Some observations on the deteriorating state of the market from RBC’s Charlie McElligott, Head of US Cross-Asset Desk Strategy
A Reminder on “How We Got Here”
The market continues to “buy into” growing long-term narrative that CBs are shifting from notional “flow” of QE purchases to yield targeting / curve steepening goals and desire for more fiscal policy.
To anybody being intellectually honest, this should be interpreted in the long-term as “a path to tightening.” Long-end weakens, curves steepen.
You have a Fed pushing rhetoric for another Dec rate hike causing dangerous Dollar strength on “policy divergence” theme reawakening, which triggers “risk off” / “financial tightening.”
Simultaneously and idiosyncratically, you see the PBoC more willing to allow ‘mkt forces’ to weaken Yuan now that it is included in the IMF’s SDR (more Dollar strength). New 6 yr lows vs USD.
EM hiccups (ZAR and KRW situations) further contributes to USD strength.
GBP hard Brexit rhetoric / narrative building. GBP coming unglued = more USD strength.
With core inflation metrics showing a pulse (and 10y US BE rates “breakout” of 2.5 yr range), along-side the OPEC +++ implications on crude (which in turn drive inflation expectations higher)—you scare a world “long duration” (aforementioned ‘long duration ETF’ performance wobble).
Rates “re-pricing” against this backdrop = cross-asset vol, due to ‘short convexity leveraged allocation strategies,’ and a macro trade dictated by the direction of one price input (USD) due to the central bank QE regime of NIRP, mega-asset purchases and vol suppression. As such, we see increasingly frequent “vol spasms” (SPX 5 day realized vol +100% in 3 sessions, which is pretty LOL-able).
EQUITY CONVEXITY BACK “IN PLAY” AS “VOL OF VOL” TO VIX RATIO ROLLS OVER:
DOLLAR STRENGTH AS A MACRO FUND PERFORMANCE DRAG: Long cyclicality it seems…
UST 5Y POSITIONING SHOWS SCALE OF “REAL MONEY” LONG AGAINST HEDGE FUND SHORT:
EEM EXPOSED FOR DOWNSIDE IN LIGHT OF DOLLAR STRENGTHENING (orange, inverted)