Visualizing The “Tectonic Shift” In The Markets' Narrative
RBC’s head of US cross-asset strategy, Charlie McElligott wants to “bang you over the head in order to expose the tectonic shift being experienced in markets on the narrative / regime shift.”
After a succinct and clarifying commentary:
We’re at a phase in this UST / developed sovereign bond trade where previously acceptable conditioning (‘buy dips’; ‘get long-er duration because it just keeps working’; ‘never-ending bond inflows will always pause selloffs’ etc) are all being reset in real-time, and this behavioral shift is painful.
In the micro, on top of the oil explosion yesterday (taking inflation expectations with it), we saw further pile-on from the incoming administration which idiosyncratically weighed further on the long-end. Trump’s Treasury Secretary nominee Steven Mnuchin’s “mention” of the possibility of issuing ultra-long bonds (50Y, 100Y) to extend the maturity of the debt certainly isn’t helping the already overwhelmed and under-water duration trade. RBC Rates Strategist Mike Cloherty with some quality tactical thoughts: “While we think that 50s or 100s would be a uniquely bad idea for the Treasury, we’d assign 50-50 odds on it happening. If we get ultras, we would expect the volatility of that ultra-long to spill down into the 30yr sector. Higher 30yr vol would make extending from 10s to 30s look like a worse trade from a Sharpe ratio perspective. The potential for issuance changes is another thing that makes the recent flattening of 10s30s seem like it has gone too far.”
Haha, I’d say so – look at the USTs curves today, with 2s30s +6bps, 2s10s +5bps.
1) larger and longer (maturity) sovereign borrowing needs to the list of bond paper-cuts too. In conjunction with the ‘already in motion’…
2) inflation impulse (energy ‘base effect’ and wage growth in US);
3) global growth ‘pick-up’ (G10 economic surprise index at 3 yr highs, global manufacturing PMI index at 2.5 yr highs);
4) pro-growth domestic US policies from the new administration (tax cuts, deregulation THEN infrastructure in that order);
5) new administration ‘more hawkish’ tilt;
6) general fiscal stimulus shift and data escape velocity driving an accelerated normalization period;
7) the global CB / political shift from monetary policy to fiscal policy (flatter to steeper); and finally
8) outright lazy legacy / crowded positioning (driven by the ‘old CB regime’) which has to be unwound…
And these factors are now forming a ‘fact pattern’ which is helping crystalize the concept of a “paradigm shift” towards a “new normal” markets regime / construct.
The fact that it is ‘getting sticky’ with regards to price-action is obviously ‘spooking’ many in the market who simply are not positioned for said ‘new world order.’ Unfortunately for them, as the aforementioned ‘old conditioning’ ceases to work, the cynicism has come at the expense of portfolio duress.
We have operated in a world since the crisis which saw the narrative set at ‘deflation,’ ‘secular stagnation,’ ZIRP / NIRP and QEternity, which collectively had conspired to drive rates lower / flatter in perpetuity…or so it was assumed. The lazy positioning we’ve discussed for a year now with regards to ‘long duration,’ or strategy constructs based upon leveraging ‘low volatility’ assets like bonds (when built during a 30-year bond bull market!) are too being reset. “Slow growth / slow-flation was the reality—how could you own cyclicals / value / high beta equities?” was the muscle-memory. Retail investors and their wealth management folks lapped-it-up: ‘up’your fixed-income / bond allocation, and lever that up with ‘low vol’ equities—INCOME AT ALL COSTS!
Obviously things went peak insanity this year off the back of the failed NIRP experiment, forcing “the world’s real $”–asset liability managers—to pile into duration for ‘funding survival.’ The whole picture peaked in July with the ‘yield grab’ at its max-bizarro: equities for yield / income, fixed income for capital appreciation.
That is why this is a move that will take longer than weeks to ‘wash out,’ as the slower-moving mega allocators within the global investment community has to position for reflation and growth. It just happened too violently for them to have moved yet.
This shift in rates—and knock-ons into inflation (under-owned), credit (loans and HY over IG), FX (EM issues but there are carry opportunities) and equities (rotation to cyclicality) has room to run.
McElligott unleashes his chartfest exposing the way the world has changed in the last 3 weeks…
GOLD AND DURATION / ‘REAL RATES’: Gold suffering under the weight of higher real rates / the duration beat-down, which simply makes it an unattractive asset to hold in a world where yield has suddenly reappeared.