An extraordinary week. How extraordinary, you ask?
Bloomberg: “Best Run for Bonds Since 2020 as Traders Bet on Fed-Hike Finale.” Ten-year Treasury yields sank 26 bps this week, the biggest weekly drop since March (-27bps). Thirty-year Treasury yields fell 25 bps, the largest decline since the first week of the year (-28bps). Benchmark MBS yields collapsed 43 bps, the largest drop since last November (64bps). Bloomberg: “Muni Rally Drives Yields Down to Biggest Weekly Drop since 2022.”
Italian 10-year yields sank 29 bps (to 4.51%), the largest decline since June (-32bps). UK 10-year gilt yields dropped 26 bps (4.29%) – the biggest fall since March. Local-currency yields were down 83 bps in Columbia, 47 bps in Hungary, 40 bps in Peru, 37 bps in Mexico, 36 bps in South Africa, 35 bps in Indonesia, 30 bps in Poland, and 27 bps in South Korea. Dollar yields collapsed 76 bps in Colombia, 60 bps in Turkey, 40 bps in Mexico, 39 bps in Brazil, 39 bps in Peru, and 37 bps in Chile.
The Chilean peso gained 6.6%, the Mexican peso 3.7%, the Colombian peso 3.3%, the South African rand 3.2%, the Peruvian sol 3.1%, the Hungarian forint 2.7%, the South Korean won 2.5%, the Czech koruna 2.5%, and the Brazilian real 2.3%. Major equities indices jumped 4.7% in Mexico, 4.3% in Brazil, 4.2% in Spain, 5.1% in Italy, and 3.7% in France.
The S&P500 jumped 5.9%, the largest weekly gain in a year. It was a huge short squeeze week. The Goldman Sachs Short Index surged 12.9%, the largest gain since the week of January 13th, 2023 (15.7%). The Regional Bank Index (KRX) jumped 10.7%, the biggest gain since the week of November 13th, 2020 (15.9%). The KBW Bank Index (BKX) rose 11.1%, the strongest advance since November 2020 (11.5%). The VIX Index declined 6.4 points to 14.91, the largest weekly drop since March.
Friday from Bloomberg Intelligence (Jackson Gutenplan and Larry R Tabb): “Options trading on the S&P 500 has surged in recent months, driven by the explosion in trading of zero-days-to-expiry options, or 0DTE, which now account for about half of the volume as traders zip in and out of contracts to capture or hedge the day’s gyrations. Average daily volume on the SPDR S&P 500 ETF Trust (SPY) and SPX Index jumped 15.1% and 14.8% from September to October, respectively. The zero-day options account for 46.7% of SPY and 49.4% of SPX trading.”
The CDS marketplace is demonstrating more than its share of wild volatility. For the week, investment-grade CDS dropped 11.8 bps (to 70bps), the largest decline since November 2020 (-12.1bps). High yield CDS collapsed 62.8 bps (to 464.4 bps), the biggest drop since May 2022 (-66bps). JPM CDS dropped 11 (to 60bps) – largest fall since April (-11.1bps), and BofA CDS fell 9.4 (to 99 bps) – biggest since May.
EM CDS sank 33 bps (to 206 bps), the largest decline in a year (-37bps). European “Crossover”/high yield CDS sank 55 bps (to 548bps), the largest drop since August (-56). European Subordinated Financial Bank CDS dropped 25 bps (to 163bps), the biggest drop since the final week of March (-34bps).
Fundamental factors behind the jubilation? The obvious candidates are the somewhat smaller-than-expected Treasury quarterly refunding. Friday’s weaker-than-expected Non-Farm Payrolls report (150k vs. 180k estimate). And, of course, the transformation of a “hawkish pause” to “dovish likely done.” By the end of the week, markets were pricing only a 5% probability of a rate hike at the December 13th FOMC meeting, down from 27% at Tuesday’s close.
November 3 – Bloomberg (Denitsa Tsekova): “Wall Street just got schooled on the dangers of market timing after a shock cross-asset rally on tentative bets that the great monetary stress of 2023 is easing at long last. Evidence that Federal Reserve Chair Jerome Powell is turning less hawkish fueled the biggest concerted melt-up since November 2022, with stocks, bonds and credit rising in tandem… How ingrained had gloom become? The run-up followed a three-month selling spree by hedge funds that was the second-biggest of the past decade, according to… Goldman Sachs… prime brokerage. Net short bets on Treasuries held by professional speculators were hovering close to the highest level on record…”
Another Everything Short Squeeze.
After receiving short shrift at the FOMC’s September meeting, “financial conditions” was back in vogue during Powell’s Wednesday press conference. There were several questions specific to financial conditions.
Powell: “So, obviously we’re monitoring, we’re attentive to the increase in longer-term yields and which have contributed to a tightening of broader financial conditions since the summer. As I mentioned, persistent changes in broader financial conditions can have implications for the path of monetary policy. In this case, the tighter financial conditions we’re seeing from higher long-term rates but also from other sources like the stronger dollar and lower equity prices could matter for future rate decisions, as long as two conditions are satisfied. The first is that the tighter conditions would need to be persistent and that is something that remains to be seen. But that’s critical, things are fluctuating back and forth, that’s not what we’re looking for. With financial conditions, we’re looking for persistent changes that are material.”
“So, I think what we can say is that financial conditions have clearly tightened, and you can see that in the rates that consumers, households and businesses are paying now, and over time that will have an effect, we just don’t know how persistent it’s going to be, and it’s tough to try to translate that in a way that I’d be comfortable communicating to how many rate hikes that is.”
November 1 – Bloomberg (Steve Matthews and Craig Torres): “Federal Reserve Chair Jerome Powell hinted the US central bank may now be finished with the most aggressive tightening cycle in four decades after it held off on raising interest rates for a second consecutive policy meeting. ‘The question we’re asking is: Should we hike more?’ Powell told reporters… ‘Slowing down is giving us, I think, a better sense of how much more we need to do, if we need to do more.’ The central bank’s… Federal Open Market Committee left its benchmark rate unchanged Wednesday in a range of 5.25% to 5.5%… Officials signaled… that a recent rise in longer-term Treasury yields reduces the impetus to hike again, though they left open the door to another increase.”
Chair Powell, and the Federal Reserve more generally, have been understandably cautious not to signal the end of tightening. They were conscious to avoid dovish signaling that would surely spur big market rallies and resulting looser conditions.
This week, Powell spoke more confidently about a tightening of market financial conditions. From 4.40% at the Fed’s September 20th meeting, 10-year yields traded to 5.00% last week. Equities have been under pressure, and most financial conditions indicators have signaled meaningful tightening since September. Moreover, there was the eruption of war in Gaza, with significantly elevated geopolitical risk.
With what has certainly been major hedging and bearish positioning in response to surging yields and geopolitical crisis (with major escalation risk), markets were locked and loaded. “Balanced Powell” leaned decisively dovish and stoked an Everything Squeeze and meaningfully looser financial conditions. Ironic. Powell’s focus on tightened conditions provoked loosening.
The big squeeze coming out of the bank bailout and the resulting loosening of financial conditions (negating Fed tightening) is the key 2023 storyline. Does this week’s squeeze have legs? If financial condition loosening persists, this should work to sustain both demand and elevated inflation. Despite all the recession talk, it’s worth remembering Q3 GDP surged to 4.9%. And while Q4 growth will slow significantly, I’m skeptical that demand has slackened sufficiently to place downward pressure on prices.
October 31 – Bloomberg (Josh Eidelson, Laura Bejder Jensen and Jo Constantz): “Workers in the US are getting record-breaking wage hikes this year thanks to strategic strikes and stunning contract wins. The result is a boost in middle-income wages and a shift in the balance of power between companies and their employees. Even before the United Auto Workers reached historic contract deals with carmakers, unions across the country had already won their members 6.6% raises on average in 2023 — the biggest bump in more than three decades… The recent victories mark a potential turning point for the country’s labor movement, which has seen union ranks and power dwindle for decades.”
The United Auto Workers successfully negotiated big pay increases, spurring quick action from non-union Toyota. More will follow. The Q3 Employment Cost Index (ECI) was reported Tuesday at a stronger-than-expected 1.1%. It’s worth noting that Q3 2021 was the first quarterly ECI above 1% since Q1 2004. And while Friday’s October job gains and Average Hourly Earnings (0.2%) were somewhat weaker-than-expected, there remain a historically elevated 9.55 million job openings.
There was confirmation this week of key market dynamics. Cross-asset markets are highly correlated – stocks, bonds, EM, and currencies. Markets remain highly correlated globally, with “risk on” or “risk off” typically a global phenomenon. Trend-following and performance-chasing dominated markets are extraordinarily speculative. “Crowded trades” are a serious issue.
November 3 – Reuters (Nell Mackenzie): “Global hedge funds using algorithms to trade stocks endured one of their worst days of the year on Thursday, a Goldman Sachs note on Friday showed, a sign that a sharp rally in shares on hopes that global rate hikes are over caught some off guard. Systematic fund managers, particularly those which had short bets on highly traded stock names, got caught trying to get out of crowded trades and found themselves stuck in losing positions, Goldman Sachs said.”
Markets function as if illiquidity is a festering issue. Derivatives-related trading appears to stress market function when algorithmic trading pushes forcefully either to the downside or the upside. The proliferation of options trading for hedging and speculating has become a major market function issue across markets.
This week, there’s evidence aplenty of financial accident risk. For one, too many in the markets are relying on derivatives to hedge market risk. This fuels market dysfunction. Hedges are put on in size, creating enormous potential selling pressure in the event of negative developments.
This week’s Israeli Gaza land invasion did not trigger rapid escalation (i.e., Hezbollah or Iran). Crude prices sank $5. The Treasury’s much anticipated quarterly refunding eased bond market concerns. Risk of Powell pressing his so-called “hawkish pause” narrative also didn’t materialize. And, on Friday, a potential negative bond market reaction to strong payroll data also didn’t happen. The Dollar Index’s slump took pressure off the vulnerable yen and renminbi, along with EM currencies generally. With short-term risks allayed on multiple fronts, hedges with short maturities swiftly became losing bets. The hasty unwind of hedges put short positions in harm’s way. And it was Back to Squeezeville.
Highly speculative markets dominated by levered trades and hedges are innately short-term focused. And we witnessed convulsions this week as near-term risks dissipated. Meanwhile, overall risk remains highly elevated. This week’s developments in Gaza only increase the likelihood of Middle East escalation over time. With the Wall Street Journal reporting that Russia (Wagner Group) plans to provide Hezbollah air-defense systems, it’s possible that Hezbollah, Iran, and other militant groups may boost defenses before escalating the conflict.
And I don’t see the bond market out of the woods. While quarterly refunding news wasn’t as dismal as feared, just give it some time. Especially if financial conditions loosen, getting from over 4% CPI to 2% will prove one tall order. Key facets of the U.S. Bubble economy remain overheated, the result of the interplay between loose financial conditions, highly speculative financial markets, and powerful inflationary impulses. Markets will (violently) ebb and flow, with a powerful propensity for squeezes. But supply and inflation issues will continue to pressure Treasury and bond markets.
I worry about this week’s conspicuous Bubble Dynamics and market dysfunction. Financial and economic systems should by now be well into major adjustments to much higher rates and market yields, worsening global fragilities, and a rapidly deteriorating geopolitical backdrop. Whether it’s inflation, bond yields, deficits, political disfunction, Chinese bubbles, our soured relationship with China, the new world order, conflicts in Ukraine and the Middle East, and the looming Taiwan issue, there is today extraordinary uncertainty that should have players reining in risk and leverage. Markets reward the opposite.
It was a market week – Back to Squeezeville – that supports the peak speculative Bubble thesis.
Original Post 3 November 2023
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