Nomura Warns: Soaring "Stagflation Tail" Problematic For Extreme Bond Positioning

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by Tyler Durden
Thursday, Feb 24, 2022 - 02:31 PM

Standard “haven” beneficiaries of the large-scale Russian attacks on Ukrainian military sites - Bonds, USD, Gold - while also seeing the violent and rational squeeze across Commodities, Breakevens and Vol - because, as Nomura's Charlie McElligott details in a note this morning, the “Stagflation” tail just picked up massive Delta on account of the potentials for an even larger inflation shock, versus policy that doesn’t have a lot of room to push-back - i.e. “just how dovish” can CB’s push their rhetoric right now, on account of their price problem (particularly in Europe)?

Crucially, the Nomura strategist warns that this means that global Central Banks are either going to have to push-back and hike regardless in an attempt to tame the inflation beast, pulling-forward eventual “Stagflation” or even “Recession” odds rapidly in the process...

OR, conversely, that we are going to have to digest even higher and more persistent inflation, while CBs try to prevent yet another “Growth Shock” through an attempted calming of FCI and market Vol

For now, 25bps remains solidly priced into March, although we are slipping below 6 hikes (currently ~5.9 priced but down from almost 7 just a few weeks back) before Year-End 2022; perhaps most notably for the “slowdown” camp, ED$ Z3Z4 spread is now implying ~20bps of Fed policy EASING in ‘24

McElligott highlights the fact that the Commodity Supply Disruption Potentials are remarkable - Russian Global Share:

  • Russia is the world’s second-biggest exporter of crude oil, after Saudi Arabia, at 5.21mn bbl/day, the second-biggest exporter of petroleum products, after the US, at 2.23mn bbl/day, the world’s biggest exporter of gas via pipeline at 198bcm and a market share of 26%, and the fourth-biggest exporter of LNG at 40bcm. Overall, Russia accounted for 8% of all global fuel exports in 2019 (rising to 13.5% in this year’s estimate), about 40% of the EU’s natural gas imports and nearly 33% of the EU’s crude oil imports” (h/t Nomura FX Insights)

  • Outside of the energy sector, Russia is also 45.6% of global Palladium supply, 15.1% of Platinum, 9.2% of Gold, 5.3% of Nickel, 5.0% of Wheat, 4.2% of Aluminum, 3.3% of Coal and 2.6% of Silver (Bloomberg)

  • And as witnessed yesterday, global Ag Commodities exploded higher as the odds of the invasion raced higher across the course of the day, in large part due to Ukranian production disruption risk (Ukraine of course known as the “breadbasket of Europe,” with 20% of global Corn export), but also a function of Russia being the largest exporter of Fertilizer in the world (27% of MOP, 49% of Ammonium Nitrate, 18% of Urea, 30% of Ammonia, 38% of NPKs…numbers which then grow if also including current Russian vassal-state Belarus)

However, as the Nomura MD warns, it is the rates/sovereign bond markets that are the asset-class where the invasion - and whatever it develops into down the road (purely a strike against military capabilities, a regime change, or a long-term occupation) - will be a true near-term problem for consensus “Short” positioning, on account of the obvious hawkish “inflation fighting” pivot from global CBs in recent months

As seen below in the CTA Trend model, every G10 Bond is “-100% Short” signal in the CTA model (USD 10Y, EUR, JPY, GBP, AUD, CAD, CHF, FRA, ITA, ESP), with 3 of 4 STIRs “-100% Short” as well (Eurodollar, Euribor, Euroyen)

CTA model Net Bond exposure is 4.3%ile since 2010  (very “short”), and more than -2 SD on aggregate since 2002

So be prepared for a bond short-squeeze (despite the implications of inflation catalysts). Here are the levels to watch for CTA reversals...

  • JPY_10Y, currently -100.0% short, [150.34], buying over 150.37 (+0.03) to get to -32% , more buying over 150.38 (+0.04) to get to 35% , flip to long over 150.38 (+0.04), max long over 152.14 (+1.80)

  • ED4, currently -100.0% short, [98.765], buying over 98.94 (+0.17) to get to -91% , more buying over 98.95 (+0.19) to get to -82% , flip to long over 99.11 (+0.34), max long over 99.11 (+0.34)

  • USD_10Y, currently -100.0% short, [126.28125], buying over 128.12 (+1.84) to get to -91% , more buying over 128.14 (+1.86) to get to -82% , flip to long over 130.32 (+4.04), max long over 132.24 (+5.96)

  • GBP_10Y, currently -100.0% short, [120.79], buying over 123.31 (+2.52) to get to -91% , more buying over 123.32 (+2.53) to get to -82% , flip to long over 125.07 (+4.28), max long over 127.5 (+6.71)r

  • EUR_10Y, currently -100.0% short, [165.99], buying over 170.69 (+4.70) to get to -91% , more buying over 170.7 (+4.71) to get to -82% , flip to long over 170.92 (+4.93), max long over 175.02 (+9.03)

On the other side of the capital markets, McElligott explains that the reason that US Equities are “only” -2.3% is because we have already de-risked / netted-down “long” exposure with such vigor over the past 2+ months, while at the same time, have seen such remarkably persistent short-dated downside buying and dynamic hedging with grossed-up “shorts”

The ongoing “Short Gamma, extreme Short Delta” dynamic in US Eq Index / ETF options will continue to feed into market “overshoots” with accelerant flows, with Spot nearing “max short Gamma” locations across the board:

  • SPX / SPY options $Gamma -11.5B, 3.7%ile; “Max Short Gamma” ~ 4200, currently at 4125 ~ -$12.5B per 1% move; $Delta -$628.1B, 0.2%ile

  • QQQ $Gamma -$558.0mm, 2.8%ile; “Max Short Gamma ~$323, currently at $320 ~ -$875mm per 1% move; $Delta -$53.4B, 0.0%ile

  • IWM $Gamma -$114.6mm, 32.6%ile; “Max Short Gamma ~$188, currently there and ~-$500mm per 1% move; $Delta -$15.4B, 1.0%ile

VIX is near 37. This implies the market is pricing in a 2.32% daily S&P move. Overhead resistance shows lightly at 4200, then more substantially at 4300. Support is at 4064 and 4000.

Finally, we note that SpotGamma is looking for a recovery in markets should there be a test of the 4050 area. This bounce would be based off of the options positioning in markets as outlined above, and we think last for a few sessions (we currently see hardly any resistance back up to 4300).

Ultimately any rally would be unstable until there is a major reduction in put positions – and we do not see that happening until March 16th-18th (FOMC & a large OPEX).