Despite much talk on desks of CTAs and volatility funds running for the hills, Goldman's Charles Himmelberg and the Economics Research team is not buying it...
We see little evidence that the recent rates selloff is due to the usual suspects such as risk parity delevering, overseas cash sellers, or mortgage hedgers. Rather the move appears partly based on fundamentals and supply increases, and partly on technicals, but we don’t see additional factors that would steepen the yield curve further in the near term
So what explains yesterday’s dramatic price action?
Goldman uses their new "macro factors" - which identify seven core macro themes distilled from daily market moves in 28 benchmark assets across equities, rates, credit, FX, and commodities. These macro themes are charted below, and consist of a global risk appetite factor, three global growth factors (US, EA and EM), two global monetary factors (US and EA), and global oil supply factor.
Based on this, Goldman's initial take is that yesterday’s correction was primarily a "US growth-off" event. While there were no obvious catalysts in the headlines, we think yesterday’s growth repricing helps square the circle with last week’s sharp repricing of monetary policy and oil supply. Both of these moves in our factors were large enough to drive a simultaneous “growth off” and “risk off” repricing, but didn’t at the time.
As such, our best initial take is that yesterday’s repricing of US growth was an overdue gut-check following last week’s monetary and oil supply shocks.
This narrative holds up when we break down yesterday’s action on an asset-by-asset basis. In our Global Markets Analyst, we showed that we can use our macro factors to decompose asset returns into their underlying economic drivers. When we run this decomposition on yesterday’s price moves (not shown), the biggest drag on equities – particularly US equities – is US growth, followed by global risk appetite. Interestingly, our model shows that this week’s concerns about monetary policy and oil supply shocks have been relatively quiet. This view is not contradicted by yesterday’s 2% decline in oil prices, which our factors attribute mainly to this week’s growth repricing.
Our conversations with clients this week suggest to us that investors may have initially underestimated the macro signal in last week’s market moves. In particular, the rise in the 2-year Treasury yield was only modest, which may have caused some to understate the magnitude of the market’s monetary concerns. But this signal was masked by concurrent concerns over oil supply, which were visible in oil prices, but which also tend to weigh heavily on bond yields. The offsetting effects of monetary concerns and oil supply therefore made the 2-year yield harder to read. Disentangling such signals is the task for which our macro factors were designed.
Additionally, Goldman notes that extreme positioning among speculators was likely a driver of the actual depth of the moves:
The severity of yesterday’s moves in the absence of catalysts strongly suggests that price declines were magniﬁed by an unwind of crowded positions. To wit, yesterday’s pain was particularly acute for technology stocks, as well as our Portfolio Strategists’ basket of Hedge Fund “VIP” overweights. That said, our macro factors can explain about 7/8 of yesterday’s S&P move. Though the unexplained portion was somewhat larger than normal, it was small by comparison to better-known episodes of asset-speciﬁc market distortions. During the VIX spike in February, for example (a move that was mostly technical, in our view), our macro factors recorded almost no change in US growth views, assigning most of the move to unexplainable idiosyncratic factors.
So, in summary, Goldman thinks, based on their macro factors that a strong case can be made that yesterday’s sell-off was a tactically overdue growth repricing. As the US growth factor in the chart above shows, the US growth factor was already looking a bit stretched, and stood in sharp contrast to last week’s sharp (but not necessarily obvious) repricing of tighter monetary policy and tighter oil supply. While such a growth surprise, by deﬁnition, would be hard to predict, it helps rationalize the repricings of the past week and a half.
Furthermore, Goldman suggests the sudden steepening of the yield curve was overdone, adding that the about-face, as long-term yields broke above key technical levels, is only a pause in the march to inversion as the Federal Reserve is set to tighten policy further...
“Our read of the selloff that began last week is that, at least the steepening aspect, is somewhat technical in nature,” they wrote. “We expect that the flattening trend that is more typical of hiking cycles will reassert itself as 10s and 30s begin to settle in a new range.”
As a reminder, the curve is on course to invert in 2019, according to Goldman’s yield forecasts. The bank forecasts the two-year yield will be above that of the 10-year at the end of the second quarter -- after finishing even (with each at 3.2 percent) as of the end of March.