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Dash to the Doldrums - The Week Ahead

FICC Podcasts 02 juillet 2021
FICC Podcasts 02 juillet 2021

 

Disponible en anglais seulement

Ian Lyngen and Ben Jeffery bring you their thoughts on the U.S. Rates market for the upcoming week of July 6th, 2021, and respond to questions submitted by listeners and clients.


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About Macro Horizons
BMO's Fixed Income, Currencies, and Commodities (FICC) Macro Strategy group led by Margaret Kerins and other special guests provide weekly and monthly updates on the FICC markets through three Macro Horizons channels; US Rates - The Week Ahead, Monthly Roundtable and High Quality Credit Spreads.

Podcast Disclaimer

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Ian Lyngen:

This is Macro Horizons, Episode 127. Dash to the Doldrums, presented by BMO Capital Markets. I'm your host, Ian Lyngen here with Ben Jeffery to bring your thoughts from the trading desk for the upcoming week of July 6th. And in keeping with the theme of the 4th of July, we'll offer the observation that U.S. rates continue to embrace independence from the economic data.

Speaker 2:

The views expressed here are those of the participants and not those of BMO Capital Markets, it's affiliates or subsidiaries.

Ian Lyngen:

Each week, we offer an updated view on the U.S. rates market and a bad joke or two, but more importantly, the show is centered on responding directly to questions submitted by listeners and clients. We also end each show with our musings on the week ahead. Please feel free to reach out on Bloomberg or email me at ian.lyngen@bmo.com with questions for future episodes. We value your input and hope to keep the show as interactive as possible. So that being said, let's get started.

Ian Lyngen:

In the week just past, the Treasury market had several key inputs to contend with. First, was it was the end of June, the end of the second quarter and the end of the first half. In typical fashion this resulted in a modest bid for Treasuries bringing 10 year yields back solidly below 1.5%. In addition, we did see the employment report, which came in stronger than expected on the headline front with an unexpected increase in the unemployment rate.

Ian Lyngen:

However, the U6 unemployment rate, which includes discouraged workers, decreased representing an improvement in the overall jobs landscape. We did see an increase in average, hourly earnings, consistent with expectations that should contribute to the reflationary concerns and leave the focus on core CPI, which will be released in mid July. In the very near term, we remain constructive on the Treasury market, leaning less heavily on the seasonal factors per se, and more on the notion that we have received so many potentially bearish redefining events over the course of the first half and still 10 year yields managed to remain below 1.5%. This speaks to a dynamic equilibrium in the Treasury market that suggests that the macro factors driving the outright level of yields have to do with the global recovery, as opposed to being localized the U.S. rebound.

Ian Lyngen:

We've also seen a thematic grind flatter in the Treasury curve. This is consistent with a pivot in monetary policy that led to a modest backup in rates in twos, threes, and fives. Given that the move in the front end of the curve was a recalibration to the updated dot plot, we expect that be a new floor for rates in the front end of the curve, while tens and thirties can continue to grind lower.

Ian Lyngen:

Thus far, the positioning data has yet to reveal any grand capitulation in terms of the net short positions. To be fair, shorts have been covered in scaled back in a variety of sectors. We've also seen this Stone and McCarthy real money survey show, a similar dynamic that said, 'what is absence is any push to be in net long, the Treasury market on a collective basis'. This leaves the pain trade decidedly as lower rates, although to a less extent from a positional perspective than we saw throughout the second quarter. All of this contributes to our call to see an extended period of consolidation with 10 year yields spending the bulk of the summer in a range of 135 to 159 with a reasonable probability that an opening gap in tins at 121 to 122 gets filled before the seasonal pressures fully abate.

Ben Jeffery:

So Ian, how about that trade balance data?

Ian Lyngen:

Yeah, I would say that the trade balance data was notable for a number of reasons but really, I think it was the non-farm payrolls report that struck people as being directionally inconsistent with the price action that subsequently emerged. We had a run-up into month end in terms of Treasury pricing. It was a classic bull flattener as people added duration and frankly, I was expecting that we would see a bit of a give back on Thursday and if not, then at least in the wake of a stronger than expected nonfarm payrolls print. After all, we did see 850,000 jobs added.

Ben Jeffery:

And that 850,000 figure now brings the three-month moving average of jobs creation to 570,000 jobs, undeniably impressive in a historical context. Although, in thinking about the market's reaction, 570,000 is still shy of the more optimistic ambitions that were making the rounds later in the first quarter, when we saw 10 year yields reach those high levels of 175 and 177. So June's jobs numbers were undoubtedly impressive, but at this stage with the enhanced unemployment benefits, still a factor to consider as well as investors’ attention, I would argue being focused more on the post labor day period. The quote unquote "repricing that we've seen in Treasuries, which still leaves 10 year yields below one 50." to me, suggest an extension of the theme of ambivalence toward the economic data, at least for one more month.

Ian Lyngen:

There's also the seasonals to take into consideration. We've been on about this notion that the Treasury market does tend to rally over the course of the summer and given the fact rates seem unresponsive to the developments on the economic side, this increases the relevance and the technicals. Let us not forget however, that the Fed's recent policy pivot really underscores where we are in the cycle and that even under the Fed's new framework, they're still unwilling to risk any credibility as inflation fighters.

Ben Jeffery:

And now that the dust has definitively settled since the June Fed meeting, their pivot, I would argue is most readily observable in the shape of the curve. We've now seen fives thirties stabilize in a trading zone that we haven't seen in almost a year, which resonates with the under-performance of the belly as a function of the revised dot plot. But at the same time, in terms of the level of outright longer dated yields, we're at a meaningfully higher plateau than we were during the summer of last year and this resonates with the idea that the front end and belly of the curve have repriced to the expectation of normalizing policy while 10 and 30 year yields are higher as a function of the recovery, but not rapidly accelerating due to concerns on runaway inflation.

Ian Lyngen:

I will note that the pullback in breakevens off of the highs is relevant when we think about calibrating forward expectations for inflation and also reflects the market's evolving understanding of how Powell and company will react in the event that what is assumed to be transitory inflation ends up being something more. Now, while there is very little on the economic calendar over the course of the next couple of weeks, the highlight will once again be the June 13th release of core CPI. Given the increase in average hourly earnings that we saw in June with the year over year pace at 3.6%, the bigger question becomes have those wage gains translated into more demand side inflation that should flow through to the economic data via core CPI.

Ben Jeffery:

And to what extent will either A, pent up demand for services and B, more robust household savings profiles, translate through to a surge in consumption now that domestically, at least COVID restrictions are generally removed from most parts of in-person commerce. This again gets at that transitory inflation narrative as the pace of economic activity associated with just turning the lights back on, almost by definition, can't be sustained over a long time horizon. So, circling back to the idea of rates, largely disregarding the economic data, the noise that we're going to experience in the fundamentals over the next several months is going to lend itself more to arrange trade and Treasuries than I think any definitive new trend, at least until the later part of the third or fourth quarter.

Ian Lyngen:

The June employment report also demonstrated a few contrasting indicators. Most notably, the increase in the unemployment rate, despite the massive headline NFP game. Within the details, we also saw a decrease of the U6 unemployment rate from 10.2 to 9.8. Now this as an alternative measure includes discouraged workers as well as workers seeking full-time employment, but settling for part-time work. The reason that this is worth highlighting is because it does show an improvement in the labor force, more consistent with the headline in NFP print, but it's also worth keeping in mind that the household survey defines discouraged workers as not looking for work within the last 12 months. This implies that the discouraged category will be shifting out of the labor force altogether, which then accounts for a decline in the U6 unemployment rate. This is all a very long way of saying that the labor market continues to adjust to the post pandemic realities and these realities imply a continued evolution of the labor force overall.

Ben Jeffery:

And there's going to be another nuance in the data to watch over the next several weeks. Given the fact that the jobless claims figures are now going to start incorporating those states that have decided to pull out of the enhanced pandemic unemployment benefits, which still showed just north of 10 million people. So again, the fact that some states are going to be having these programs, some states are not and the interplay between this dynamic and the labor force participation rate is going to make interpreting the data over the later parts of June and through July and August, fairly challenging.

Ian Lyngen:

This is also consistent with the idea that the macro outlook has effectively been put on a hold for the course of the summer. We continue to anticipate that September and October will really serve to define the next stage of the recovery.

Ben Jeffery:

And while the Macro outlook might be taking the summer off, so to speak in our pre NFP survey there, wasn't really a meaningful expectation that conviction this summer is going to be substantially less than summer's past on a scale of one to 10 in terms of investor engagement, the mean, and median response was five. And in addition to the scaled responses themselves, we saw several respondents highlight the Jackson hole symposium at the end of August as a top tier reason why market participants will be at their desks this summer, at least as much as is typical for this point in the year.

Ian Lyngen:

Also, got a bit of an update on the Fed's thinking for the tapering timeline via Harker's comments, who noted that $10 billion a month of tapering over the course of the year is his expectation and all else being equal. He'd like to start the process at later this year. This elicited absolutely no price action, which I think is relevant because it's very consistent with what we have heard from market participants in terms of expectations. So, if a fed president can float such a specific trial balloon related to tapering, and there's no price action, there's really no reason to expect that when we get the official announcement, sometime in the fourth quarter, that we'll see a meaningful repricing in Treasuries towards higher rates.

Ben Jeffery:

And while, sure, Harker doesn't vote until 2023, the fact that he is a little bit Hawk of center on the broader FLMC spectrum, points to the more hawkish members of the committee advocating for a similar timeline that is tapering announced at some point in the third quarter, beginning some point in the fourth quarter and running for roughly a year. However, on the more dovish side, we do have both Williams and Powell. And while we have not yet heard explicitly from either of them on their preference for the structure of tapering gaging, the degree of deliciousness off of Q4 start would put the chair and the New York Fed president's preference sometime in Q1 running for some time likely right around a year, which then would get us to 2023 and the point at which liftoff conversations are likely going to get louder, but Ian, exactly to your point, all of this is well-known in the market and yet still here, we have tenure yields below one 50

Ian Lyngen:

And 30 year yields, right at 2%.

Ben Jeffery:

2%, 30 years, that's a long time.

Ian Lyngen:

Yep, 30 year Treasuries. The name is Bond, Long Bond.

Ian Lyngen:

In the week ahead the Treasury market has a very little fundamental information to incorporate. We have ISM services, which as an indicator of the overall performance of the economy, will be useful. But given that it comes after the non-farm payrolls print, it will have a much more subdued market impact than otherwise. There's also the FLMC minutes release, which will cover the June meeting and provide some context for how the Fed is currently viewing the risk that inflation proves to be more than simply transitory. In the event that the FLMC minutes reveal and even less dovish committee, that should be net bearish for the front end of the curve, and allow for a continued drift lower in 10 and 30 year yields. With tapering talk now widely in the market and very little price action, as a result, people will argue that the Fed has done a very good job in avoiding a taper tantrum and the market has now moved on to trading the next shift in monetary policy, which will be the liftoff rate hike.

Ian Lyngen:

As a result, we expect that any strong economic data that the market does trade will primarily be focused in the belly of the curve, the five-year sector, as well as Euro dollars as the debate about the precise timing of the first rate hike continues. This implies that the fives thirties flattener will remain a viable trade as we progress through the recovery and while some pockets of inflation are sure to remain, as long as monetary policy makers are characterizing them as transitory, there's little reason to expect the Fed to bring forward rate hike, expectations, even further, or accelerate the tapering timeline, anything that ultimately challenges that timeline, however, will be a tradable event, and it's within that context that we'll continue to follow the developments with the pandemic overseas as the global economy begins to slowly emerge from the pandemic. We've reached the point in this week's episode, where we'd like to offer our sincere thanks and condolences to anyone who has managed to make it this far and with the institutional investor survey kicking off on Tuesday, July 6th, we'll note that you can vote from anywhere. Please.

Ian Lyngen:

Thanks for listening to Macro Horizons. Please visit us at bmocm.com/macrohorizons, as we aspire to keep our strategy effort as interactive as possible. We'd love to hear what you thought of today's episode. So please email me directly with any feedback at ian.lyngen@bmo.com. You can listen to this show and subscribe on Apple podcasts or your favorite podcast provider. This show and resources are supported by our team here at BMO, including the FIC macro strategy group and BMO's marketing team. This show has been produced and edited by Puddle Creative.

Speaker 2:

This podcast has been prepared with the assistance of employees, of Bank of Montreal, BMO Nesbitt Burns incorporated, and BMO Capital Markets corporation, together BMO, who are involved in fixed income and foreign exchange sales and marketing efforts. Accordingly, it should be considered to be a product of the fixed income and foreign exchange businesses generally, and not a research report that reflects the views of disinterested research analysts, not withstanding the foregoing. This podcast should not be construed as an offer or the solicitation of an offer to sell or to buy or subscribe for any particular product or services, including without limitation, any commodities, securities, or other financial instruments. We are not soliciting any specific action based on this podcast. It is for the general information of our clients. It does not constitute a recommendation or suggestion that any investment or strategy referenced here in may be suitable for you.

Speaker 2:

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Speaker 2:

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Ian Lyngen, CFA Directeur général et chef, Stratégie de taux des titres en dollars US
Ben Jeffery Spécialiste en stratégie, taux américains, titres à revenu fixe

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