Nomura: "This Was The Moment When Everything Changed"

From Charlie Mcelligott, head of Nomura's Cross-Asset Strategy


For the “right” reasons, the market continues to focus on tomorrow’s US CPI print, which will act as a referendum on the merit of the fixed-income repricing experienced since the start of December.  As stated previously, the list of ‘bearish catalysts’ for fixed-income is long and illustrious:

  1. above-trend global growth
  2. percolating US inflation and wages (i.e. last week’s AHE print)
  3. real-time US fiscal stimulus via tax reform (with further wage implications)
  4. US ‘deficit spending’ requiring massive Treasury refunding needs in 2018 (running nearly 2x’s 2017)
  5. particulars of the aforementioned tax reform, which will disincentivize US mega-corporates from ‘parking’ offshore cash in UST-instruments and credits, and instead likely force them to pivot to turning net sellers in coming months and years.

In hindsight, the ‘tie-breaker’ which drove UST 10Y yields out of their multi-month 2.35-2.50 range into this new stratosphere looks to have been the US fiscal stimulus / tax reform plan passing the initial Senate vote on December 2nd, 2017. 

By December 6th, the UST 10Y Term Premium had inflected from 1+ year lows (-62bps) and “hasn’t looked back,” +45bps to now just -17bps.  Why?  This was the point where the Fed’s post-crisis playbook of “perpetually low nominal rates and flatter curves” was then deemed by the market as potentially “old news.”  Instead, the market appropriately determined that in light of the economic expansion, the growing likelihood of higher inflation, the coming refunding / supply wave etc that rate volatility now had to move higher, because the bond market was, going-forward, no longer going to be “controlled” entirely by the same “forward guidance” regime of the GFC period….as a new era of interest rate risk was deemed to be upon us.

As such, USD 3m10Y Swaption Vol printed all-time lows on Dec 13th, while the MOVE index (UST volatility) bottomed Dec 14th.

Also on Dec 14th, the Quant Insight “macro regime” model for UST 10Y—essentially the “explainability” of the price of the underlying asset based off the key macro factor factors--peaked at 86% before collapsing all the way down to just 5% “explainable” by January 12th.  On Dec 14th, the Nomura FX Volatility Index put in a three year and a half year low ( since +65%).  For US equities, the 12m forward PE Ratio peaked Dec 15th.  By Dec 18th, Bitcoin also peaked at $18,674 ( since ‘melted down’ to the current $8465 level).  Since Dec 5th (3 days after Senate passage of tax bill), UST 5Y breakevens have rallied 20bps, while Gold has rallied $87 / oz.  The US Economic Surprise Index peaked Dec 22nd.  I could go on and on….

Point here being that the uber-ambiguous “something has changed in the market” meme that’s been going-around is based-upon the underlying change in perception with regard to a bond market that is waking from its slumber due to a new-found Central Bank willingness to normalize policy on account of actual signs of “growth” and “inflation”—ESPECIALLY after being “put over the top” by US fiscal stimulus.  The above observations are simply the manifestations of this mentality-shift in the market….qualitative observation into quantitative phenomenon.