Markets may not be turmoiling yet, but as per this “emergency” Sunday night “hot take” from RBC’s cross-asset head Charlie McElligott notes, things are certainly starting to break.
SPECIAL EDITION RBC Big Picture: BIG TROUBLE FOR CONSENSUS ‘REFLATION’ TRADES AS ‘FISCAL POLICY’ FEARS CONFIRMED
#HOTTAKE: ‘Risk-off’ in a sloppy Asian opening to start the week (ES1 -18 handles, $/Y -100pips to 110.34, UST 10Y ylds at 2.36), as markets digest the scope and viability of the US ‘fiscal policy’ narrative going-forward off the tremors of Friday’s failed healthcare repeal vote.
“Reflation” themes were already staggering in recent weeks off-the-back of the recent the crude oil sell-off (and the implications for weakened ‘inflation expectations’)—but to now see the longer-term ‘US fiscal policy upside kicker’ looking especially threatened, it is likely that the ‘big three’ trade expressions (longs in US Dollar US Banks and shorts in US Rates) are looking very exposed for an acceleration of recent drawdowns (in conjunction with longs in HY, ‘cyclicals / defensives’ L/S pairs, equities ‘value’ factor, equities high beta, US equities small cap).
‘Long Dollar’ trades are currently seen unwinding ‘real-time’ as ‘the world’s most crowded trade’ and ‘reflation’ proxy earlier this evening broke the convergence of both its 200dma and the 76.4% Fibo Retracement of the entire Dollar move since the US election—exposing significant downside. Legacy shorts held against the US Dollar in Euro (making 2017 highs vs USD), Yen (making 2017 highs vs USD), Pound and Canadian Dollar are being painfully squeezed as traders are liquidating after ‘processing’ the implications of the Trump Administration’s failed ACA repeal Friday, with many ‘late-comers’ to these trades significantly ‘under water’ already and looking to ‘tap out’ on losers. Tactical funds and discretionary macro were already pivoting ‘short USD’ last week on the new “policy CONVERGENCE” dynamic, and now with momentum having clearly pivoted in the other direction, one would expect systematic / trend / CTA to be heavily-involved now as well on the short-side of USD trades.
The story that we were getting Friday from some buyside traders and sellside strategists (by-and-large) was that a “no” vote was almost irrelevant to risk-assets, as market participants want the US Administration to ‘move on’ and ‘focus its efforts’ on tax policy anyhow (versus being mired in further debate with the ‘repeal and replace’ of the ACA). What many were missing here though (and noted by Mark Orsley Friday afternoon) is that the sequencing of ‘healthcare’ and ‘budget’ before ‘taxes’ was intentional and critical, as spending cuts from a repeal of the ACA were effectively a ‘requirement’ against the pending new administration’s tax-plan which will only further increase the deficit. This is obviously an impediment then to efforts to keep any new tax plan ‘deficit neutral,’ so essentially, the GOP is starting in a bigger hole, some say to the tune of $1T dollars….and this of course is not including the extremely controversial BAT component, which too has lost much momentum over the past two months, despite projections that it could provide upwards of $1T of revenues over a 10 year period in order to fund the individual and corporate tax cut proposals (ironically, the same ‘Freedom Caucus’ of GOP’ers which symbolically defeated the ‘new’ healthcare plan on Friday are also against the BAT…yikes).
What does it all mean? Some of the talk emanating from DC policy-circles is now of the view that this now means an almost certainty of a ‘watered down’ tax plan, which instead of deep ‘headline’ cuts planned will now feature much more modest cuts (corporates as priority over individuals) and focus on “streamlining” tax code / loopholes. This is not the ‘joy’ that many of those 2500 S&P targets ‘signed-up’ for.
What is at risk? I noted many of the ‘consensual longs’ which have already showed significant signs of being de-grossed in recent weeks. But as we now see a high likelihood of the potential for a rates reversal to accelerate and long duration’ rallies in the face of the ‘rates short’ crowd, there will be major implications within equities too, as ‘low vol’ defensives (REITS / Utes / Staples / Telcos) and ‘anti-beta’ market neutral strategies are certain to see further escalation of their recent strength. The good news for equities-longs is that ‘secular growers’ like tech, consumer discretionary and biotech is too likely to benefit from money rotating out of ‘deep cyclicals’and ‘value.’