Exactly one week ago, when BofA’s Michael Hartnett explained what global capital markets need to rebound from their recent doldrums, he laid out what he sees are the world’s two biggest problems:

  • Problem 1: US economy in “bad Goldilocks”, i.e. US economy not hot/strong enough to lift global GDP & EPS; but not cold/bad enough to induce global coordinated response
  • Problem 2: global policy-maker rhetoric in recent days shows “coordinated innocence” not stimulus, all blaming global economy for weak domestic economies (“Overseas factors are to blame”…Japan PM Abe; “drag on U.S. economy from greater-than-expected-slowdown in China & other EM economies”…FOMC minutes; “increasing concerns about the prospects for the global economy”…ECB Draghi; “the change in China’s growth rate can be attributed in part to weak performance of the global economy”…PBoC)

That recaps the problems; as to what the markets need he said the following:

“We remain sellers into strength in coming weeks/months of risk assets at least until a coordinated and aggressive global policy response (e.g. Shanghai Accord) begins to reverse the deterioration in global profit expectations and credit conditions.”

It was the expectation of a “massive policy stimulus” out of this weekend’s G-20 that unleashed last week’s furious short squeeze on concerns that shorts could be steamrolled by some G-20 surprise, as remote as it may have been. Citi’s Brent Donnelly confirmed as much: “the relevant question now is whether or not this 160-handle rally in SPX (!) is partially attributable to shorts squaring up ahead of the G20 meeting.” His answer: absolutely.

Indeed, as we reported yesterday, the G-20 has come and gone and has been a total flop, which was also not exactly a surprise: As Hartnett also said one week ago, “stabilization of “4C’s” (China, Commodities, Credit, Consumer) allowed SPX 1800 to hold/bounce to 1950-2000; weak policy stimulus in coming weeks could end rally/risk fresh declines to induce growth-boosting policy accord.”

Donnelly was just as blunt: “I would say the rally in the past two days has had extra momentum because of G20 and now shorts should be looking to reestablish—so I think stocks should trade weak from here into Monday.”

Worse, it was not just that the G-20 disappointed; it actually left everyone even more confused than going into the weekend:

Ambiguity on dealing with exchange rate swings also left market participants guessing. The policymakers reiterated that such volatility “can have adverse implications for economic and financial stability. At the same, they forswore “competitive devaluations” and vowed not to “target our exchange rates for competitive purposes.” It isn’t clear from these two sentences whether Japan has license to try to reverse the yen’s gains against the dollar since the start of the year, assuming it can stop the run-up.

Ok, so the G-20 not only disappointed it also left market watchers scratching their head making the case for further downside more credible, but what about the lingering risk of another major central bank intervention in the coming days: after all on deck as the BOJ’s meeting as well as the ECB.

The problem for the BOJ is that after it pulled the ridiculous NIRP stunt, it may have no political capital left for further surprises, and certainly no ammo. According to the Nikkei, “Bank of Japan Gov. Haruhiko Kuroda assured reporters on Saturday that no fellow G-20 officials had voiced objections to the BOJ’s negative interest rate policy. But Jeroen Dijsselbloem, the Dutch finance minister and president of the Eurogroup of eurozone finance chiefs, said “there was some concern that we would get into a situation of competitive devaluations” as a result of the BOJ’s move.

Osamu Takashima at Citigroup Global Markets Japan said that “Japan’s policy of trying to lift its economy by moving the yen in a weaker direction with monetary policy isn’t very welcome.”

He added that if the G-20 statement is seen as a deterrent against fresh monetary stimulus from the BOJ, another bout of yen appreciation may follow, and with it a renewed sell-off in Japanese stocks.

As the Yen appreciates, that would imply further selling in the S&P as more carry trades are forced to be unwound, especially since the market finally understands what Hartnett really meant when he said that “we remain sellers into strength in coming weeks/months of risk assets at least until a coordinated and aggressive global policy response begins.”

In other words, after the squeeze, now the next leg lower can start – one which prompts central banks to intervene. And since the BOJ is now sidelined, it means the ball is entirely in the court of the ECB. This is how Citi’s head of FX Steven Englander lays out the next steps:

  1. Policymakers are more likely to blame bad luck than policy ineffectiveness for the way in which currencies move. They will be mindful of concerns on banks from negative rates and flat curves, and will probably find some way of cushioning banks from the impact of their moves.
  2. The fear of policy ineffectiveness has led investors to downgrade both the impact of future policy moves and the probability of future policy moves. If central banks come back with further eases, with some provisions to cushion the impact on bank profits, there will be a partial bounce back in asset markets. Financial markets may still respond, even if the expected impact on final demand on inflation is limited.
  3. The ECB is in focus. EZ is undershooting on growth and inflation, and ECB President Draghi has been impassioned on the need to provide more stimulus. If they lowball or grudgingly meet expectations, we could face another December 4 move because market participants will see it as the equivalent of a ‘last ease in the cycle announcement’, basically ECB throwing in the towel. If they move aggressively (and take measures beyond vanilla QE and 10bps on rates), they will catch market off guard and unwind the view that policymakers see themselves as powerless.

In other words, the next big move in the market is now entirely in Mario Draghi’s hands.