RBC Explains The Market's Sudden Regime Shift
There’s a clear change in the air as growth stocks are pummeled, bond yields spike, and central bankers wax hawkish.
Here is RBC’s head of cross-asset strategy Charlie McElligott to explain what’s happening…
The selloff in USTs & duration / concurrent ‘bear steepening’ is further-set to act as an ‘accelerant’ on both my equities ‘rotation’ call and the unwind of the broad ‘slow-flation’ narrative overshoot and its key trade expressions.
And just to get this question out of the way: as we have mentioned many times in the past 5 years, equities can handle higher nominal rates to a certain extent before becoming ‘too violent,’ at which point we’d have to become concerned about the potential for risk-parity deleveraging flows across what have been recently ‘low vol’ assets, which has allowed for greater leverage deployment on said ‘risk allocations’ which would then be taken-down. This could be exacerbated by recent ‘longs’ into USTs tapping, as some faster money late-comers get stung here. However in the ‘now,’ the recently higher realized vols in rates isn’t bleeding into a gamma repricing yet (Jenny Xiao—“It’s pretty incredible that a 15bps selloff couldn’t muster anything more than a 1 annual bpvol move in gamma”). And FWIW too, with ‘real rates’ chopping along here and unable to break meaningful higher (= “tighter” financial conditions), I don’t expect this to be a headwind for awhile either.
Currently, it’s the same ‘higher nominal rates’ catalysts which I’ve been noting that are continuing to push yields around. Hawkish rhetoric from global central bankers (most recently BoE’s Haldane this morning stating they “need to look seriously at raising rates”) is certainly a large dynamic right now, catching the ‘slow-flation’ crowd–who had recently piled-into duration and flatteners on account of slowing data trajectory and what had been a collapse in inflation expectations / inflation proxies—‘wrong way.’ More ‘higher rates’ right-sizing as the ‘narrative excess’ is corrected.
Further playing into my hands on the “slow-flation narrative & positioning overshoot” theme at the core of the equities factor-rotation trade I’ve been pushing are two key commodity inflation proxies reversing course:
Crude ‘capitulatory’ flows from ‘lazy OPEC longs’ seemingly reached peak ‘tap-out’ over the past 3 weeks (with net manager length at 11-month lows and all-time highs in ICE Brent spec shorts)….which allowed for a ‘stabilization’ off the 50dma and pivot ultimately higher. Now it seems ‘less bad’ inventory data is helping to fuel a modest squeeze higher, with WTI +7.7% in one week….although there are some notable ‘production decline wins’ worth-noting here too: our Energy equities team is highlighting that the ‘lower 48 states’ production saw the largest drop in 10 months, and has declined twice now this month.
And even more importantly from an ‘inflation expectations’ key price ‘sensitivity’ input, Qingdao Iron Ore pivoted MASSIVELY-HIGHER off the lows mid-month, as the Chinese ‘flinched’ on liquidity (3 weeks of powerful injections via OMOs and MLF beginning late May) began to ‘pay off’ in the form of a 16.8% rally in 10 sessions (and for the broad industrial metals complex as well). And mind-you…this rally has continued despite the PBoC liquidity withdrawals of the past week, as money market rates in aggregate have moved lower.
Take a look at said ‘easing’ of tighter financing conditions as per overnight SHIBOR over the past week alone…it’s like a steroid-shot for the global commodities complex:
Bloomberg Global Commodities Index and Overnight SHIBOR:
Overnight SHIBOR and Qingdao Iron Ore:
In turn, look at the counter-trend move across inflation proxies—pivoting HIGHER / WIDER for the first time in months–everything from US 5y5y inflation fwds to breakevens to the aforementioned iron ore and crude:
It’s still the same story we’ve been grinding over for the past three years:
…the entire global macro trade continues to hinge on the perceived ‘binary’ direction of ‘inflation’ (‘reflation’ vs ‘disinflation’ debate)
…which then dictates everything from the rates ‘flatteners vs steepeners’ trade to US equities factor rotations (‘value’ and ‘size’ factors vs ‘momentum,’ ‘growth,’ ‘quality,’ and ‘anti-beta’) to CCCs vs high-grade in credit.
Why? Because every asset class in the post-GFC era now possesses a heightened sensitivity to ‘interest rates’ on account of ZIRP & QE monpol.