RBC Explains What The Hell Is Going On: "Prudent" Fed & Chinese Intervention

A "prudent" Fed (and China's "National Team") have spurred a risk-on rally, as RBC's head of cross-asset strategy Charlie McElligott notes the market's 'Pavolovian' response to Fed's 'dovish hints' contained within the Minutes - despite simultaneously staying ‘on message’ with hiking / tapering commentary - prompts a "QE of old" response: stocks and Treasuries bid, while the USD faded.

China further perpetuates the ‘risk rally’ via apparent market interventions:

1.       Intervention in FX markets to strengthen the Yuan overnight, with speculation of a number of Chinese banks selling Dollars in the onshore market overnight which drove the Yuan higher.

 

2.       Chinese “National Team” stock market inventions as well, with sharp-turns higher off of an initially weaker equities opening and again-weaker industrial metals.   Major reversals off lows saw nearly all domestic markets close at highs (Shanghai Prop +2.8%), while Hong Kong’s Hang Seng closed at highs since July 2015, with Chinese real estate developers leading.

Initial (and expected) ‘sell the news’ on the snoozer OPEC outcome, as they extend the output cut 9 months per expectations—which disappointed the ‘bullish surprise’ camp which anticipated more OPEC-‘gaming’ of the market, thinking it was possible for a deeper-cut in conjunction with the consensus extension.

This move lower in crude is notable if it were to escalate the current rollover in ‘inflation expectations’ (10Y BE’s below 200dma) which continue to show as the largest price drivers of risk-assets and major rates markets currently per the QI factor PCA model—although should be noted that both SPX and HYG (US HY proxy) are both deeply OUT OF REGIME with low r-squareds / low explanatory power.

Due to my much-discussed “Chinese deleveraging / Fed tightening / ECB pivoting ‘less dovish’” trifecta, we are seeing good buying in cash USTs and receiving in swaps (strong 5Y auction as well) keeping rates pinned despite the ongoing risk-asset rally.

Rates in-turn continue to dictate factor-behavior in equities -> inability for yields to move higher means ‘growth’ and ‘anti-beta’ continue to drive leadership, while ‘value’ is dead as a doornail until rates can move higher again.

Credit and multi-asset fund feedback: sitting with very high cash / look-alikes as they feel they aren’t being compensated to take on significant additional risk at such brutally-tight spreads here.  Positive spin is that they are constructive but wanting a selloff to deploy this cash, meaning there is still ammo for a ‘buyers are higher / tighter’ chase.  Note: IG desk seeing net client SELLING in secondary this week (big notional) to fund the calendar as issuance train ‘rolls on.’

COMMENTARY:

FED DOVISH-HAWKISHNESS: The Fed has once again managed to ‘thread the needle’ as it pertains to the market perception of the minutes release yesterday.  Despite maintaining messaging showing that the June meeting is ‘on track’ for the next hike, in conjunction with voicing confidence on back-half balance-sheet tapering–both in line with consensus—the FOMC too was able to communicate a ‘still cautious’ bias simultaneously, regarding the obvious flattening trajectory of the recent growth story.  Essentially, the minutes read to many as if there was actually HEIGHTENED DEBATE surrounding rate increases.

"Members generally judged that it would be prudent to await additional evidence indicating that the recent slowing in the pace of economic activity had been transitory before taking another step in removing accommodation."

Similarly, there was debate on still-soft PCE price inflation forcing a “gradual approach to tightening,” as some recent communications could be viewed as too hawkish, which in turn was contributing to softer long-term inflation expectations per business surveys (TALK ABOUT ‘REFLEXIVITY’…geeeeeez guys):

"Some participants noted that core PCE price inflation had been running below the Committee’s objective for overall inflation for the past eight years and that it was important to return inflation to 2 percent, or that the public’s longer-term inflation expectations may have fallen somewhat, and that a gradual approach to tightening could help return expectations and inflation to 2 percent. One participant cited results of a District survey of businesses indicating that more than one-third of respondents saw the Federal Reserve as more likely to accept inflation below its 2 percent objective than above; that participant interpreted the survey results as suggesting that the Committee’s communications about the symmetry of its inflation objective had not completely taken hold, a concern also mentioned by a couple of other participants...."

Specifically, the Fed eased concerns surrounding the ‘one-two’ punch of hiking in conjunction with balance-sheet tapering efforts via implementation of a ‘cap’ that would be lifted every three months upon commencement of said BS run-off.

So once again, the Fed’s HAWKISH actions (‘on message’ with June hike and taper commencement for Fall / Q4) perversely created a DOVISH market response, with ‘real rates’ (5Y TIPS yields as proxy) actually EASING almost 6bps from prior the meetings release to overnight lows.

As such, we saw a “QE of old” market-reaction: stocks AND USTs higher against lower USD.  #havecake #eatittoo

CHINESE INTERVENTIONS: Fast forward then to the Asian session, where the Yuan surged the most in four months as Chinese banks were speculated in the onshore market selling Dollars.  Shortly thereafter domestic equities markets experienced massive reversals higher as well—most notably in financials, where state-backed funds have previously been mandated with buying shares to support the market.

What followed: The CSI 300 ‘financials’ sub-index turning from -30bps on the open to closing +3.8%; the ChiNext (smallcap) index erased a decline of -1.8% to finish ‘up’ on the day; and the benchmark Shanghai Comp is now +3.0% off the Wednesday ‘post Moody’s downgrade’ lows.  Solid effort, folks.

CSI 300 FINANCIALS SEE A 5.6SD MOVE OVERNIGHT (RELATIVE TO YTD RETURNS):

TREASURIES ‘STRONG LIKE BULL’: Rates are again unable to move higher, with longs building in cash/ futs and receiving in swaps.  The larger theme has been the “Chinese deleveraging / Fed tightening / ECB pivoting ‘less dovish’” story, with the contribution of course from the much-discussed softer US data and now, a ‘less hawkish’ interpretation of yesterday’s Fed minutes—especially as it relates to the ‘pace’ of tapering.

Add in the US consumer ‘papercuts’ mounting (AZO, AAP, LOW and TIF earnings or soft comps all notable in recent days) and there ya go. 

EQUITIES FACTOR PERFORMANCE CONTINUES TO BE ENTIRELY-BASED AROUND INABILITY OF RATES TO MOVE HIGHER: Repeat after me—barbell of long ‘growth’ / long ‘anti-beta’ continues to drive leadership, while ‘value’ remain almost completely at the mercy of rates, with ‘cyclicals’ (Energy, Financials, Industrials, Materials) currently stuck as four of the six worst S&P sectors quarter- and year-to-date.

GROWTH’ AND ‘ANTI-BETA’ LEADING AGAIN YESTERDAY AGAINST LAGGING ‘VALUE’ IS REPRESENTATIVE OF THE YTD THEME—BECAUSE RATES ARE STUCK LOWER DUE TO FADING ECONOMIC EXPECTATIONS: Growth, quality, anti-beta / low volatility / defensives lead against value, small caps and cyclicals lagging.