Investors' Rush to QE Trades Risks "Overly Soft Landing" as Inflation Concerns Loom
Monday, Aug 26, 2024 3:00 pm ET
In a surprising turn of events, investors' rush back into QE trades may face the risk of an “overly soft landing.” This scenario involves the strong U.S. economy combined with domestic and international accommodative policies potentially reigniting inflation, negating the rate cut expectations currently priced in by the market.
Nomura's cross-asset strategist, Charlie McElligott, has voiced warnings. He pointed out that the recent rise in U.S. stocks returns investors to the risk of falling behind the market. The recent deleveraging event has now driven the fear of missing out (FOMO) in the equity options spaces, causing an upward scramble.
McElligott noted that, from a macro perspective, Federal Reserve Chair Jerome Powell's speech at the Jackson Hole symposium incited a significant "broad-based rally" due to his shift in focus. Powell emphasized ensuring a soft landing, now prioritizing job market conditions, suggesting that "price stability" has largely been achieved. This pivot indicates a shift toward unilateral easing policies to counter any further labor market weakening.
Simply put, the Federal Reserve's current emphasis appears to center on accommodative measures to counter any signs of rising unemployment, taking a zero-tolerance approach. McElligott interprets Powell’s actions as a reintroduction of the Fed’s put option, which effectively greenlights rebounds in assets while facilitating dollar devaluation.
McElligott further articulates this phenomenon as a resurgence of past QE trades—long U.S. Treasuries, high-risk assets, and gold, while shorting the dollar. It appears the Fed is effectively endorsing these arbitrage trades, preparing to re-establish the world’s largest short volatility position, aiming to foster positive wealth effects and economic benefits, cushioning the labor market’s cooling impact.
He underscores the evident theme of going long on gold while shorting the dollar, expecting an escalation in two phases: initially with the Fed entering a rate-cutting cycle, followed by asset purchases/long-duration bonds. These assumptions rest on core PCE inflation maintaining a 2.6% level. Cynically, the Fed may opt for the lesser of two evils, accepting higher inflation to suppress labor market cooling.
McElligott states that following Powell’s Jackson Hole speech, a new bullish wave has predictably begun, distancing from those forced to short during the equity volatility shock earlier this month.
Now, with the relative volume averaging down and markets climbing, risk exposure will mechanically be re-elevated.
Ironically, this “blind” return to QE trades by investors risks an “overly soft landing.” As the robust U.S. economy combines with a global rate-cut cycle and domestic/international easing policies, inflation may surge to levels that negate the currently expected rate cut magnitudes.
Beyond the unpredictable U.S. presidential election and shifting global geopolitical landscape, McElligott sees the next significant macro risk potentially emerging in the first quarter of 2025 with the U.S. Treasury’s financing announcement. Post-election, the U.S. Treasury might resume issuing more Treasuries, initiating another rebuild of the term premium, which historically hasn’t been welcomed by U.S. equities.
Nomura's cross-asset strategist, Charlie McElligott, has voiced warnings. He pointed out that the recent rise in U.S. stocks returns investors to the risk of falling behind the market. The recent deleveraging event has now driven the fear of missing out (FOMO) in the equity options spaces, causing an upward scramble.
McElligott noted that, from a macro perspective, Federal Reserve Chair Jerome Powell's speech at the Jackson Hole symposium incited a significant "broad-based rally" due to his shift in focus. Powell emphasized ensuring a soft landing, now prioritizing job market conditions, suggesting that "price stability" has largely been achieved. This pivot indicates a shift toward unilateral easing policies to counter any further labor market weakening.
Simply put, the Federal Reserve's current emphasis appears to center on accommodative measures to counter any signs of rising unemployment, taking a zero-tolerance approach. McElligott interprets Powell’s actions as a reintroduction of the Fed’s put option, which effectively greenlights rebounds in assets while facilitating dollar devaluation.
McElligott further articulates this phenomenon as a resurgence of past QE trades—long U.S. Treasuries, high-risk assets, and gold, while shorting the dollar. It appears the Fed is effectively endorsing these arbitrage trades, preparing to re-establish the world’s largest short volatility position, aiming to foster positive wealth effects and economic benefits, cushioning the labor market’s cooling impact.
He underscores the evident theme of going long on gold while shorting the dollar, expecting an escalation in two phases: initially with the Fed entering a rate-cutting cycle, followed by asset purchases/long-duration bonds. These assumptions rest on core PCE inflation maintaining a 2.6% level. Cynically, the Fed may opt for the lesser of two evils, accepting higher inflation to suppress labor market cooling.
McElligott states that following Powell’s Jackson Hole speech, a new bullish wave has predictably begun, distancing from those forced to short during the equity volatility shock earlier this month.
Now, with the relative volume averaging down and markets climbing, risk exposure will mechanically be re-elevated.
Ironically, this “blind” return to QE trades by investors risks an “overly soft landing.” As the robust U.S. economy combines with a global rate-cut cycle and domestic/international easing policies, inflation may surge to levels that negate the currently expected rate cut magnitudes.
Beyond the unpredictable U.S. presidential election and shifting global geopolitical landscape, McElligott sees the next significant macro risk potentially emerging in the first quarter of 2025 with the U.S. Treasury’s financing announcement. Post-election, the U.S. Treasury might resume issuing more Treasuries, initiating another rebuild of the term premium, which historically hasn’t been welcomed by U.S. equities.