In less than 48 hours, Jerome Powell will have held his extremely anticipated Jackson Hole speech, scheduled for 10am Eastern, and while pundits can't stop talking about what the Fed chair may or may not say about the impending taper (as a reminder, even if Powell announces a taper, it won't really matter as the Fed will still be buying bonds for most of 2022 and more to the point, it is the Treasury that will be draining as much as $800 billion in liquidity in the coming months as part of its post debt-ceiling quantitative tightening as explained yesterday).
What is more remarkable is that for all the verbal diarrhea, markets could care less. As Nomura's Charlie McElligott explains this morning, both rates and equities are pricing-in de minimis event-risk around Jackson Hole, "with Friday’s TY Straddle pricing a little over 6.4bps implied breakeven (the lowest 5 day straddle seen in 10 weeks, per IFR), while Equities shows SPY Aug 27th 448 Straddle at just 0.7% move."
There is a reason for this: the market has convinced itself that Powell will hold fire on a taper announcement, and in fact the risk of a dovish Powell has increased at a time of lowered Q3 GDP forecasts which are "reflecting a greater impact of delta variant on the outlook, as evidenced by weaker housing starts, retail sales and manufacturing surveys…while at the same time, fwd looking U Mich- and Service PMI- surveys are showing significant drops as well." Furthermore, the fact that noted Fed “hawk” Kaplan last Friday explicitly addressed growing Delta variant risk, saying he may need to adjust his views and that he is watching “very carefully”, was seen as a “tell” that the conversations internally amongst the FOMC members might have already turned, with regard to this now larger impact of the virus wave on economic activity.
Ironically, McElligott also notes that the Fed would be doing this just as many in the market are turning the other way and indicating that they are again willing to take shots on bearish fixed-income expressions, with one key component of that being a view that the worst of the COVID Delta wave is behind us and was already “priced-in” with yield lows made start August. As we noted last night, the delta of Delta is now negative...
... with new hospitalization- and case growth- trajectories turning lower in the US, and following the timeline of UK / Scottish cases rolling-over a month ago, while at the same time new Chinese cases having cratered, (on Wednesday the Meishan terminal at China’s second busiest port reopened following a two week shutdown).
As a result, while Powell may take the cautious approach, and avoid explicit taper mentions on Friday, Nomura believes that the market is already focusing on this cheerful “forward looking” view heading into the Fall / Q4’s bullish “risk-on” seasonality, plus supply pick-up, perception of taper and delta roll-over is the basis of renewed interest in “running-back” cyclical value/reflation/reopening trades from investors into the months ahead (WTI oil has soared 10% from Monday lows, 10Y TSY Yields are +9bps from last Thursday), and as McElligott notes, if we were to see an even bigger “dovish surprise” from Powell on Friday "any richening in USTs thereafter would likely see some discretionary folks take another “tactical shot” from the short-side in USTs."
In fact, one look at today's 10Y yield shows that some are not waiting and are already taking the tactical shot.
So going back to the market's complacency, and lack of expect moves on Friday, McElligott warns that if there were any surprises, the moves would of course spill over well into next week’s trade, so owning 9/3 expiration for hedges is a better idea (or 9/10 exp EDU4 midcurve).
But the punchline - particularly in the context of this bizarre lack of hedging - is another key dynamic highlighted by McElligott, which is at play, namely that there is enormous amount of TY optionality rolling-off at this Friday’s expiration, with 63% of TY option OI expiring and indicating potential for a "Gamma unclench" (the Nomura strategist brings attention to just a 1.55 Put/Call Ratio in TY which is multi-month lows alongside TY Skew, as traders pivoted to “slowdown” in recent weeks.
Bottom line: if Powell does not surprise the market and keeps a modestly (but not overly) dovish tone, Friday will be a non-event contrary to the legendary "hype" level the coming Jackson Hole virtual symposium has attained. On the other hand, if Powell does surprise by being either too dovish, or too hawkish and explicitly suggesting that the taper is about to begin, then all bets are off and a violent VaR shock looms for all rates and 60/40 portfolios, which will then immediately cascade to all duration derivatives (such as the FAAMG generals) before it sweep across the stock market.