Tag Archives: #yieldcurvesteepening

The Bottom’s Not In

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Attention this morning’s returned
To Treasuries, where we have learned
The bottom’s not in
As yields underpin
The dollar that once had been spurned

Plus ça change, plus ça même chose.

During the past several weeks, there have been a number of stories that seemed designed to shift our attention away from what has been the major market driver in 2021…the Treasury market.  But despite the Ever Given running aground, despite the forced liquidation of Archegos Capital Management and despite Covid’s resurgence throughout Europe and additional mooted lockdowns there, the clear driver of market activity remains US Treasury yields, specifically in the back end of the curve.  As I type this morning, the 10-year has risen 5.7bps on the session with the yield now 1.765%, its highest level since January 22, 2020.  This movement has dragged up yields across the US yield curve, with 5-year yields fast approaching 1.0% while even 2-year yields, which remain anchored by the Fed’s promises to keep the Fed Funds rate at its current level through at least 2023, has edged up by 1.4 basis points.

And this movement is not isolated to the United States, as sovereign yields across the board are higher today with European markets looking at gains of between 5.5bps and 7.5 bps, while overnight saw Australian yields climb 9.2 basis points.  But it is clearly the Treasury market in the lead.  The current story seems to revolve around the ongoing outperformance of the US economy vis-à-vis those of Europe and much of Asia, the success of the US vaccine program and the promise of yet another fiscal stimulus bill coming from the Biden administration.  That trifecta dwarfs all other nations’ activities and so has seen ongoing flows into US equity markets as well as into the dollar.  And the thing is, for now, it is hard to see what can derail this story in the short-term.  In fact, with the latest payroll data due to be released Friday and expected to show a substantial gain in the number of jobs, while more and more states reduce Covid inspired economic restrictions, things seem like they will only get better.

And perhaps things will only get better.  Perhaps we have passed the worst of the pandemic.  Perhaps all Covid inspired restrictions will be relaxed and people will head back out on vacations and to movies and theme parks. Perhaps shopping malls will regain their allure as people look for anyplace to go that is not inside their own home.  In this case, as the service sector reopens along with the jobs attendant to that process, the Fed would likely be able to justify a very gradual reduction in some of their stimulus.  And this could all happen.  But, so could we wake up tomorrow to learn that pigs really can fly.

Instead, while there is no doubt that the US remains the driving force in the economy right now, as it leads other nations out of the pandemic, the imbalances that have developed due to the policies implemented during the pandemic will take a very long time to unwind.  In addition, they pose a very real threat to the stability of markets and economies.  For instance, how will nations around the world address the issue of the massive rise in their debt/GDP ratios.  While servicing costs right now are tenable given the historically low level of interest rates, investors may well start demanding higher yields to compensate for the growing riskiness of those portfolios.  After all, we have seen many nations default on their debt in the past, with Greece and Argentina just the two latest on the list.

But rising yields will force governments to choose between honoring their debt promises, or paying for their activities, a choice no elected politician ever wants to make.  It is not unreasonable to assume that this choice will be forced on countries by the markets (and in fact, is starting to be forced as we watch yield curves steepen) with two potential outcomes; either the central bank caps yields to insure that debt service remains viable, or the debt is restructured by the central bank who will monetize it.  Either situation will almost certainly result in rising inflation, not of the asset kind, but will also result in a situation where those tools that central banks claim they have to fight inflation will not be available.  After all, if they are capping yields, they cannot very well raise rates to fight inflation.

It is this endgame that has some very thoughtful people concerned, as when this situation has arisen in the past, and after all, there is nothing new under the sun, the result has been a combination of much more significant inflation and debt defaults.  Now, in the US, the idea of a debt default seems quite impossible.  However, the idea of higher inflation, especially given the Fed’s stated desire to see inflation rise, is much easier to accept.  And after all, given the newly stated desire to achieve an average inflation rate, with a desire to see higher than 2.0% inflation readings for some indeterminate amount of time, how will the Fed know when they’ve seen enough?  The point is, the Fed, and every central bank, still has a very difficult task ahead of them to maintain stability while supporting the economy.  And there is no guarantee that their actions will work.

With that joyous thought in mind, a quick look at other markets beyond bonds shows that equities remain supported with widespread gains overnight (Nikkei +0.15%, Hang Seng +0.8%, Shanghai +0.6%), while European bourses are all green as well (DAX +0.6%, CAC +0.55%, FTSE 100 +0.25%).  US futures, however, are starting to fade, led by the NASDAQ (-0.8%) although SPX futures (-0.2%) have turned lower as well.  Remember, the NASDAQ, with its predominantly growth-oriented companies, is similar to a long-term bond, as higher yields reduce the current discounted value of its future growth.

Commodity markets are under pressure this morning as well with oil (-1.5%) falling back a bit further, and both base and precious metals all under the gun.  This commodity story is synchronous with the combination of rising yields and…a rising dollar.  And the dollar continues to rise, against all early year supposition.

Versus the G10, it is higher against all comers, with JPY (-0.5%) leading the way lower and breaking above 110 for the first time in a year.  However, this move looks far more sustainable than the price action seen in the immediate wake of the initial Covid panic.  Quite frankly, in the short-term, there is no reason to think USDJPY cannot rise to 115.00.  But the weakness is universal with SEK (-0.4%) and NOK (-0.3%) also continuing lower.  While the latter is undermined by the oil decline, the Swedish krona remains the highest beta G10 currency, and is simply leading the euro (-0.25%) on its downward path.

EMG currencies are not in any better shape with TRY (-2.2%) by far the worst performer as more bets get piled on that the new central bank governor will be cutting interest rates soon at the behest of President Erdogan.  INR (-1.2%) is the next worst performer, suffering as state-run banks were seen actively buying dollars in the market ahead of their fiscal year-end, cleaning up their balance sheets.  But pretty much the entire bloc is lower by between 0.2% and 0.4% on the simple fact that the dollar is growing in demand as US yields lead the way higher.

On the data front, two minor releases today, Case Shiller Home Prices (exp 11.2%) and Consumer Confidence (96.9) are unlikely to have much impact as the market looks forward to the employment situation starting with tomorrow’s ADP Employment report and then Friday’s NFP data.

Adding it all up comes to the idea that the current trends, higher yields and a higher dollar, remain firmly entrenched and I see no reason for them to change in the near future.

Good luck and stay safe
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His New Paradigm

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No longer will we
Buy stocks every month.  Instead
We will surprise you

Last night, the final major central bank meeting of the week was held, and in it the BOJ announced the results of its policy review.  The two most notable features of this review were the scrapping of the annual ¥6 trillion target of equity ETF purchases, although they did explain that if they felt it necessary and conditions warranted, they could purchase up to ¥12 trillion, and a formalized range of the targeted yield in 10-year JGB’s at 0.25% either side of 0.00%.  As an addendum, they also indicated that any equity purchases going forward would be linked to the TOPIX Index, which tracks the entire first section of the Japanese stock market, rather than the Nikkei 225, which is far more concentrated.  Remember, one of the concerns registered by investors has been that the BOJ is not only the largest holder of JGB’s, but also the largest holder of Japanese equities in the country/world.  Regarding the JGB market, the market’s working assumption has been the acceptable trading range was +/- 0.20%, so this is a bit wider despite Kuroda-san’s insistence that nothing had changed.

In what cannot be a terribly surprising outcome, the Nikkei 225 fell on the news, -1.4%, although the TOPIX actually edged higher by 0.2%.  I guess when the biggest, and least price sensitive, buyer shifts from one index to another, this outcome is to be expected.  As to the JGB market, pretty much nothing happened with yields rising a scant 0.5bps and well within the new formal range at +0.10%.  Finally, the yen is essentially unchanged on the day as well, although the dollar’s broad-based strength of the past several weeks has really helped the BOJ here as the yen has declined more than 5% year-to-date, something the BOJ had been singularly unable to engineer on its own.

The bond market wasted no time
In forcing a major yield climb
Responding to Jay
And all he did say
Defining his new paradigm

While Treasury yields have backed off a touch this morning, the damage has clearly been done by Chairman Powell.  His Wednesday press conference, where he doubled down on just how dovish he was going to remain regardless of the bond market’s performance, has set the stage for what will ultimately be his biggest test.  After all, as a policy response, it is not a great leap to dramatically cut interest rates in the face of a pandemic driven economic collapse. However, once a policymaker insists that they are unconcerned with inflation and they are going to allow the economy to “run hot” for a while, it is a MUCH harder problem to determine when too much movement has occurred and to rein in potential excesses that can prevent the ultimate goals from being reached.

It is this set of conditions in which we currently find ourselves and which will be the lead story for months to come.  If history is any guide, the bond market will continue to sell off, ostensibly on the back of stronger economic data, but in reality, as an ongoing test of Powell and the new Fed stance.  Jay was extremely clear on Wednesday that he was unconcerned with the movement in the bond market, describing financial conditions as very accommodative.  Starting next month, the inflation data is going to be rising much more rapidly as the comparison from 2020 will show much stronger price pressures on a Y/Y basis.  This is THE battle for the next six months, with all other markets destined to react to the outcome.

The two possible outcomes shape up as follows: the Fed will be forced to respond to rising yields as the pressure on the Treasury grows and financing costs increase too rapidly thus resulting in expanded QE, Operation Twist, or YCC; or Powell stays true to his word and allows 10-year yields to rise much higher (think 2.8%-3.0%) with a corresponding steepening in the yield curve which drives the equity bus over a cliff and forces a Fed response to a cratering stock market under the guise of tightening financial conditions that need to be addressed.  Through our FX lens, the first will result in the dollar topping out much sooner than the second, as it will cap real yields and ultimately send them farther into negative territory.  But in either case, it appears that the dollar has room to run for the time being.  It will be an epic battle and my money is on the market forcing the Fed to blink before they would like.

Now to today’s markets.  After yesterday’s tech led US sell-off, we already saw that Japanese stocks were under pressure, but there was weakness across the board in Asia (Hang Seng -1.4%, Shanghai -1.7%) and we are entirely red in Europe as well (DAX -0.4%, CAC -0.4%, FTSE 100 -0.6%).  US futures, on the other hand, are pointing higher at this hour, up between 0.2%-0.5%.  We shall see if that holds up.

Bonds have reversed some of yesterday’s declines (higher yields) with Treasuries 1 basis point lower and European sovereigns seeing larger yield declines (Bunds -3bps, OATs -3bps, Gilts -4.5bps).  However, if the Treasury market resumes its decline, I would expect European yields to track higher as well, albeit at a slower pace.

Oil prices got smoked yesterday, falling more than 10% at one point before closing down 7.5% on the day.  That puts this morning’s modest 0.6% rise into context.  It appears that the oil market had gotten a bit ahead of itself.  As to the rest of the commodity bloc, metals are generally lower this morning although most ags are firmer.

Finally, the dollar is beginning to edge higher as New York walks in, with SEK (-0.3%) and NOK (-0.25%) leading the way down, although the entire G10 bloc in negative territory.  As neither nation had new news, these moves appear to be simple follow-ons to the resuming dollar trend of modest strength.  The EMG space is a bit different, with several currencies faring well this morning, notably TRY (+1.15%) on continued buying after the surprising rate hike, and MXN (+0.65%) as traders start to bet on Banxico raising rates more aggressively, following in the footsteps of Brazil.  On the downside, KRW (-0.6%) essentially gave up yesterday’s gains on the broad risk-off sentiment in Asia, which also dragged TWD (-0.5%) lower.  After that, the bulk of the movement in this space has been modest, at best, in either direction.

There is no US data to be released today, and no Fed speakers either.  Rather, the big story in the market is the triple witching in equities (expiration of options, futures and futures options), which oftentimes has a significant market impact.  And meanwhile, all eyes will remain on the Treasury market, as it is currently the single most important signal available.

Good luck, good weekend and stay safe
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Tempting the Fates

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What everyone now can assume
Is Jay and his friends in the room
Will never raise rates
Thus, tempting the fates
In search of a ne’er ending boom

Well, that’s that!  To anyone who thought that the Fed was concerned over rising back-end yields and a steeper yield curve, Chairman Powell made it abundantly clear that it is not even on their radar.  No longer will the Fed be concerned with mere forecasts of economic strength or pending inflation.  As in the Battle of Bunker Hill, they will not “…fire until they see the whites of [inflation’s] eyes”.   “Until we give a signal, you can assume we are not there yet,” Powell explained when asked about the timing of tapering asset purchases and tightening policy.  It would seem that is a pretty clear statement of intent on the Fed’s part, to maintain the current policy for years to come.

To recap, the Fed raised their forecasts for GDP growth to 6.5% in 2021, 3.3% in 2022 and 2.2% in 2023, while increasing their inflation forecasts (core PCE) to 2.2%, 2.0% and 2.1% respectively for the same years.  Finally, their view on unemployment adjusted to 4.5% this year with declines to 3.9% and 3.5% in ’22 and ’23.  All in all, they have quite a rosy view of the future, above trend growth, full employment and no inflation.  I sure hope they are correct, but I fear that the world may not turn out as they currently see it through their rose-tinted glasses.  The market’s biggest concern continues to be inflation, which, after decades of secular decline, appears to be at an inflection point for the future.  This can be seen in the bond market’s reaction to yesterday’s activities.

Prior to the FOMC statement, (which, by the way, was virtually verbatim with the January statement, except for one sentence describing the economic situation), risk was under pressure as equity markets were slipping, 10-year Treasury yields were rallying to new highs for the move and the dollar was firming up.  But the statement release halted those movements, and once the press conference got underway, Powell’s dovishness was evident.  This encouraged all three markets to reverse early moves and stocks closed higher, bonds flat and the dollar softer.  It seems, there was a great deal of positive sentiment at that time.

However, over the ensuing 16 hours, there has been a slight shift in sentiment as evidenced by the fact that the 10-year Treasury is now down 2/3’s of a point with the yield higher by 8 basis points, rising to 1.72%.  This is the highest yield seen since January 2020, pre-pandemic, but certainly shows no sign of stopping here.  In fact, 30-year Treasuries now yield 2.5%, their highest level since July 2019, and here, too, there is no evidence that the move is slowing down.  If anything, both of these bonds appear to be picking up speed in their race to higher levels.  Meanwhile, TIP yields are climbing as well, but not quite as quickly taking the 10-year breakeven to 2.31%.  In other words, that is the market forecast for inflation.  FYI, this is the highest level in this measure since May 2013.  As mentioned above, it appears there is a secular change in inflation on the way.

Perhaps what makes this most remarkable is the dramatic difference in the Fed’s stance and that of some other major central banks.  On the one hand, Madame Lagarde informed us last week that the ECB would be speeding up their PEPP purchases to counter the effect of rising yields.  Again, this morning she explained, “what we are responding to is a yield increase that could get ahead of the expected economic recovery.”   On the other hand, the Norges Bank, while leaving rates on hold at 0.00% this morning predicted it would start raising rates in the “latter half” of this year, far sooner than previous expectations.  Meanwhile, in the emerging markets, we have an even more aggressive story, with the Banco Central do Brazil raising the overnight SELIC rate by a more than expected 0.75% last night, as despite Covid continuing to ravage the country and the economy stuttering, inflation is starting to move higher at a faster pace.

The point here is that after almost a full year of synchronous monetary policy around the world, things are starting to change at different rates in different places.  The one thing almost certain to follow from this change in policies is that market volatility, across all asset classes, is likely to increase.  And since most markets either get measured in dollars, or versus dollars, and the inherent volatility in the US bond market is increasing, we may soon be testing central bank limits of control, especially the Fed’s.  After all, if the 2yr-10-yr spread widened to 2.75%, a level it has reached numerous times in the past, will the Fed remain sanguine on the subject?  Will the stock market implode?  Will the dollar race higher?  These are the questions that are likely to be on our lips going forward.  The fun is just beginning as the Fed embarks on its new policy roadway.

With all that in mind, what is this morning’s session doing?  Based on the different central bank activities, things are performing as one would expect.  The initial warm glow following the FOMC meeting followed into Asia with gains in most major markets there (Nikkei +1.0%, Hang Seng +1.3%, Shanghai +0.5%) although Australia’s ASX 200 fell 0.7% during the session.  Meanwhile, Lagarde’s comments, reiterating that the ECB would be buying more bonds has encouraged equity investors in Europe with gains across the board led by the DAX (+1.2%), although the rest of the set are far less impressive (CAC +0.25%, FTSE 100 +0.1%).  However, US futures tell a different story, as the rising long bond yields are continuing to have a severe impact on the NASDAQ with futures there -1.0% and dragging SPX (-0.3%) down with it although DOW futures have actually edged higher by 0.2%.  This is the ongoing rotation story, out of growth/big tech and into value and cyclical stocks.

In the bond market, the damage is severe with Treasuries leading the way followed by Gilts (+5.5bps) as the market awaits the BOE meeting results, and then much smaller rises in yields on the continent (Bunds +2.6bps, OATs +1.9bps, Italian BTPs +1.7bps) as traders recognize that the ECB is going to prevent a dramatic decline there.

Perhaps the most surprising outcome this morning is in the commodity bloc, where virtually all commodity prices are lower, albeit not by too much.  Oil (-0.3%), gold (-0.5%) and copper (-0.3%) are uniformly under pressure.  This could be a response to the Fed’s benign inflation forecasts, but I think it is more likely a response to the dollar’s strength.

Speaking of the dollar, it is mostly stronger this morning, recouping the bulk of yesterday afternoon’s losses.  In the G10, only AUD (+0.25%) is higher of note after the employment report released overnight showed far more strength than expected (Unemployment Rate fell to 5.8%).  But otherwise, the rest of the bloc is under pressure, once again led by SEK (-0.45%) and CHF (-0.35%), with both currencies seeing outflows on the back of higher USD yields.  In the EMG bloc, TRY (+2.0%) has just jumped higher after the central bank there surprised the market and raised rates by 2.0% rather than the 1.0% expected.  So, like Brazil, despite economic concerns, inflation is rearing its ugly head. However, beyond that, last night saw strength in KRW (+0.6%) after the BOK indicated they will not allow excessive market volatility (read declines) in the wake of the FOMC meeting.  And that was really the extent of the positives.  On the downside, PLN (-0.9%) is the laggard, as the market is concerned over additional Covid closures slowing any comeback and encouraging easier monetary policy further into the future than previously thought.  The rest of the CE4 are in similar, if not as dire straits this morning as the euro’s softness is undermining the whole group.  As to LATAM, the peso is starting the day unchanged and the rest of the continent has not yet opened.

On the data front, today brings Initial Claims (exp 700K), Continuing Claims (4.034M), Philly Fed (23.3) and Leading Indicators (0.3%).  In addition, we hear from the BOE, with no policy change expected, and then Chairman Powell speaks around noon at the BIS conference.  My guess is that there will be a great deal of interest in what he has to say and if he tries to walk back the idea that the Fed is comfortable with the yield curve steepening as quickly as it is. One thing to recognize is that markets can move much faster than anticipated when given a green light.  With the 10-year yield currently at 1.737%, a move to 2.0% by the end of the month is quite realistic.  And my sense is that might raise a few eyebrows at the Mariner Eccles building.

As to the dollar, follow the yields.  If they continue to rise, so will the dollar.  If they stop, I expect the dollar will as well.

Good luck and stay safe
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