Nomura: Powell restarts Fed's put options, traders blindly return to past QE trades

Goldman Sachs' expert on fund flows, Scott Rubner, predicts that the S&P 500 will hit a new high this week, reinforcing investors' fear of missing out on the market trend. Nomura's cross-asset strategist Charlie McElligott, on the other hand, warns that the recent rise in U.S. stocks has once again put investors at risk of falling behind the market. The recent deleveraging event has now made FOMO the dominant force in a standard behavioral finance manner, with "upward grab" behavior in the stock index options field seeming to be forced to escalate.

McElligott points out in his report that from a macro perspective, the latest "comprehensive rebound" triggered by Federal Reserve Chairman Powell's speech at the Jackson Hole central bank annual meeting last Friday was very impactful. This is because Powell told everyone that due to increased downside risks to employment, the Fed has shifted all its focus to ensuring a soft landing, turning to a reaction function that is completely asymmetric to the labor market conditions, one of the Fed's dual mandates - "price stability" has been largely achieved and is no longer the primary focus of the Fed's efforts.

In simple terms, this means that the Fed's focus is now unilaterally accommodative policy to address any further labor weakness, i.e., taking a zero-tolerance approach to further increases in the unemployment rate. McElligott believes that since the outbreak of the new crown epidemic, entering an unprecedented global tightening cycle following an inflation crisis, this is the first time Powell has reintroduced Fed put options, paving the way for a weaker dollar and giving the green light to "all rebounds" in other assets.

McElligott further believes that this backdrop has created a broad market theme that actually looks like a return to past quantitative easing (QE) trades, i.e., going long on U.S. Treasuries, high-risk assets, gold, while shorting the U.S. dollar. Because the Fed has effectively signed an arbitrage agreement, preparing to rebuild the world's largest short volatility position, creating positive wealth effects and a benign cycle of impact on the U.S. economy and consumers, helping to absorb the further cooling effects on the labor market.

McElligott emphasizes that the trade of going long on gold and shorting the U.S. dollar is an obvious theme, and will be upgraded in two steps from now on. The first step is that the Fed will enter a rate-cutting cycle, and the second step is the Fed buying assets/long-duration bonds. All these assumptions are based on core PCE inflation remaining at 2.6%. Cynically speaking, the Fed will choose the lesser of two evils, accepting higher levels of inflation to suppress the cooling of the labor market.

McElligott believes that after Powell's speech at Jackson Hole, a new round of upward bullish trend has predictably begun, moving away from many who were forced to short after experiencing stock volatility shocks earlier this month

Now, as mobile relative trading volume decreases on average and the market rises, the risk exposure will be mechanically forced to rise again.

Ironically, investors' "blind" return to quantitative easing (QE) trading this time faces the risk of an "over-soft landing", that is, the strong US economy combined with loose domestic and international policies under the global interest rate cut cycle, which will once again stimulate inflation to rise, pushing inflation to a level that is not expected to be reached by the current market pricing for future interest rate cuts.

In addition to the "unpredictable" presidential election currently taking place in the United States and changes in global geopolitical situations, McElligott believes that the next major macro risk in terms of interest rates may be the US Treasury's refinancing announcement in the first quarter of 2025. After the election, the US Treasury will need to acknowledge that it may need to issue more government bonds, which will initiate another term premium rebuild for long-term US government bonds. Based on the experiences of the previous two term premium rebuilds, the US stock market does not welcome this