First thing this morning, one of the recent "bullish converts", Bloomberg Marc Breslow was the first to accuse Yellen of making a big mistake, and warning that this may be it for stocks for the time being. He was followed by "Macro Tourist" Kevin Muir, who likewise had been "bullish for a while" then turned negative today on concerns that the global liquidity tsunami is ending. Now, RBC's cross asset wizard, Charlie McElligott (recently caught in a friendly feud with his magical JPM peer, Marco Kolanovic), has released a note explaining that today's selloff may be just the beginning as traders realize that what Yellen has done, especially with China's credit impulse collapsing, is "tightening into slowing", aka the single biggest policy error the Fed could do.
His full note below.
'TIGHTENING INTO SLOWING' VIEW GAINS FURTHER STEAM
- ‘Sloppy’ risk-assets this morning not just a ‘Trump obstruction’ story
- Collapsing inflation expectations / breakevens are driving ‘real yield’ TIGHTENING
- In addition to the Fed hike, we see BoC and BoE too further inflect towards TIGHTENING
- As such, the “tightening into slowing” narrative gains further market traction
- Two-sessions yesterday:
- 1) ‘Post CPI’: rates & breakevens collapse drives $ back into the status-quo, ‘Slow-Flation’ narrative trades
- 2) ‘Yellen Q&A’: signs of de-risking / profit-taking / grossing-down on mounting belief of potential ‘Policy Error into a Growth Scare’
- Bigger picture, ‘long game’ Fed hiking and ‘tactical’ markets can both be right on account of ongoing ‘macro range trade’ scenario
Yesterday was a tale of two totally-distinct trading sessions wrapped in one day, and which frankly captured BOTH of the ‘scenarios’ I laid-out in my notes yesterday—essentially, ‘post CPI’ and the ‘Yellen Q&A.’
My ‘scenario 1’ fit the first two-thirds of the trading day bang-on, as post the CPI whiff, nominal rates, breakevens and USD all collapsed, creating the exact impact I expected in factor market-neutral themes: a bid to ‘anti-beta’ and ‘growth’ tilts against downside in ‘value’ and ‘size’ (essentially, back to the YTD leadership / laggards regime long ‘secular growth,’ ‘defensives’ and ‘quality,’ against short ‘cyclical beta’ and ‘small caps’).
Later though, JY did what the market wasn’t prepared for, and as I warned pre-Fed here:
“Turning to the Fed now: the entire investing world now feels completely justified in coming into today with 'dovish hike' expectations. The issue there is that it sets a VERY fine-line on messaging, where you have such consensual expectation of ‘dovish hike’ that the slightest disappointment in this view could rock us.
IF the Fed were to somehow ‘screw-up’ this very simple ‘soft-ball’ messaging task and come off as anything resembling ‘hawkish’--perhaps by again attempting to use the term ‘transitory’ to describe what are ‘outright collapsing’ inflation expectations—the market murmur of ‘Fed policy error’ grows exponentially.
And as per this morning’s note, this would be the ‘2nd scenario’ I talked about towards the bottom of the piece--a broader de-risking interpretation largely based upon a view that the Fed has truly painted itself into corner here.
If they continue to push 'tightening' under ‘transitory inflation weakness’--when now we are confirmed as SLOWING and GETTING SOFTER--we could get that ‘de-risk’ where folks actually ‘gross-down’…
That’s the ‘policy error’ interpretation, and it’s entirely dependent upon today’s Fed guidance. The market will NEED to hear them state plainly / upgrade the tone of the concern / clearly message that they are ‘watching inflation closely’ to assuage these fears.”
So here is the way I described what happened yesterday to a few folks, in very-much ‘oversimplified’ terms (think of it as ‘rich man’s haiku’):
- She came out ‘hawkish’
- And looks ‘tone-deaf’ to some (perceived ‘downplaying’ of 3 consecutive Core CPI misses as “transitory”)
- And mkt looks at it like potential ‘policy-error’
- Which can cause a ‘growth-scare’
- Which is occurring with grosses- and nets- near cycle-highs
- While BE's are collapsing alongside curves
- And oh yeah, oil -4%
- So now you're seeing some modest signs of 'gross-down' behavior (or simple ‘profit-taking’) as clients get increasingly uncomfortable with what may lie ahead
Note that this is EXACTLY what I’ve been speaking-to as the ‘growing risk-asset bearish narrative’ over the past few months, and is now coming a big-step closer to fruition: “tightening into disinflation” / “slowing into tightening” et cetera.
And idiosyncratically over the course of the week, you can ‘add-in’ this: not only did the Fed hike again this week…but we have an absolutely clear inflection by the Bank of Canada, as well as today’s ‘shocker’ BoE vote which edged-up 5-3 (closer to hiking than anticipated).
Long-story-short, that is why I believe stocks are acting pretty sloppy (Spooz -25 handles from yesterday morning’s highs): real rates are TIGHTENING as breakevens collapse. Sound familiar? That’s the “tightening into a slowdown” narrative popping-up again, and is a bad cocktail for risk.
That said, let’s talk bigger-picture on ‘market’ versus ‘Fed’ perception:
The Fed believes they have to tighten long-term monetary policy based upon a ‘still-evident’ utilization of the Philips Curve, as highlighted by Tom Porcelli yesterday while picking-through the commentary (and why Tom continues to be absolutely steadfast in the view that they are absolutely committed to their hiking course, whether the market ‘gets it’ or not!).
The ‘market,’ on other hand, is thinking very tactically, allowing ‘real-time’ market ‘inflation expectations’ proxies to TRADE AROUND this view of policy misalignment against ‘slow-flation’; thus, the recent duration bid / flatteners, the bid to ‘safe yield’ IG credit and equities ‘bond-proxies’ alongside ‘stocks that can grow regardless of the economic cycle’ (tech, biotech, consumer internet) while fading commodities (iron ore and crude especially) and economically-sensitive equities like energy, banks, materials and industrials.
Here’s my point: they can both be ‘right’ because they are operating on different time horizons. In that sense, the ‘macro range trade’ still exists, trading this 2.00% to 2.40% range where one ‘buy rate sensitives’ at 2.00% as Fed remains resolute to continue hiking (offers you ‘convexity’ to moves higher in yields), while too you can trade ‘short reflation’ at 2.40% on account of this ‘tightening into disinflation’ theme remains intact.
FWIW and in-closing, the risk of course to this range-trade view then becomes a larger ‘risk asset’ selloff / drawdown accelerating to something more meaningful which could then pull us through that 2.00% level break the range. That said, this continues to be a lower-likelihood outcome in the ‘now’ as we still see those ‘slowing-but-still-expansive’ data in US today (ongoing better Jobless Claims and strong Philly Fed and Empire Manufacturing--especially in the ‘New Orders’ bucket) perpetuating the conditioned ‘buy the dip’ mentality with ‘real money’ equities investors.
‘TIGHTENING’ WITH U.S. AND CHINESE FINANCIAL CONDITIONS:
THE INCREDIBLE IMPACT OF TIGHTER CHINESE CONDITIONS (HIGHER CHINESE SHORT-TERM RATES--OVERNIGHT SHIBOR, INVERTED) ON GLOBAL COMMODITIES:
FOLLOW THE FLOW, AS THE CONTRACTING CHINESE CREDIT IMPULSE TIGHTENS FINANCIAL CONDITIONS, DRIVING GLOBAL INFLATION AND ECONOMIC SURPRISE INDICES LOWER ALONGSIDE RATES:
U.S. CURVES FLATTENING TO ’07 / ’08 LEVELS:
THE DIRECTION OF NOMINAL YIELDS AND THEIR IMPACT UPON EQUITIES ‘VALUE : GROWTH’ / ‘CYCLICALS : DEFENSIVES’ RATIOS:
MORE EVIDENCE OF FUNDAMENTAL MACRO IMPACT ON U.S. EQUITY FACTORS—5Y REAL YIELDS AND S&P ‘VALUE : GROWTH’ RATIO