher, possibly overshoot the trend line and then another frustrating move lower. That would definitely be the main pain trade… Refinitiv
NASDAQ – watch those rates carefully The last sell off occurred with the 10 year moving sharply above the 3% level. Maybe this time is different, but make sure to watch yields closely here… Refinitiv
NASDAQ’s main “bid” continues fading Tech was a huge play on Fed expanding the BS. Chart shows Fed BS rate of change vs NDX. The main tech juice continues fading… Refinitiv
This measure of the “bear” did not improve a lot in the squeeze Almost half of Nasdaq constituents are trading at least 50% down vs 2020 highs… JPM
The NASDAQ 00/03 bear market saw 9 >10% rallies This one we experienced is now starting to get long in the tooth though, in terms of magnitude…. Soc Gen
Earnings cuts Tech estimates continue to come down…. Soc Gen
Tech cheap? FAANG no. Back to 1 sigma expensive again vs market Datastream
Extreme double top in Tech Chart is “S&P500 Tech relative”. Pretty important level if you believe in breaks / fails of double top formations… JPM
Tech vs bond fear Tech is the rate sensitive play. While rates volatility remains very elevated, the VXN has stayed rather dull. VXN is unfortunately not dirt cheap, but given where bond volatility is trading, expecting much lower tech volatility is most probably naive. Refinitiv
Fed has lost control of bond volatility Nothing new to regular readers of TME, but can bond volatility stay this elevated and tech continue the bear market rally? Refinitiv
How is the NASDAQ gamma “situation”? The violent bounce has led to short gamma dealers having to chase deltas as they have become shorter and shorter on the way up. Note the flip level is right around these levels. From here the dynamics change: dealers will become sellers of deltas should we move further into long gamma, but the downside dynamics remain the same: dealers need to sell deltas should we sell off again. In short, NASDAQ is soon becoming a sell or sell asset from a dealer gamma perspective. Tier1Alpha
My own view is that inflation is much more embedded in the US than elsewhere so the Fed will have to persist longer there than elsewhere.
This, therefore, remains a bear market rally, not least because this set-up implies a rising DXY to steamroll an already weakening global economy.