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Mayday (!) - The Week Ahead

FICC Podcasts mai 07, 2021
FICC Podcasts mai 07, 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 May 10th, 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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*Disponible en anglais seulement

Ian Lyngen:

This is Macro Horizons, episode 119 Mayday!, presented by BMO Capital Markets. I'm your host, Ian Lyngen here with Ben Jeffery to bring you our thoughts from the trading desk for the upcoming week of May 10th. And in the wake of the colossal forecasting error for the April payrolls report, we're reminded that if life truly functioned on a seasonally adjusted basis, you would always be 70 and sunny in Anchorage.

Speaker 2:

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

Ian Lyngen:

Each week we offer an updated view on the US 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 I-A-N.L-Y-N-G-E-N@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 a lot of fundamental information to help guide trading, but in effect, didn't respond to anything up until Friday's non-farm payroll report. Now the massive miss on the downside for jobs creation in April has come under a certain degree of scrutiny as it relates to seasonal adjustments and what that might or might not imply for the accuracy of the underlying numbers. Nonetheless, a nearly 800,000 job miss will serve to bring into question economic data going forward. Now this isn't a critique of the data collection process, but rather a reinforcement of the fact we are in uncharted territory in terms of coming out of a massive recession, driven by a global pandemic with a wide variety of expectations for how this all ultimately translates through into a continuation of the strong growth that we started with at the beginning of 2021. The inflation expectations component remains essential in guiding the forward path of US rates as well as implicitly monetary policy.

Ian Lyngen:

One of the most striking aspects of the price action that occurred in the wake of the payrolls report was how quickly the eurodollars market pushed forward liftoff expectations from December 2022 until the middle of 2023. Now, some of that has been scaled back as the Treasury market appears to be finding a dynamic equilibrium with 10 year yields around 150. 10s did get as low as 146, which was right up against the 74 day moving average. And that's a level that we expect will provide key resistance going forward. In the wake of the manufacturing and services, ISM reports earlier in the week. The market started contemplating whether or not this is as good as it gets from an optimism perspective. That certainly resonates in so far as how we saw the year playing out. And that's a notion that does find solace in the disappointing jobs picture.

Ian Lyngen:

Now, recall that there's still roughly 10 million workers who are stopped out of the labor market at the beginning of the pandemic, who have yet to be fully reintegrated. If nothing else, the price action is certainly consistent with the traditional seasonal patterns, which tend to suggest that rates will peak early drift lower throughout the summer months, reaching the years low, somewhere in mid September before reversing that as optimism for the year ahead is priced in. From our perspective, the highest probability that a two handle is reached. We'll come in the process of pricing in the optimism for 2022 and beyond whether that is a Q4 event or a Q1 2022 event remains to be seen. And frankly, will be almost entirely a function of how quickly the market is able to recover more significant economic optimism in the wake of the April non-farm payroll's print.

Ben Jeffery:

Remember when 266,000 jobs added in a single month used to be a positive thing?

Ian Lyngen:

I do. And I also remember when Beta used to be a serious challenge for VHS, but that's a story for another time. Well, this month's non-farm payroll report illustrated was that it is not going to be a direct path out of the pandemic to pre COVID economic conditions. One of the more interesting parts of the price action that followed the employment report was the fact that Treasury has rallied in 10 year yields got as low as 146, but that move quickly faded as the market became skeptical about the seasonal adjustments to the data. Now, when we talk about any economic data series, it's important to keep in mind that generally speaking, they're almost invariably adjusted for seasonality.

Ian Lyngen:

The issue with this particular series was the notion that the massive job losses at the beginning of the pandemic are distorting the outcome at this stage. While in the final analysis that might have some meaningful merit, what I'm taking away from this entire episode is that the economic data is going to increasingly come under scrutiny and will be very difficult for investors to trust strong or weak reports over the course of the next several months.

Ben Jeffery:

And this gets at something that Powell has mentioned recently, which is that we're still very far from the Feds bar of quote unquote, substantial further progress. We heard the chair say that in order to start considering removing the current accommodative bias, we would need to see not just one job's print akin to last month’s read, but a string of several months with jobs growing at roughly the scale that we saw in March. So in terms of calibrating, the timing of monetary policy normalization. I also think that seasonal adjustments aside, this latest NFP release, pushes the timeline for tapering and ultimately a rate hike, at least as exemplified in the eurodollars market, further out on the horizon.

Ian Lyngen:

Yeah. And to your point, Ben. Ahead of the employment report, the Euro dollars market was fully pricing in the first rate hike in December 2022, after the release that was pushed back to mid 2023. This certainly illustrates how important job creation is at this stage in the cycle. But it also demonstrates how vulnerable forward expectations become, the further into the future, the market attempts to forecast

Ben Jeffery:

Another idea that came to the surface this week was that maybe this year's Jackson Hole Symposium will be the preferred venue for Powell to float the first trial balloon around the idea of tapering. Remember back in 2013, Bernanke's taper tantrum occurred on roughly a similar timeline. So it's going to be interesting to see how expectations are refined as we get into summer and toward that event at the end of August.

Ian Lyngen:

Well, there certainly is still plenty of time for the economic data to show the type of strength that the fed would need to see, to make Jackson Hole the departure point for the conversation around tapering. We continue to expect that tapering ends up being announced officially in the fourth quarter and implemented in the first quarter of 2022. What will be fascinating is to see how market expectations are further refined over the course of the coming weeks. We came into this year expecting that the run-up in yields based on reopening optimism would eventually overshoot and it appears to have done so with 177 in 10 year yields marking the upper bound or the range. Very reasonable to expect that that level now holds at least until the fourth quarter with the idea of being once the US economy is fully reopened. And we have a better sense for how many workers we've been able to pull in off the sidelines, we will then recalibrate expectations for 2022 and beyond.

Ben Jeffery:

And in watching that pullback from 177, 10 year yields, it's been very interesting that it hasn't come at the expense of inflation expectations. In fact, it's been the exact opposite. We've seen 10-year breakevens push once again to their cycle peaks at the highest level since 2013, but that increase has been more than offset by the decline in real yields. Hence, nominal 10 yields have fallen to roughly 150. So while inflation expectations have remained well intact and accelerated, the moderation of some growth expectations have brought real yields off their latest peaks. Now in this context, peaks is still an extremely negative territory, but this divergence has caught a lot of investors attention over this past week.

Ian Lyngen:

And I would add, it does follow intuitively that as real yields move, we see larger fluctuations in the belly of the curve, in the nominal market. And that's driven simply by the timing of normalization. It's also worth noting that the divergence between elevated inflation expectations and the realized data itself can persist as we have seen. And I expect we will continue to see for quite some time. This is useful context when we contemplate next week's core CPI release, where the April data is expected to show a three-tenths of a percent increase on a month over month basis. There's no question that the disappointing jobs release has complicated matters, not least of which, as I mentioned earlier, investors implicit trust in the quality of the data. Said differently, not inconceivable that a market that was already predisposed to ignore the economic data is faced with a stronger core CPI print that offers a meaningful disconnect with what we're seeing in terms of job growth.

Ben Jeffery:

And we also get to look at retail sales, which will help inform the trajectory of consumption as the influence of fiscal stimulus fades. And this brings up a very relevant point on the earnings front that was contained within the employment situation report. And what we saw was a meaningful surprise in average hourly earnings up seven tenths of a percent month over month versus expectations for a flat read. And while on the surface that might be encouraging, higher wages, higher consumption, better growth. The argument could be made that, that's actually a negative indication of the variety of jobs that were brought back. Because if lower wage jobs did not gain at the same rate as higher paying ones, that mechanically is going to translate to a higher wages figure, even if under the surface, that dynamic is not as encouraging from a consumption perspective.

Ian Lyngen:

And the details of the report actually showed a counter-intuitive rotation. So in fact, what we saw was an increase of more than 300,000 jobs in the hospitality and leisure sector while transportation and warehousing jobs declined, that would imply that those lower wage jobs were coming back. And therefore, we should expect average hourly earnings to be weighed down somewhat. The fact that we didn't see that suggest that there might be some component of paying up for employees, whether that is to bring them off the sidelines and the enhanced unemployment benefits. Or retaining current employees, as we've seen plenty of headlines about pandemic burnout leading to incentives for entry level employees.

Ben Jeffery:

So do you think it's reasonable that these distortions may persist as long as these enhanced unemployment benefits are in effect? So essentially, through the end of summer into September.

Ian Lyngen:

Think there's going to be distortions within the economic data for the balance of the year. It won't be until the US economy is completely open and we have enough of the labor force re-engaged in the market that the data truly begins to normalize, which puts investors in the very difficult position of effectively flying blind until it's abundantly clear that the pandemic is over. I'll be curious to see when US health officials decide to claim victory over the pandemic. And if there are any broader ramifications for consumer behavior as a result. One of my core tenets for this stage of the pandemic is reopening won't remove the binding constraint for people to spend money and reengage in the in-person commerce. Rather it will come down to the individual level and the implied comfort with getting back out in the world and embracing the new normal.

Ben Jeffery:

And while I think you and I are on the same page that domestically we'll be pretty much reopened by the end of summer, I don't necessarily think that's going to translate to meaningfully higher Treasury yields. After all, throughout the pandemic, Treasury's position in the financial system has been reaffirmed in that it's not solely about domestic growth and inflation, but rather global growth and inflation in terms of setting the outright level of rates. So while the US has done a remarkably good job in getting the vaccine rolled out so far, there's still large parts of the world. And several very important emerging markets, India comes to mind, that continues to struggle in their darkest days of the pandemic. It's going to take a great deal of time for the world as a whole, to truly get through COVID-19 and into whatever new normal on a global scale ultimately looks like.

Ian Lyngen:

Well, that brings up a great question that we received from a client, which was, how do we account for the apparent divergence in worldviews between the bank of Canada and the bank of England versus the Fed? It appears that the Fed remains far more hesitant about the outlook than what we're seeing in Canada and the UK. I think a big portion of that is a reflection of the dynamic that you just laid out, Ben. And that is the Fed has become the de facto central bank to the world, not just the US. Whereas the BOC and the BOE have more defined scopes and parameters that they're using when evaluating the appropriateness of monetary policy. That does leave the Fed and US rates and a very complicated situation in which you can see real GDP growing above 6% inflation above 2% and 10 year yields below 150.

Ben Jeffery:

Didn't 10 year yields used to have a two handle?

Ian Lyngen:

10 year yields used to have a five handle.

Ben Jeffery:

The S&P?

Ian Lyngen:

Soon enough. In the week ahead, the Treasury market has a great deal of fundamental and flow information to help guide trading. We have core CPI on Wednesday, as well as retail sales on Friday. That said, given the disappointing non-farm payroll's print, not only will skepticism be high in terms of the quality of the economic data given the adjustments associated with the pandemic itself. But also the reliance on the macro narrative that assumes that the US economy is going to come roaring back at this stage in the pandemic. Investors will also be tasked with taking down the May refunding auctions. We have $58 billion, three years on Tuesday followed by $41 billion, 10 years on Wednesday, wrapping up with $37 billion, 30-years on Thursday. Although it's being equal, one might assume that this would present a material challenge to the Treasury market, given the overall backdrop. However, given the uncertainties introduced on the labor front, combined with the fact that the next move in coupon auction sizes is presumably going to be lower rather than higher.

Ian Lyngen:

We're reasonably confident in the prospects for the refunding process to be relatively smooth. And as a result, we will look to continue leaning long in the Treasury market with a nod to the fact that some degree of concession will most likely occur. If such an auction concession isn't evident in the run-up to supply itself, particularly in 10s and 30s, then we would look for at least a modest tail to take down the new notes and bonds. Foreign participation in the US Treasury market is going to be key in estimating the direction of rates from here, the interest in overseas buyers to underwrite Treasury supply at these new now lower yield levels will be an informative takeaway if nothing else.

Ian Lyngen:

Still, given the headwinds facing the global recovery, it's difficult to imagine that we won't see an average, if not, above average degree of sponsorship from the sector. In terms of adjusting macro expectations for the upcoming months, one of the most materials shifts even before the April employment report was the market's growing in difference toward the economic data. The 800,000 job miss on Friday only serves to further reinforce the idea that it's going to be difficult to get an accurate gauge of where we are as an economy, until we're fully opened and have a much larger portion of the labor market reengaged.

Ian Lyngen:

Now, that isn't to say that there won't be any trading opportunities between now and then, but range bound as a theme, as a function of the uncertainty is going to become the norm. And it's within that context that we're reminded that even prior to the pandemic in the period between August 2019 and December 2019, 10 year yields held a range of 143 to 197. So the idea that we could get 10s back above 2% is challenging at this point, certainly not between now and the fourth quarter. And on the downside, the pre pandemic low yield mark of 131 does represent an attractive target, especially if we continue to see the situation with COVID-19 worsening overseas. 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 as vaccine supply now outpaces demand in the US and inducements include free alcohol, not rubbing alcohol. We cannot help but ponder what's next. Free interest rate podcasts? Oh, wait, maybe interestless is more apropos in our case.

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 ianlyngen@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 FICC 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:

It does not take into account the particular investment objectives, financial conditions, or needs of individual clients. Nothing in this podcast constitutes investment legal accounting, or tax advice, or representation that any investment or strategy is suitable or appropriate to your unique circumstances. Or otherwise it constitutes an opinion or a recommendation to you. BMO is not providing advice regarding the value or advisability of trading in commodity interests, including futures, contracts, and commodity options or any other activity, which would cause BMO or any of its affiliates to be considered a commodity trading advisor under the US Commodity Exchange Act. BMO is not undertaking to act as a swab advisor to you, or in your best interest in you. To the extent applicable, we will rely solely on advice from your qualified, independent representative making hedging or trading decisions. This podcast is not to be relied upon in substitution for the exercise of independent judgment.

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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