In a nutshell, it’s all thanks to the Fed, all over again, as we explained first thing this morning in our market wrap. But more specifically, as RCB’s Charlie McElligott explains, the “risk-parity / various other leveraged ‘target risk’ strategies are back in the driver’s seat, as the Fed and BoJ went back to their “happy place” of a vol-suppression kind of world.”
Yep: what last week was a risk-impairity, is back to being a risk-party all over again.
Here are the details from RBC’s Charlie McElligott:
CB SUMMARY: Fed again shows its true policy colors, again clarifying their un-stated “weak dollar policy” for the world to see. In conjunction with a BoJ who was given credit by markets for not going the “break glass in case of emergency” route just yet–while too as-noted in yesterday’s “Big Picture” stealthily executing a “backdoor tapering” without jarring JGBs (via the yield-targeting experiment, which IF U.S. YIELDS WERE TO RISE is a sneaky way to weaken the Yen)—it was all that was needed by markets to re-rack the risk-seeking / curve flattening / vol smashing CB macro regime of the prior few months, especially the leveraged / vol control community.
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COMMENTARY: The Fed was some much more dovish than market had anticipated, specifically noting the FOMC’s 1) lowered dot plot, 2) removal of future dots, 3) the cut to their long-term GDP estimate–were what the equities-world fixated-on. Why? Clearly, the Fed is of the view that slower-growth is what lies ahead, and as such, the lower neutral rate means fewer hikes in the future—i.e. back to “lower forever.” Bottom line: nobody within the Fed–or market watchers outside of it–is expecting much hiking in the years ahead. I will highlight a quotation (noted by RBC’s Tom Porcelli) from Yellen yesterday which crystalizes the implied reticence towards making a definitively hawkish move in the near-term—showing that a very high bar still remains in her mind:
“…but with labor market slack being taken up at a somewhat slower pace than in previous years, scope for some further improvement in the labor market remaining, and inflation continuing to run below our 2 percent target, we chose to wait for further evidence of continued progress toward our objectives.”
As such, the “QE / reflation trade” is back “ON” for at least another two months—EM (EEM +2.8%), crude (USO +3.3%), gold (GDX +7.1%!), credit gapped tighter (esp beta energy and materials HY) and ‘cyclical-beta’ equities / Nasdaq (new all-time highs) all screamed higher, while the UST curve bull flattened, and the Dollar (and $Yen–sorry Abe / Kuroda—you’ve been usurped) and VIX (-16.5% on the day LOLOLOL) were smashed. An interesting note from Brian Chen on our ETF team this morning regards HYG / JNK too, where both ETFs closed ~90bps-ish premium to NAV. He expects significant “offers wanted in competition” activity in the create lists, as “…HYG has been difficult to source in the sec lending market, and short-covering ensues.” Major golf-clap for the UST long bond upside (Noorani) and VIX put spread (Simon) trade ideas pushed by RBC Macro this past week—these bad boys both have room to run. Also want to note that Mark Orsley this morning is putting out a “long NQ” (Nasdaq emini) call in light of the risk-environment provided by the central bank “vol murdering spree,” as the index sets-up as a reverse head and shoulders which broke its neckline.
Specifically with the equities market’s reception of the hyper-anticipated dual-policy updates, “everything” worked. We saw an enormous rally in “inflation” plays / leverage / weak balance sheet plays / “cyclical beta”—while too the opposite-end-of-the-spectrum “yield compression” trade re-reality helped drive performance back into the “bond proxies” (div yld, low vol factor, defensives). SOMETHING FOR EVERYBODY.
Judging from the extent of the squeezes in various “most-shorted” proxies, net exposure was added with gusto on the session as shorts books were reduced sharply. Perhaps some of this “buy everything” (both long buying and hedge fund short covering) was driven by the “real” source of funds—high mutual fund cash levels being taken-down and “put to work”….after all, on a year-to-date basis, the mutual fund equities “overweights” basket is trailing the mutual fund equities “underweights” basket by an ABSOLUTELY BRUTAL 9.6%, and that underperformance gap has to be closed for career-preservation purposes (GS noting only 16% of large-cap mutual funds are beating their benchmarks YTD, below the 10 year avg of 37%–h/t MF).
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And just like that: risk-parity / various other leveraged ‘target risk’ strategies (S&P Target Risk Aggressive Index saw its best day since first week in July yesterday) are back in the driver’s seat, as the Fed and BoJ went back to their “happy place” of a vol-suppression kind of world. That is exactly who / what we are seeing in equities futures, UST futures / curves right now. Lever it up again!
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