MacroVoices #368 Charlie McElligott: Banking Crisis, FOMC, 0DTE, CTAs & more

Episode Summary

Executive Summary: In this March 23, 2023 episode, Nomura strategist Charlie McElligott argues that bank failures expose structural vulnerabilities in a banking system built for low rates, and that deposit flight and tighter lending could accelerate a hard landing. The discussion covers the Fed’s policy dilemma, market positioning and volatility, options and trend-following flows, then reviews technical levels in oil, equities, the dollar, gold, and credit.

Main Topics: Banking stress, deposit flight, and lending risks: McElligott views the failures of SVB, Signature, and Credit Suisse as symptoms of structural pressure on bank profitability and solvency: higher funding costs, yield-curve challenges, unrealized duration losses, and deposits migrating to money-market funds and Treasury bills. Regional banks’ substantial role in lending makes a prolonged contraction consequential for the economy. The Fed’s constrained policy choices: The Fed faces a trade-off between fighting persistent inflation and avoiding further damage to banks and credit. McElligott expects at most one more hike under the near-term outlook, while markets were pricing a faster pivot and rate cuts; meaningful easing may require clear deterioration in jobs, earnings, or credit. Recession signals, positioning, and cross-asset trades: McElligott identifies bull steepening in Treasuries, weaker crude, defensive equity leadership, and reduced appetite for leveraged and cyclical exposures as signs of rising recession risk. Gold and Bitcoin benefited from expectations of a dovish shift, while defensive and high-quality assets outperformed. VIX and zero-days-to-expiration options: McElligott says recent VIX upside demand reflected renewed hedging after investors rebuilt exposure, with dealer short-convexity dynamics potentially amplifying moves. Zero-day options are used by both retail and institutional customers for short-term hedging or convex exposure; customer buying and market-maker selling can amplify intraday moves, though positions generally expire or are closed by day’s end. CTA and systematic trend-following losses: After a strong 2022 for trend strategies, sharp reversals in rate and currency expectations produced whipsaws. January’s risk-on reversal, February’s renewed hawkish repricing, and March’s banking-driven shift toward cuts disrupted crowded trades and hurt CTAs and macro funds. Market charts and levels in the post-game: The hosts reviewed oil’s rebound after a technical breakdown, S&P 500 and Nasdaq resistance and support, a weaker dollar, gold near $2,000, and widening high-yield spreads. Eric Townsend saw potential for a bear-market rally but expected greater weakness later; other participants emphasized waiting for price action to confirm direction.

Key Arguments: The bank crisis is structural rather than merely a collection of isolated failures: banks built around near-zero rates face higher funding costs, deposit competition, regulatory pressure, and losses on long-duration assets. A shift of deposits from regional banks to larger institutions could further weaken regional lending. McElligott noted that smaller and medium-sized banks account for sizable shares of U.S. commercial real estate, residential real estate, and other loans. Emergency bank-liquidity facilities should not automatically be interpreted as QE. McElligott argued that funds may replace departing deposits or remain in money markets and bills, rather than financing new lending to the real economy. The Fed is constrained: more tightening may intensify financial stress, but rate cuts would likely require deterioration in inflation, employment, earnings, or credit. A sharp labor-market or credit downturn could prompt rapid cuts. Market behavior has shifted toward recession protection and quality: Treasury curve steepening, defensive equity leadership, and pressure on cyclicals and leveraged firms are consistent with tighter financial conditions. Zero-day options can increase intraday volatility through dealer hedging, but McElligott described current usage as manageable because positions are typically monetized or expire the same day. Systematic trend strategies were hit by repeated reversals in rates, the dollar, and risk appetite after their strong, persistent short-risk trends in 2022 gave way to choppy conditions in 2023.

Data Points: S&P 500 weekly change and close: Up 1.1%; 3,970 - Macro Scoreboard week over week as of the March 22 close; the index sharply reversed after the FOMC. Nasdaq weekly change: Up 2.7% - Outperformed the S&P 500 in the weekly scoreboard. U.S. Dollar Index weekly change and close: Down 2.1%; 102.53 - The hosts noted a technical breakdown following Powell’s comments. WTI crude weekly change and close: Up 4.7%; $70.90 - May contract, after briefly testing support near $64.59. Gold weekly change and close: Up 2.5%; approximately $1,979 - Gold approached the psychologically important $2,000 resistance level. Copper weekly change and close: Up 5.5%; $4.05 - Rebounded sharply after the prior week’s breakdown. U.S. 10-year Treasury yield: Down 2 basis points to 3.43% - The scoreboard described the yield as near the lower end of its year-to-date range. Share of U.S. loans at smaller and medium-sized banks: 38% overall; 28% commercial and industrial; 37% residential real estate; 67% commercial real estate; 27% credit cards; 50% auto; 48% other consumer - Federal Reserve figures cited by McElligott to illustrate the importance of these lenders to credit provision. S&P options that are zero-days-to-expiration: More than 50% of SPY options on a typical day; about 49% cited as a high for S&P contracts - McElligott described the scale of zero-day options activity and said customer flow is generally a net buyer of options. CTA performance in 2022: Approximately mid-30% gains - McElligott characterized 2022 as a generationally favorable trend-following environment. EIA crude inventory change: Crude build of 1.1 million barrels; Cushing draw of 1.1 million; gasoline draw of 6.4 million; distillates draw of 3.3 million - Inventory data discussed in the post-game segment; U.S. production was unchanged at 12.2 million barrels per day. Key S&P 500 technical levels discussed: Resistance near 4,000; support near 3,850; possible downside levels around 3,800 and 3,600 - Post-game discussion of options positioning, technical support, and potential downside scenarios.

Pivotal Quotes: "The damned if you do, damned if you don't observation is bang on." — Charlie McElligott: On the Fed’s conflict between continuing to fight inflation and limiting further banking and financial stress. "These are long-term structural dynamics." — Charlie McElligott: On why recent bank failures may signal a broader profitability and solvency problem rather than isolated events. "Cash is an at-the-money put." — Charlie McElligott: Explaining why investors with little market exposure in 2022 had less need to buy downside protection.

Implications: Investors may need to account for tighter bank credit, a higher chance of recession, and volatile policy expectations. Watch deposit and lending trends, credit spreads, labor data, and key technical levels; the episode’s market views are commentary, not investment advice.