RBC on macro

QUICK READ: China taketh away, and China giveth back…

The tenuous  effects of (and newest iteration of) “global growth scare v3.0” from earlier in the week–off the back of the bad China export data print and the implications of a “strengthening too fast” US Dollar–were washed away overnight, following Chinese PPI printing its first month of YoY growth since Jan 2012.  It seems rather obvious then that the pickup in Chinese inflation has been driven by the recovery in oil, while too recently picking-up the tailwind of the RMB depreciation as well—potent stuff.

As such, we are again seeing “pro-cyclical” risk leadership out of the overnight tradeglobal core rates are again higher (UST 10Y at 1.776) seeing bear-steepening through long-end weakness (Gilts really breaking-down on the “bad kind of inflation” narrative in the UK post the GBP move, yields at highs since Brexit vote day), WTI crude is +1.0%, Spooz +8 handles and EU equities are seeing major outperformance from financials / energy / materials / consumer discretionary sectors.

The timing of this is HUGELY important, because the past week’s VaR-based selloff was clearly driving an unwind of the mega six-month “cyclicals over defensive / bond-proxy / low vol” trade within the equities complex, which frankly has acted as a leading-indicator of “reflation”—well ahead of FX, commods and certainly rates.  There had been a “risk unfriendly” rotation back into the “wrong kind of leadership” up to this point WTD: Utes, REITs, Healthcare, Staples and Telcos were 5 of the S&P’s top 6 performing sectors yesterday, for instance.  Tactical ‘High Beta,’ ‘Inflation,’ ‘Weak Balance Sheet,’ ‘Size’ (small over large) and ‘Bottom-Quintile’ (worst performers) trades which had driven the MASSIVE performance catch-up (esp in Q3, where HFR Equity HF index actually outperformed benchmark S&P index, and HF VIP Longs were +10.2%, against SPX +3.3%) were showing signs of capitulatory unwinding through yesterday’s close.

So, we again get ANOTHER chance at perpetuation of the recent regime, where inflation expectations can drive the risk-asset narrative, and perhaps most importantly, re-price rates (especially the long-end / duration trade).  Again, what is “mission-critical” then is the rate of change within rates—anything disorderly into the “fact of nature” that is the “short convexity” market structure we now operate within will continue to induce cross-asset volatility spasms (thus, the “long convexity” trade we saw yday in equities—a buyer of 150k Jan SPY 170 Puts—a 20% out of the money portfolio hedge and vol term-structure trade).  Risk-assets can work if inflation AND growth are the drivers of said higher rates…but if it’s more “volatility spasms” which in turn cause systematic unwinds in a world very “long duration” (not just bonds, but equities too obviously!)…OR you get the inflation without the growth pick-up (a “stagflation” scenario), you then would see higher rates act as a headwind to stock valuation, as they suddenly look a lot more expensive per the equity risk premia.


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