Choisissez votre langue

Search

Powell's Propensity - The Week Ahead

FICC Podcasts 09 juin 2022
FICC Podcasts 09 juin 2022


Disponible en anglais seulement

Ian Lyngen and Ben Jeffery bring you their thoughts on the U.S. Rates market for the upcoming week of June 13th, 2022, and respond to questions submitted by listeners and clients.



Follow us on Apple Podcasts, Google Podcasts, Stitcher and Spotify or your preferred podcast provider.


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

LIRE LA SUITE

Disponible en anglais seulement

Ian Lyngen:

This is Macro Horizons, episode 175, Powell's Propensity, 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 June 13th.

Ian Lyngen:

And as the PGA and LIV duel it out for the top golfing talent, we're just waiting for the bidding war between Spotify and Sirius to heat up. After all, real yields just went positive and bonds are back. Maybe.

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.

Ian Lyngen:

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 variety of inputs from which to extract direction. And on net, we saw a trend toward consolidation with auction concessions as a theme. Now, early in the week, we had a pretty sharp sell off that was largely a function of pricing in the incoming supply, not only supply in the Treasury market, but also supply in investment grade corporates.

Ian Lyngen:

Now, historically, we tend to think of rate lock hedging as a net neutral for the market, with anything hedged early in the week on round via a week unwound via covering, and such flows are only really relevant in short time periods, the exception being when technical or psychological thresholds of relevance are reached in terms of outright yield terms.

Ian Lyngen:

That isn't precisely what happened this week. However, it is notable that we have seen a reemergence of the flattening trend in 2s/10s, and that's a trend that we continue to favor. Our near term target is 13 basis points in 2s/10s, with the potential to break beyond that.

Ian Lyngen:

One of the common questions that we've received in this context is that, given how poorly that trade carries, when do we expect a paradigm shift back into negative territory? The short answer is between June 15th and the 4th of July weekend. Now, our logic here is pretty straightforward. We're going to have the Fed's rate decision on Wednesday, which is expected to deliver a 50 basis point rate hike and set the market up for another 50 basis points in July and the potential for yet another move in September.

Ian Lyngen:

Now, there's very little in terms of economic data once we're beyond the Fed, until we get to the June non-farm payrolls data in early July. This means that there will be little, at least on the fundamental side, to prevent the prevailing trend from extending.

Ian Lyngen:

One of the risks in this context is that we have another leg lower in risk assets. Now, the most recent sell off in stocks was actually associated with a bid for the front end of the market. We don't anticipate that that will universally be the case as the year unfolds. However, the narrative is, if equities are down 20 or 25%, then the Fed might choose to slow the aggressiveness of their hiking campaign. We ultimately don't think that they will, although we're certainly cognizant that that was the price action the last time stocks took a material hit.

Ian Lyngen:

It's in this context that we continue to contemplate where exactly is the Powell put. We've now learned it's not when the S&P 500 is down 20%. It goes without saying it comes before stocks are 50% off the highs. And it's probably, in practical terms, somewhere in between. Let's call it 30 to 35%.

Ian Lyngen:

Now, all it's being equal, we need to see some pretty significant headwinds emerge over the course of the summer to see a correction of that magnitude. Nonetheless, the interplay between risk assets and Treasury yields needs to be top of mind as we approach the summer doldrums.

Ben Jeffery:

So Ian, we've nearly made it through the first half of 2022. Inflation is here. Hawkish central banking has arrived. Stagflation worries are on the rise. So I have a question. What have we learned, and where do we go from here?

Ian Lyngen:

That's a good question, Ben. And frankly, I wish I had a much better answer than the one that I'll give. But we are where we are at this point in the cycle. The reality is that the market has a much better sense of the reaction function of global central banks, not just the Fed. But keeping it in the context of the Fed, we now know that not only is the Fed willing to increase rates at 50 basis points a move, but even a 75 basis point move isn't off the table at this point.

Ian Lyngen:

Now, obviously, that isn't going to be a June or July event. However, depending on how the economic data unfolds over the course of the summer, one would be remiss not to have a larger move on the table, at least potentially.

Ian Lyngen:

We've also learned that Treasury investors are content to remain sidelined, at least for the time being. This has been evident in the auction takedowns over the course of the last several months, as well as the fact the 10-year yields have found some dynamic equilibrium around the 3% mark. Now, we're not back to that 3.26 peak that we saw during the last cycle or the earlier 3.20 level, but it's also notable that we have yet to rally to 2.50.

Ian Lyngen:

Another thing that we have learned and that warrants exploring is that the Fed is willing to trade growth for price stability. Now, we knew to some extent coming into this year that it was going to be a difficult balance for monetary policymakers to ensure that labor market conditions remain favorable while increasing borrowing costs in the front end of the curve. What we didn't know is that Powell would be as committed to chasing inflation as he has demonstrated, particularly as the risk of a recession becomes increasingly topical.

Ben Jeffery:

And aside from monetary policy, I would also say the first half of this year has reinforced just what a unique shock the pandemic was to the global economy. Remember, it was only two years ago that economic activity around the world came to effectively a screeching halt. And I would argue what has caught the market, central bankers, investors most off guard is how quickly and by how much demand came back online, following not only the widespread rollout of vaccines, but also the removal of pandemic restriction generally. Obviously, there's a few exceptions to that rule, and what that meant in terms of the demand side of the equation, meeting supply that continued to feel the impact of what happened during the pandemic on a far more prolonged timeline.

Ben Jeffery:

Put another way, demand rebounded very quickly with the tailwind of the most accommodative monetary policy we've ever seen, as well as an effectively unprecedented fiscal boost in the US and elsewhere. And I would argue the first half of this year, namely what we've seen in terms of inflation, represents the durability of exactly that dynamic, demand that surged far beyond what was expected, combined with a much slower reaction on the supply side front, both in terms of goods, but also in terms of the labor market.

Ian Lyngen:

Yet another thing that we have learned over the course of this year is that one would be ill advised to ignore the geopolitical landscape. While tensions between Russia and the West were certainly on the radar at the beginning of the year, the actions in Ukraine were largely unexpected, and so was the fallout in terms of higher prices for food and energy as a result. That's certainly one thing that we had not anticipated at the beginning of this year.

Ian Lyngen:

And I'll add to that the response of global central banks was notable, if for no other reason than the potential hit to GDP was overshadowed by central bankers' concerns about inflation. Now, we have seen that come to fruition in terms of the economic data with the ongoing pressures in the inflation complex. Nonetheless, there's a strong argument to be made that as the year unfolds, the economic headwinds will become more relevant, especially in an environment where inflation begins to recede.

Ben Jeffery:

And despite the push for infrastructure changes more in favor of green energy, I would also say the price action in the oil market over the first half of this year demonstrates the ongoing relevance of that benchmark commodity, not just in terms of fuel and gas prices, but also as an input to large portions of the manufacturing sector and just how intertwined oil prices are with the global geopolitical stage.

Ben Jeffery:

Obviously, Russia plays a significant role on that stage, but let's not forget there's other potential flash points around the world as well. And even with things like ESG investing, driving the world's economy to be less reliant on oil at this stage and certainly for the second half of 2022, elevated oil prices are going to be a defining feature of the overall global economy and also overall financial markets.

Ben Jeffery:

Ian, you mentioned the difference between headline and core prices, and that's something that we've talked a lot about. And particularly, as we move toward next week's Fed meeting, in the event we start to see a greater emphasis on core prices, something that Vice Chair Brainard suggested, that's going to be a very relevant early indication that the Fed might be starting to think about downshifting their tightening from half a point at every meeting to something more measured, 25 basis points every meeting, or even the cadence that we saw during the last cycle, which was 25 basis points every quarter.

Ian Lyngen:

Oh, that's so 2018. And yet another takeaway from the first half of this year was the market's collective willingness to look beyond a disappointing GDP print in the first quarter and even the potential for another disappointment in Q2. Recall that, after revisions, Q1 real GDP declined 1.5%. Now, a lot of that, I'll argue most of it, was a function of the higher than expected GDP deflator, i.e. inflation at 8% puts real consumption into a different perspective.

Ian Lyngen:

We also had the impact on exports from the stronger dollar, which on net led to what might be the beginning of a modest slowdown. What I found fascinating was that not only was the Fed quick to dismiss this as a one off print and not a potential for an outright recession, but so was the market, at least to some extent. And the caveat of some extent is in effect an acknowledgement of the fact that the front end of the market continues to drift toward higher rates, while the longer end remains largely range bound. Now, not as range bound as we might have thought at the beginning of the year, but we're only at 3% tens. We're not at five.

Ben Jeffery:

And before we shift into a discussion about levels to watch over the rest of this year, I just want to highlight what you said about dollar strength. And like oil, the strength of the USD so far this year has been a hallmark of overall trading. In Treasury specifically, we've seen the yen drop to its lowest level versus the dollar since 2002. And given the volatility in FX markets, that means that hedging dollar exposure back into yen for Japanese investors has become very, very expensive and, most relevant for our discussion, Ian, meant that Japanese buyers have generally speaking been net sellers of treasuries so far this year. Selling, yes, but also not buying and taking advantage of the bearish repricing we've seen this year.

Ben Jeffery:

I think you and I both agree, Ian, that dynamic will not persist indefinitely. But using the concession that was required at this week's 10 year auction as a bit of anecdotal evidence, clearly Japan remains on the Treasury market sidelines. And I would argue that's been a big contributor to the push we've seen beyond 3% tens.

Ian Lyngen:

And it's not only Japanese investors who have been conspicuously absent in the Treasury market. As we see via the TIC data, Chinese holdings of treasuries have declined over the course of the year, most notably in March. Now, we're not interpreting this as a vote of non-confidence for treasuries as an asset class, but rather, suspect that what we're seeing is simply a function of what's going on in the Chinese economy at the moment.

Ian Lyngen:

We also know that domestically investors have been sidelined as well. This is consistent with investors looking for the opportunity for higher rates that allow for better placement.

Ben Jeffery:

And this is an important pillar of our bullishness over the rest of this year, specifically that those type of investors, think Japan, China, large institutional buyers, are never going to be the first ones to step in and catch the proverbial falling knife. In terms of placement into duration, that variety of demand typically waits until it has become clear that the path forward is toward lower yields, AKA trend followers and not trend setters. We've yet to see that play out. And should we see a more concerted rally in duration back to or through the recently set low yield marks, it's incoming demand from Japan and China that we expect will add a tailwind to that bid and get us back toward that 2.50 level or below in 10 year yields.

Ian Lyngen:

So in summary, we've acquired a lot of knowledge, but haven't really learned anything, because we're still bullish.

Ian Lyngen:

In the week ahead, the focus will be on monetary policy, specifically the FOMC decision on Wednesday. Expectations are for a 50 basis point rate hike, followed by a relatively hawkish statement. Now, the Fed will need to be hawkish in their official communication, if for no other reason than they've just delivered another half point hike.

Ian Lyngen:

In addition, Powell has made the case and we expect it to be met with follow through, that we'll see another 50 basis points in July. The recent trend overall of inflation data should leave 50 basis points on the table for September as well.

Ian Lyngen:

When we think about the details within the SEP, we expect that the Fed will follow suit with what the ECB delivered in terms of their economic projections, upward bias on inflation, downward bias on growth.

Ian Lyngen:

As for the employment market, with a 3.5% unemployment rate in hand, we don't see any urgency for the Fed to shift their forecast in that regard.

Ian Lyngen:

When it comes to the dot plot itself, it goes without saying that there's going to be upward revisions to 2022, as well as 2023. Simply to reflect what the Fed has already done and is in the process of communicating will be this summer's path toward higher policy rates. The terminal rate assumption as reflected in the Fed funds market has rebounded north of 3%, call it to 3.25, give or take, that will be achieved by the middle of next year. Now, one should expect that will be the departure point for what the 2023 dots actually show.

Ian Lyngen:

What will be more interesting is to see how the 2024 dots are adjusted. Do we see an increasing number of market participants willing to signal that the Fed will ultimately need to cut rates after reaching this cycle's terminal? We're reminded that historically the Fed is only able to keep policy rates at the terminal of any given cycle for six to nine months. That timeframe falls well into the time represented by the Fed's projection. So if the Fed is being intellectually honest, they might assume that they are going to need to deliver a fine tuning rate cut in 2024. And that should be reflected in the dots. That said, we and the market would be surprised if that actually came to fruition.

Ian Lyngen:

The other aspect of the Fed's projections that will be in focus is the long-term policy rate assumption. In March, the long run dot was revised down to 2.4 from 2.5. This was the first downward revision in some time. All that's being equal, we would expect that that level would be maintained, with an acknowledgement of the fact that the more aggressive the Fed is earlier in the cycle, the less they'll ultimately need to hike. And if that is the operating procedure going forward, there's a case to be made that the long run dot should see downward pressure over the course of the next cycle.

Ian Lyngen:

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 reopenings fully absorbed, for anyone who might have missed at the auctions, don't worry. They'll make more and more and more and more. Thanks, Janet.

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 FICC Macro Strategy Group and BMO's marketing team.

Ian Lyngen:

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 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.

Speaker 2:

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 reference herein may be suitable for you. It does not take into account the particular investment objectives, financial conditions, or needs of individual clients.

Speaker 2:

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 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.

Speaker 2:

BMO is not undertaking to act as a Schwab advisor to you or in your best interests in you. To the extent applicable, you'll rely solely on advice from your qualified independent representative in making hedging or trading decisions. This podcast is not to be relied upon in substitution for the exercise of independent judgment. You should conduct your own independent analysis of the matters referred to herein, together with your qualified independent representative if applicable.

Speaker 2:

BMO assumes no responsibility for verification of the information in this podcast. No representation or warranty is made as to the accuracy or completeness of such information. And BMO accepts no liability whatsoever for any loss arising from any use of or reliance on this podcast. BMO assumes no obligation to correct or update this podcast. This podcast does not contain all information that may be required to evaluate any transaction or matter. And information may be available to BMO and/or its affiliates that is not reflected herein.

Speaker 2:

BMO and its affiliates may have positions, long or shorts, and affect transactions or make markets in securities mentioned herein or provide advice or loans to or participate in the underwriting or restructuring of the obligations of issuers and companies mentioned herein. Moreover, BMO's trading guests may have acted on the basis of the information in this podcast. For further information, please go to BMOCM.com/MacroHorizons/legal.

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

Autre contenu intéressant