BofA"s Apocalyptic Forecast: Stocks Flash Crash, Bond Bubble Bursts In H1 2018, War May Follow

Having predicted back in July that the "most dangerous moment for markets will come in 3 or 4 months", i.e., now, BofA"s Michael Hartnett was - in retrospect - wrong (unless of course the S&P plunges in the next few days). However, having stuck to his underlying logic - which was as sound then as it is now - Hartnett has not given up on his "bad cop" forecast (not to be mistaken with the S&P target to be unveiled shortly by BofA"s equity team and which will probably be around 2,800), and in a note released overnight, the Chief Investment Strategist not only once again dares to time his market peak forecast, which he now thinks will take place in the first half of 2018, but goes so far as to predict that there will be a flash crash "a la 1987/1994/1998" in just a few months.

Contrasting his preview of 2018 with the almost concluded 2017, Hartnett sets the sour mood with his very first words, stating that he believes "2018 risk asset catalysts are much less bullish than in 2017" for the simple reason that the bearish positioning going into 2017 has been completely flipped: "positioning now long, not short; profit expectations high, not low; policy close to max stimulus; peak positioning, peak profits, peak policy stimulus means peak asset returns in 2018."  He also goes on to point out that the historical omens are poor:

• Bull market in S&P500 would become the longest ever on August 22, 2018 (and the second biggest ever at 2863 on S&P500).


• Equities have only outperformed bonds for seven consecutive years on three occasions in the past 220 years (the last time was 1928 - Chart 1).

Having read Hartnett for many years, we can sense an almost tangible undertone of anger and frustration at central banks for making his bearish forecasts for 2 years in a row go up in a puff of smoke. Which probably explains why one of BofA"s best strategists has decided to double down, and raise the stakes beyond a simple market crash, and to a flash crash, if only for dramatic impact.

But before we get there, here is Hartnett"s explanation why the market will peak in the first half of 2018:

The Big H1 Top

We forecast a H1 top in risk assets as the last vestiges of QE, the passage of US tax reform and robust early year EPS revisions incite full investor capitulation into risk assets. Potential targets are SPX 2863, CCMP 8000, with US government bond yields moving >2.75%.

 

We start 2018 with a pro-risk asset allocation of equities>bonds, EAFE>US, gold>oil, bullish US dollar.

 

We believe the air in risk assets is getting thinner and thinner, but the Big Top in price is still ahead of us. We will downgrade risk aggressively once we see excess positioning, profits and policy.

 

Peak positioning would be signaled by…

• BofAML Bull & Bear Indicator exceeds “sell signal” of 8 (Chart 2);


• Active mutual equity funds start to see inflows;


• BofAML GWIM equity allocation exceeds 63%, an all-time high (currently 61%).

How to know if/when peak profits arrived?

US ISM dips below 55: needs to end 2018 >55 to beat consensus global EPS estimate of 10.5% (Chart 3); Inverted yield curve, which in seven out of seven occasions in the last 50 years has been the prelude to recession.

 

 

More to the point, how to know that peak central bank policy has arrived?

• Q2 peak in G4 central bank liquidity of $15.3tn: net central bank buying of financial assets drops from $1.5tn in 2016 and $2.0tn in 2017 to nearly zero in 2018;


• US tax reform passed, after which investors must discount tighter, not earlier economic policies.

Which brings us to Bank of America"s "big long" trade: volatility, and the stark prediction that in just a few months, a 1987-type flash crash which will wipe out trillions in market cap, is imminent.

The Big Long: volatility

 

Second, we believe that peak positioning, profits, and policy in 2018 will engender peak asset price returns and trough volatility. In 2017, stock market volatility fell to 50-year lows, bond volatility fell to 30-year lows, ETFs accounted for 70% of daily average global equity volume, the AUM of quant hedge funds is now $432bn (up $271bn since 2009).

 

A flash crash (à la ’87/’94/’98) in H1 2018 seems quite likely, in our view, as the major sedative of volatility, the central banks, start to withdraw liquidity.

According to Hartnett, the right way to to trade the upcoming flash cash and the "Big Long is throguh a combination of  long 2yr/short 10yr Treasuries, long TIPS steepener vs flattener in OATei, long SPX put ratio calendar, long Russian equities.

As an added "bonus", in addition to a "big long", the BofA strategist also has a "big short" trade, which perhaps not surprisingly, is in credit.

The Big Short: credit

 

Third, we believe that higher inflation, higher corporate debt levels, higher bond volatility and the end of the QE era will be most damaging for corporate bonds.

 

The big 3 consensus assumptions are: Goldilocks, no Fear of Fed/ECB, and no Mean Reversion. The game-changer is wage inflation, which on our forecasts is likely to become more visible. Wage inflation would shatter consensus via higher credit spreads. 3½% US wage growth, 2½% US CPI, and 2% Eurozone CPI are all inflation levels likely to increase volatility and credit spreads.

For those looking to trade in advance of the bursting of the credit bubble, BofA"s advice: go long CDX HY & iTraxx XOVER.

* * *

Finally, if that wasn"t bad enough, in addition to the combined bursting of the short-vol and long credit bubbles, BofA has one final prophecy: "the biggest risk of all is that the structural “Deflationary D’s” (excess Debt, aging Demographics, tech Disruption) cause wage inflation to again surprise to the downside." Here"s why:

The Big Risk: tech bubble

 

Finally, we believe the biggest risk of all is that the structural “Deflationary D’s” (excess Debt, aging Demographics, tech Disruption) cause wage inflation to again surprise to the downside. The era of excess liquidity, bond yields fall, and the Nasdaq goes exponential. 2018 calls for the big top, big volatility long, big credit short, all once again prove to be way too early. An “Icarus unleashed” bubble nonetheless could end in 2019 with a bear market on hostile Fed hiking, Occupy Silicon Valley and War on Inequality politics.

Translation: the Fed - having created the record wealth, income and class divide that resulted in Brexit, Trump and a wave of nationalism across Europe - is unable to stop, and unleashes civil, and perhaps world war as its final act.

How to hedge against "the biggest risk of all"? Hartnett has two words of advice: buy gold.

"One Simple Reason The Yield Curve Is Collapsing"

The divergence between the "hope" melt-up in stock markets and the "nope" collapse of the US Treasury yield curve has never been so wide... and has never engendered so many excuses by commission-takers and asset-gatherers for why the latter is wrong and the former correct.

One thing is clear, as The Fed tightens rates, the market is increaingly insensitive to the next tightening as financial conditions have eased dramatically as the Fed tightens. Former fund manager Richard Breslow suspects "you ain"t seen nothing yet" as the linkage between FOMC raising rates and a flattening yield curve suggests this tradable trend is far from over.

Via Bloomberg,

The yield curve in the Treasury market has continued on its flattening way. Look at a one-year chart and it shows a relentless, if at times choppy, move from its widest at the beginning of the period to today’s new tight. Everyone seems to have their theories why and what it means, giving clear proof that great minds can differ. And even the bond market isn’t simply well-established science. One thing that they do agree upon is the obvious: it’s been a clear, tradable trend. But before we start waxing eloquent on the historic magnitude of the move, keep in mind, this tightening absolutely pales in comparison to several others of the last 25 years.

It’s perhaps been so confounding only because, for all the ink spent on it, it’s been relatively gentle and gradual compared to past episodes. And why should that be?  

 

Perhaps because the FOMC has been raising rates at such a slow, methodical pace. And even then, investors continue to doubt the dots, despite December being taken as a given.

 

[ZH: As we noted previously, financial conditions did not snap tighter until The Fed has tightened rates to 5.25% in 2007]

 

Yield-curve moves have been intimately linked to FOMC policy direction and the speed of change. So, consider what might happen should the market come around to the Fed’s forecasts. Or the other way around. But don’t think the spread is necessarily anywhere near some impregnable floor.

 

 

 

And, most certainly, avoid falling for the notion that all by itself it will tell you where the economy is headed. That’s only the case if you believe the Fed always ends up over-doing it. Which may indeed explain the Greenspan era and why bond traders loved him so much--once everyone was able to put the 1994 spat behind them and he worked so hard to make it up to them.

 

All of this raises another angle to ponder. The Fed continues to enjoy a tremendous free-ridership advantage of tightening while the ECB and BOJ keep pumping in liquidity. Investors are forced to keep buying Treasuries on any back-up, and if not gagging on the prices, certainly retching every time there’s a lecture about complacency. Governor Kuroda has been emphatic that Japan must motor on pumping in liquidity with inflation continuing so low. President Draghi was able to fend off those who wanted a “clear exit” from asset purchases.

 

Many doubt, however, this forward guidance will hold. It’s not as if QE is exactly popular any more. And if economic slack continues to disappear any hint of inflation will be met by two competing responses.

 

Calls to let prices overshoot and be patient. And markets rushing to price in policy shifts from these two banks. That’s when all the back-slapping about how well it’s all going gets tested. It’s unclear whether this “all clear” sign for the rest of the world will let the Fed loose or make them rein in their ambitions.

The only thing we can be reasonably sure of, Breslow concludes, is the Fed realizes that whatever happens they need to make hay while the sun shines and history argues that is a curve flattener.

Citi Urges "Caution Ahead": Four Major Chinese Indicators Are "Staring To Wave Red Flags"

Another day, another warnings about China"s fading credit impulse (see here in February, and Pimco most recently), and market complacency about what the recent monetary tightening and drop in commodity prices in Chinese markets means for global markets, this time from Citigroup.

In the latest note from Citi"s cross-asset strategist, Jeremy Hale, titled simply enough "China: Caution Ahead", he highlights the long-standing trend lower in the EMRA, or Emerging Markets Risk Aversion Index (CIGMEMRA Index on Bloomberg) which is Citi"s measure of aggregate risk aversion in developing countries, which in turn has led many investors to ask the bank whether "investors are getting complacent on EM."

While Hale fails to answer directly, he does point out that while forward returns are mixed across the asset classes, "risky assets don’t usually fare that well when EMRA is low."

In this context, China is key, and much of the peace of mind for investors has been based upon broad sympathy with the view that 2017 will be mainly a year of “steady boat” economic policy from the Chinese Authorities as we head into the 19th Party Congress this autumn.

Hale notes that one potential factor that could threaten the "steady as she goes" status quo is the informal rule that China"s leaders retire if they have reached the age of 68 when the congress takes place. If President Xi has the clout to get the age limit  waived (not to yet be assumed) then the Xi-Wang duo could continue to run China for another five years, if not longer. As such, heading into the plenum, stability has been an EM positive.

Politics and the 19th Congress aside, Citi notes that certain, more mundane Chinese macro indicators "are starting to wave red flags", among which:

• The Markit PMI is starting to turn over


• China"s Inflation Surprise Index - a leading indicator to global inflation metric - has posted a recent sharp drop


• China"s import trade has likewise tumbled after surging recently


• Chinese Iron Ore imports into Qingado port have plunged

These are shown below:

Adding another "red flag", Hale also notes that "some market commentators in recent weeks have highlighted that perhaps there is a major risk that consensus opinion is again overlooking the influence of China’s credit cycles, and thus perhaps overstating the potential contribution of future Chinese demand growth to the global outlook (Figure 4). And Citi’s EM strategists think that the recent macro-prudential tightening in China could possibly contribute to more negative spillovers in the coming months."

While we have repreatedly demonstrated various iterations of this all important Chinese "credit impulse" in the past, the following chart of the 12M change in China"s credit impulse, this time as created by Citi, deserves to be seen again:

As a result, in order to assess the changes to the monetary backdrop in China, Citi’s China economists have created their very own Monetary Conditions Index (MCI, higher = looser monetary conditions, Figure 5). The Citi China MCI is calculated by using the weighted average of lending rates, M2 growth, and the REER. Interestingly, their caveat to just using a more mainstream credit cycle chart (like the  Bloomberg one above) is that there are places where the credit growth deviates from indicators such as the PMI. Moreover, China’s credit system has gradually been moving from a bank loan denominated system to a more diversified financing model (Figure 5, bottom RHS).

The most obvious observation in the chart above is the clear effect of the recent 2015 stimulus. "The MCI index rose sharply from all-time lows, but since November last year this has turned. Four consecutive months of declines in this MCI suggest liquidity conditions are starting to tighten."

Next question: What happens if this tightening continues?

To assess the historical impact of declines in the MCI and thus perhaps forecast as to what may be witnessed in coming quarters, Citi takes 4 previous turning points in the China MCI and then plot what materializes in each cycle and on average in the 24 months post local peak in the MCI.

Citi"s bottom line is hardly a surprise: 

"as we witness a turn to tighter monetary conditions, this tends to be quite bearish for the hard data as we show above (Figure 6). Across the board, on average, these charts suggest material downside risks to YoY growth in measures of domestic activity."

Hale then breaks down the impact of China"s slowdown across various asset classes, as follows:

• Broad FX: On average, both aggregate G10 and EM FX tend to soften around -6% vs the USD, within the first 9 months after a turn in the MCI, although different cycles vary to some degree thereafter.


• Rates: 10y UST yields on average tend to move sideways initially as the reflationary momentum fades. Around 8 months after the MCI turns, history shows that the 10y UST yields fall. Breaking this into its real and breakeven constituents shows the repricing lower in 10y breakevens is most evident (~- 40bps on average in 9 months), as likely disinflationary forces kick in from slowing demand growth. On average, curve implications are biased towards substantial flattening (on average ~20bps in 9 months) as the implication takes grip on the global outlook.


• Equities: Risky assets in EM (local) broadly hold up well until suffering on average a soft patch at around 5-6 months, seeing around a 5% correction in local terms.


• Credit: Here, risks to wider EM spreads are worth highlighting. Current CDX EM spread levels may be too tight by a significant magnitude. Widening of EM corporate spreads is evident in every historical period. Similarly in sovereign space, China CDS on average widens in the first 6 months after loose conditions peak. Both these historical developments are important for trades in our macro portfolio, as we discuss later.


• Commodities: Broader effects quite limited (Figure 11). More China centric commodities see downside risks mainly between 6-9m after the turn in the MCI. Given that’s where we are in the current period, the recent slides in copper and iron ore may not be surprising therefore. Any relationship to gold prices isn’t wholly evident

The next question is should China slow, what - if anything - can the PBOC still do?

If this MCI tightening persists and macro data follow, how can the PBoC react?

More recently, as we have written before, China has focused more on fiscal policy and the RRR, rather than policy rate cuts (Figure 12, LHS). One reason for this is that the PBoC is probably cognisant that they are reaching their “zero bound” and that the room to maneuver in a crisis is becoming limited. As such they are likely preserving some fire power. Indeed, note how the current easing cycle has been much less aggressive (in magnitude and from a time perspective) than in some historic episodes (Figure 12, bottom, middle).

As an aside, what this means is that China now has, by far, the highest real policy rates amongst the largest economies (they actually moved into positive territory again). Together with a still very rich  currency, this exacerbates the headwinds for the domestic economy long term. Our hunch is that the PBoC will likely continue using the RRR to manage liquidity – and this is also our economists’ base case. And probably only in a sharper downturn are they likely to resort to policy rates cuts.

* * *

Hale"s takeaway is predictable: "tighter monetary conditions in China, if sustained, may mean that the period of unexpectedly strong Chinese activity growth, which started in 2016 Q1, is coming to an end."

Despite continuing to use higher money-market rates to discourage leverage, the PBoC have enough in their toolkit to ease liquidity conditions if needed. But investors should be warned that volatility may not be contained till the end of the autumn. Historically, on average, EM risk aversion has risen from this point in the MCI cycle (Figure 13).

While the jury is still out (crashing commodities notwithstanding) whether China has indeed turned the monetary corner, Hale admits that "the implications for sovereign CDS are clearly negative and thus widening China CDS is one way to hedge portfolios/trade this theme.

Citi"s big picture conclusion is actually hardly a surprise, as it recaps what we have said and shown before: China"s reflationary spark is fading, and it will now be up to Trump to provide the next global impetus for economic recovery.

Admittedly, China’s contribution to the broader global recovery may be waning. Further legs to the global reflation theme may now rely even more so on the Trump administration’s ability to deliver on key campaign promises.

As discussed in previous Weekly’s, we continue to hold an outright tactical long in 10y UST futures (with a stop on the 10y generic yield at 2.45%), which likely has a high delta to the data momentum that are showing signs of decline from post GFC cyclical highs. We continue to favour our 5s10s $ flattener too, which should also perform should China growth slowdown or Trump delay on tax reform/ fiscal stimulus.

Finally, to all those who still harbor hope that the current administration has a chance of passing any laws that boost the US economy, it may be a good idea to hedge "just in case" - at least volatility is record low across all asset classes...

Confusion In Bond World, As Eurodollar Shorts Hit New Record High Over $3 Trillion

One week after we observed the biggest monthly short squeeze in 10Y TSYs in history, it was a relatively calm week in the longer-end of the Treasury curve.

According to the latest CFTC data, spec net shorts in aggregate Treasury futures was little changed from the previous week at 612K contracts in TY equivalents. While, they continued to pare net shorts in TU and TY by 18K and 14K contracts, respectively, they increased their  net shorts in FV and TN by 35K contracts and 6K contracts, respectively. Spec net shorts as share of open interest was unchanged at -5.8% over the week and was at about -2.0 standard deviations away from neutral.

While net Treasury futures shorts are now back to the lowest levels since early December 2016, traders continued to pile into the short-end betting massively on further rate hikes as Eurodollar shorts push on beyond $3 trillion: in the last week specs sold another 73K contracts in Eurodollar futures, taking their net shorts to the seventh successive week of record high of -3,129K contracts.

What is surprising is that there was no short covering after Bill Dudley"s March 31 comments which were taken as dovish by the market, sparking EDs to flatten and reds to outperform on potential for a less hawkish Fed in 2018, which as we observed last week prompted a collapse in the Eurodollar 2018 spread (EDZ7/EDZ8) to briefly slide below a key support level on what was seen as the last sign of "reflation trade" capitulation on the front end.

 

While the mid-week CFTC report captured the market reaction to the initial round of Dudley comments, it failed to take into account Dudley"s Friday "little pause" discussion, which as we quoted RBC on Friday afternoon, prompted "Devastating Eurodollar Unwinds."

The confusion following the contradictory Dudley statements prompted Morgan Stanley to announce on Friday that it was taking off its EDZ7/Z8 flattener, but keeping a EDZ7/Z9 flattener. This is what Morgan Stanley"s Matthew Hornbach said over the weekend:

Did Dudley change our mind?

No sooner had we published our thoughts on how markets price the pace of rate hikes than Dudley clarified his remarks from last week.

Some people misconstrued what I said last week. I said a little pause. A pause is pretty short already, and I think a little pause is even shorter than that. Presumably at the time that you make the decision on the balance sheet you might want to forgo the decision on short-term rates just to make sure that the balance-sheet decision doesn’t turn out to be a bigger decision than you thought you were making. So, I would emphasize the words ’little pause".

We said last week that we thought Dudley"s original comments suggested that, upon the initiation of balance sheet reduction, if financial conditions tighten too much, the Fed may have to take a step back from raising the fed funds target rate. We never thought he meant going on hold for an extended period of time. So now that Dudley has clarified his view, we no longer suggest investors hold EDZ7/EDZ8 flatteners.

However, we still suggest investors enter EDZ7/EDZ9 flatteners based on our analysis of how markets priced the pace of rate hikes in previous cycles. We looked at 3 historical hiking cycles and here"s what we found:

• The Fed delivered more rate hikes than the market expected early on in these cycles, but delivered fewer than the market expected toward the end.


• The Fed delivered fewer hikes than expected toward the end of these cycles because it cut rates during the period in which the market had previously expected hikes to occur.


• The market never fully priced the pace at which the Fed ended up delivering hikes from each cycle"s start to its end.


• At their most hawkish, markets priced 2/3rds of the annualized pace of the previous 3 hiking cycles, on average.

At present, the market only prices 2 of the 3 hikes the Fed projects over the next 12 months. Our analysis of previous cycles suggests this pricing is fair, even if the Fed delivers 3 hikes as projected. 

Hence, we don"t see the need for EDZ7/EDZ8 to flatten from current levels.

However, the potential for the prospect of balance sheet reduction in 2018 to tighten financial conditions enough to warrant a pause in rate hikes, even if not strategic, and possibly rate cuts eventually, means that the market is not likely to price more than 3 rate hikes on net through 2019, in our view. Hence, we still suggest investors embrace EDZ7/EDZ9 flatteners

With Eurodollar shorts failing to be squeezed into last week"s violent move, we anticipate that Dudley"s clarification will only add to the net shorting on the short end. Of course, just like with the record 10Y short squeeze, it is a matter of when not if, the trade will unwind. As such we continue to look for the dovish catalyst that may lead to epic carnage among the Eurodollar trader community once this trade begins to move in reverse first gradually, and then quite rapidly.

The Scariest Forecast For Treasury Bulls

With Trump"s border tax adjustment looking increasingly likely, the stock market - as JPM has warned in recent days - is starting to fade the relentless Trumponomic, hope-driven rally since election day instead focusing on the details inside the president-elect"s proposed plans. And, as explained earlier in the week, if the border tax proposal is implemented, economists at Deutsche Bank estimate the tax could send inflation far above the Federal Reserve"s 2% target and drive a 15% surge in the dollar.

While this would be bad for stocks, as a 5% increase in the dollar translates into about a 3% negative earnings revision for the S&P 500 all else equal, a surge in inflation would also wreak havoc on bond prices, and send interest rates surging, at least initially, before they subsquently plunge as a result of a rapidly tightening, deep "behind the curve" Fed unleashes a curve inversion and recessionary stagflation becomes the bogeyman du jour.

There"s more.

In a separate report by Deutsche, the bank looks at future prospects for rates and concludes that "tightening monetary policy, higher breakevens, and declining central bank purchases relative to net supply should all contribute to significant bearish steepening during 2017."

In its analysis of future bond rates, Deutsche Bank says that the biggest risk is that when looking at the menu of "threats" presented by the Trump stimulus, "there is a significant risk that if the Fed decides to aggressively lean against higher inflation expectations, the entire “regime shift” might stall. That is, higher wages and inflation expectations are a prerequisite to the substitution of capital for labor, which is in itself necessary for more rapid productivity growth and hence higher potential growth and sustainably higher levels of r*."

And then the focus shifts so that whatever degree of accommodation is warranted, there will be the push to rebalance away from rising short rates to shrinking the Fed’s balance sheet, in other words, the Fed begins real normalization.

In DB"s model, the net effect of ending reinvestment of SOMA portfolio run-off, some asset sales, and an ECB taper is almost 200 bps. This would allows 10s to move well over 4 percent in 2018. That although roll offs are significant - maybe $50 billion/month – in order to get the balance sheet down from more than $4 trillion to say $1 trillion before the 4-year presidential term is over would still require asset sales of  approximately $50 billion.

Assuming Deutsche Bank is correct, the result would be the scariest forecast bond bulls have seen in years: a 10-Year TSY whose yield fades all gains attained during the past decade, in the span of just two short years, hitting 4.5% in early 2019. The adverse implications from such a fast, steep move on all asset classes, not just bonds, would be devastating.

Will this forecast come true? Readers can make their own determinations upon reading DB"s assumptions:

Formally, DB"s model of 10s has three explanatory variables. The main driver is the ratio global QE purchases to net supply in nominal terms with a nine-month lead, i.e., the market is forward looking. Global QE and supply figures are from the US, Europe and Japan. The other two variables in the model are Fed funds and the 2s/funds spread. The model is estimated between October 2006 and September 2016.

These assumptions are summarized in the following three scenarios:

1. Base case: Trump’s fiscal stimulus, amounting to about $530 billion per year for ten years.


2. Base case + ECB taper + Fed portfolio rolloff. In this case, 10s are about +70bp higher in yields than in the base case.


3. Base case + ECB taper + Fed portfolio rolloff + Fed asset sales. 10s are about +100bp higher in yields than in base case.

The assumptions in the scenarios are:

• President-elect Trump’s stimulus package, scored by the Committee for a Responsible Federal Budget adds $5.3 trillion to the deficit over the next decade. This averages to $530 billion per year, starting in July 2017, around the time the plan is expected to be passed by Congress.


• The ECB tapers QE purchases by ½ in 2018, and stops all purchases in 2019.


• Fed balance sheet reductions: The Fed stops reinvestments of maturing Treasuries and MBS pre-payments starting Q4 2017. Asset sales at $250 billion in 2018 and $500 billion in 2019.


• The Fed funds target range rises to 2.50%-2.75% by year end 2019, with the 2s/funds spread at 60bp.

Visually:

Needless to say, DB is convinced that there is a lot of pain coming for the bond market. To wit:

"Our strongest market view, therefore, is that investors should be short duration. Rates are going higher. The curve should end up steeper but this Fed"s initial reaction as per this week can confuse curve dynamics. Real rates should not rise more than breakevens. In the short run dollar strength should persist."

We are far less confident, especially if indeed the border tax is implemented, sending the dollar soaring, US exports, and GDP crashing, and corporate profits plunge. In short: if Trump unleashes a recession by implementing a policy which is meant to eliminate the US trade deficit.

In such a case, forget steepeners: buy every flattener you can get your hands on, and then use leverage, because before you know it the 2s30s will be back in the double digits, then single, and then, not too long from now, negative.

Whether that is the catalyst that will kick off QE4 or whatever the current number is, we don"t know, but by that point China will be spitting up blood as a result of a historic collapse in the Yuan, hundreds of billions in monthly outflows and a paralyzed, and crushed financial system. Ironically, in light of the devastation that may soon befall China should Trump"s policies pan out, the US - recession or not - may still be the "cleanest dirty shirt" in a world where things are about to get very messy.

Calm Before The Storm - Coming Out Of The Voldrums

Implied volatilities - the market"s best guess at short-term-future uncertainty - collapsed last week across every asset class from FX to equity. For now, as Bloomberg"s Richard Breslow notes, markets seem comfortably calm amid the real storm of macro, micro, and geopolitical risks, but many of the same "calm" markets are at critical technical levels putting them all "in play."

Also sprach Draghi: an ECB meeting for all and none, but as Bloomberg"s Richard Breslow explains, the bottom line is that he said little, promised less and the markets survived just fine. There was little clamoring for, nor palpable financial condition stress requiring, immediate action -- and he obliged. He bought himself full optionality for December at no cost. Under the circumstances, it gives an interesting twist to the moniker Super Mario.

So in this brief window of opportunity, asset prices will be able to sort themselves out without some new central bank push. It’s worth watching where the natural forces of markets take things. And what technical levels hold or give way.

There was no announcement of a QE extension. Lots of people warned that could lead to bond mayhem. Result? A bull flattener led by core Europe. Periphery yields shrugged the whole thing off. Spain’s 50-year offering went off without a hitch.

Earlier this week, bund yields “spiked” to the 200-day moving average, before falling back. Watch this level (currently 9.4bps). There’s either a core scarcity issue or there isn’t. Do we really need the ECB to tell us how many bunds are out there?

In fact, as a reminder, keep an eye on the 200-dma for every major sovereign 10-year. All are in play.

*  *  *

Which is even more concerning given Peter Tchir"s "Scariest Chart fro Bond Yields"...

While the market seems to fixate on VIX and the implications of VIX for the equity markets, the Treasury VIX often languishes in obscurity, but for only the 3rd time in its existence (it was created January 2013), it has closed below 3.95 (the red circles on the chart).

Each of the last two times that the Treasury VIX closed below 3.95, 10-year Treasury yields headed sharply higher.

*  *  *

Equities are interesting because they’re not interesting. Not flying, but most certainly defying all rumors of their imminent demise. They’re in well-defined ranges. Wait for a breakout to get excited and play the range. It’s worked over and over. And that’s with talk of taper, BOJ on hold and the Fed teeing up December. Impressive.

People are bulled up on oil. WTI is trying to hold above $50 -- A feat it has struggled with. That’s the pivot and it’s close. If it can stay up here, should the dollar go bid, it would be a powerful sign.

The dollar looks strong against the majors, sideways versus emerging markets. Tells me this isn’t a dollar move.

As countries back away from deeper negative rates, they’re getting the weaker currencies they wanted in the first place. Monetary policy fantasists might want to take note