Choisissez votre langue

Search

Renseignements

Aucune correspondance

Services

Aucune correspondance

Secteurs d’activité

Aucune correspondance

Personnes

Aucune correspondance

Renseignements

Aucune correspondance

Services

Aucune correspondance

Personnes

Aucune correspondance

Secteurs d’activité

Aucune correspondance

Doveless in Washington - The Week Ahead

FICC Podcasts 24 septembre 2021
FICC Podcasts 24 septembre 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 September 27th, 2021, 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

Ian Lyngen:

This is Macro Horizons episode 139, Doveless  in Washington, presented by BMO Capital Markets. I'm your host, Ian Lyngen here with Ben Jeffrey to bring you our thoughts from the trading desk for the upcoming week of September 27th. And as the Feds beloved dot plot continues to define the shape of the yield curve, we're reminded of the relevance of the rate strategist mantra, I see bond people.

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 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 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 passed the highlight was unquestionably the FOMC meeting. The market came into the week with expectations for the Fed to lay the ground work for tapering sometime later this year and that's precisely what we saw. There was no official taper announcement on September 22nd, but Powell was very clear that the thresholds of inflation and employment have effectively been met and that tapering will become a reality very soon. We are now focused on the November meeting as the most likely point at which the Fed will announce tapering with the New York Fed's official asset purchase schedule released later in the month. We're anticipating that December will see the actual first reduction in bond buying.

Ian Lyngen:

Now that puts the Fed on course to end QE by the middle of 2022, which is also very consistent with what the Fed said on Wednesday. To some extent, the surprising aspect of the Fed meeting was the degree to which the dot plot was increased. We got the first look at the 2024 dot plot, and it was very consistent with the notion of a quarterly increase in rates with a nod to the fact that the terminal rate is still penciled in at 250. When we think about how difficult it was for the Fed to achieve that terminal rate in the prior cycle and the fact that monetary policy officials have pulled forward tightening expectations, we struggle to see the path to get 10 and 30 year yields materially above where they were at the end of the last cycle.

Ian Lyngen:

For context, between August and December of 2019, before the Coronavirus drove financial markets, 10 year yields were in a range of 143 to 197. As we think about the next 6 to 12 months, while there's a case to be made to push yields back above that 175 level and 10 year space in 2022, the notion that rates are to reprice to a higher rate plateau that proves sustainable presents a challenge. That said, it would not be as challenging had the Fed really doubled down on the new policy framework and demonstrated a comfort with letting inflation run even hotter during this cycle. But the fact the matter is that supply constraints, the chip shortage, the transportation issues all led to pockets of scarcity and thus inflation and therefore core CPI outperformed even the Fed's expectations. The net result being that the Fed is choosing to adhere less stringently to the new framework. And while maximum employment is still surely part of the Fed's objectives, monetary policymaker are unwilling to risk the decades of credibility built up as very powerful inflation fighters on one single cycle.

Ben Jeffery:

Well Ian, I think it a Fed meeting that was defined by the revisions to the dot plot. And frankly what Powell didn't say.

Ian Lyngen:

I think you're right Ben. The market has unquestionably been focused on the forward projection of policy rates. We saw an increase effectively across the board, although it is notable that the long rate didn't change. And the takeaway for market participants was that the Fed is willing to bring forward rate hike expectations and potentially accelerate the pace if the inflation figures continue to come in higher than expected. My primary takeaway from this is while we came into the beginning of this year assuming that the Fed's new framework would shift monetary policymakers reaction function to the incoming data. The fact of the matter was the new Fed looks an awful lot like the old Fed and that has implications for the shape of the yield curve. And more importantly, the outright level of yields. If anything, the September FOMC meeting doubled down on the hawkishness that we saw in June and effectively, will serve as a cap to how far 10 and 30 year yields can retrace if we assume that in the face of higher realized inflation, the Fed will be effectively forced to respond.

Ben Jeffery:

And in an addition to the dot plot, we also got more clarity around how Powell is thinking about tapering QE in addition to the changes of the language within the formal statement. The Fed acknowledge that pairing back asset purchases will "soon be warranted", which really in practical terms just lays the groundwork for an announcement at the November meeting with the flexibility to delay to December if needed, in the event that September jobs growth meaningfully disappoints. Not a base case by any means, but at this point it's all about a foregone conclusion that tapering is going to begin before 2022.

Ben Jeffery:

In terms of pace of scaling back bond buying, Powell also said that he would like to see the process completed by mid-2022. So calling that June or July of next year, that would suggest a $15 billion decrease per month, $10 billion in Treasuries, $5 billion in mortgages starting in either November or December and running until either June or July. Now when thinking about what Powell did not say, while there was a nod to the more stringent criteria for liftoff versus tapering, we didn't hear the chair emphasize that tapering timing and liftoff are two separate issues. And the fact that he didn't push back against that is telling, and I think accounts for some of the belly's knee jerk under performance.

Ian Lyngen:

Yeah Ben, that idea is spot on because we have been focused as a market on the notion that just because the threshold has been achieved to taper bond buying and eventually in the QE program that won't necessitate rate hikes in 2022. That said, given the updates to the dot plot, a liftoff rate hike next year is well within the realm of conceivable outcomes. More importantly, the Fed has done little to dissuade the market from assuming that once bond buying has been completed, the first rate hike will be six months later. We're cautious of assuming that that's actually a given, although Powell seems very content to allow the market to run with that assumption.

Ian Lyngen:

The one aspect of Powell's decision to not emphasize the lower bar for tapering is that it allows the Fed to gauge the market's reaction while holding in reserve the ability to revert to more dovish Fed speak. So in practical terms, if the equity market had sold off dramatically, or if rates had materially diverged from the dot plot assumptions, the Fed could attempt to walk back their renewed hawkishness by emphasizing that there's still a lot of economic data between now and the liftoff rate hike.

Ben Jeffery:

And remember, while the median 2022 dot did come off the effect of lower bound, it only wrote is to 25 basis points, which means that's a 50/50 split on the committee about whether or not the cycles first rate hike will take place before the end of next year. So Ian, you and I are completely on the same page that these projections are A, just projections. And B, provide a degree of flexibility for the FOMC to return to a more data dependent framework and that paradigm is going to be especially relevant over Q4 of this year and probably during the first half of next year. The performance of the labor market and just how quickly sidelined workers are reengaged will probably be insufficient to shift tapering timelines, but it could definitely inform Fed rhetoric or even formal projections at the December meeting regarding when the Fed ultimately sees rates off zero.

Ian Lyngen:

The price action that came in the wake of the Fed is worth examining in some detail. We went into the policy event assuming that the Fed would in fact draw a bigger distinction between tapering and liftoff, and that would've implied a steeper curve because the assumption would be that the Fed would be on hold for even longer. Instead, what we saw was a sell-off in twos, threes and fives focused obviously on the belly of the curve and a modest flattening as tens and thirties were effectively rudderless in the wake of the Fed. Thursday's price action however, appeared to be something of a bearish catch up as 10 year yields got as high as 145 before some overnight buying interest emerged.

Ian Lyngen:

Now we're very cognizant that the top of the yield range is in the process of being redefined. Our next target for 10 year yields is the zone of 155 to 160. And what will be most instrumental in guiding forward expectations in this regard is the degree to which sideline market participants attempt to come in and take advantage of the modestly higher rates as the fourth quarter gets underway.

Ben Jeffery:

And looking at the five year sector in particular and especially relevant after the revised dot plot, we've now come within striking distance of 1%. Obviously significant from a technical and psychological perspective, but given the scale of the repricing that we've seen over the past week or so, I'm less convinced that the moves are going to continue to be sharp jumps higher. And we may be in for a period of a slow and steady under performance in the belly of the curve. If only given the fact that between 1% and 125, there's not a lot to point to in terms of support levels. And especially if the Fed remains committed to the ideas laid out at the September meeting. That still should push five year yields higher, even if it will likely be at a bit more gradual pace than what we've seen this week.

Ian Lyngen:

And further to your point Ben, the big repricing that occurred at the beginning of the pandemic happened when 10 year yields were at roughly 140. So you're correct in your assertion that it's relatively uncharted territory between 1% and 125. I'd also add that the mechanics of the simple passage of time also support higher rates in twos, threes, and fives. Two year yields. Haven't quite got to the point where the bulk of the 24 month window will be characterized by a push toward higher rates, but we're going to eventually get there. So that implies that the medium term flattening bias that we continue to favor at this moment is expressed in fives thirties, but looking forward will eventually transition to the twos tens which will mark a very typical transition in the normal cycle of moving toward higher rates.

Ben Jeffery:

And in that move toward higher yields, we received a question this week of, if 10 year yields do rise to back above 150, for example, what will that do to the equity market? And while yes, in the context of the record low yield set during the pandemic, 150 is undoubtedly high. Remember that during the first quarter, 10 year yields effectively were on a one way trip to that 177 level and still we saw very resilient risk asset performance and domestic equities that continued to set all-time highs. Sure the Evergrande situation triggered a little bit of a pullback over this past week, but with the S&P 500 still within 3% of its record peak, at least in my mind, stocks will be able to withstand a 10 year yield at just 1.5%.

Ian Lyngen:

The caveat that I would add here however, is as the market was selling off in Q1, there was a ton of stimulus hitting the real economy and the financial markets. Recall that we had two rounds of direct transfers to the household level in terms of stimulus checks and the Fed was fully engaged in QE. Fast forward to Q4, the assumption is that in the year ahead at least, the Fed will be winding down per with an eye on hiking rates. And that potentially offers the exact opposite underlying dynamic that we saw in Q1. So I would look to the direction of the Fed's balance sheet in QE as far more potentially impactful to risk assets than the outright level of 10 year yields.

Ian Lyngen:

Moreover, when we think about out the objectives of QE, what the Fed is effectively attempting to do is first move investors further out the yield curve. And that's why we saw the initial flattening. Then further out the credit curve, which is why we saw credit spreads compress. And eventually that leads to other parts Of the capital structure, which is why we saw equities rebound as quickly as they did and reach record high levels. What happens when the Fed then slowly starts to remove the proverbial punch bowl? That's what I would identify as the primary risk for a taper tantrum. It's not modestly higher rates, it's what happens to the equity market. And I think that that's one of the reasons that Evergrande has come into focus because the risk is that it represents the beginning of a trend that might develop once global central banks start moving further and further away from an uber accommodated monetary policy stance.

Ben Jeffery:

Ian that's undoubtedly one of the chief risks that investors are going to be evaluating over the next 12 months. And it's that uncertainty that's translated to the 50/50 split we've seen on the FOMC about when exactly it is that we'll see this cycle's first rate hike.

 

Ian Lyngen:

Hey Ben, there is nothing wrong with the 50/50 split. And like my high school guidance counselor said, "Not to worry Ian, half of us are below average". In the week ahead, the Treasury market has a few pieces of economic data with which to contend, but we suspect that the primary focus will be the price action itself. Now with 10 year yields having established that 145 yield peak in the very near term, we continue to expect that that will be challenged. If for no other reason than the constructive seasonal influences have faded with the middle of September, typically marking the end of the bull run for Treasuries in any given year. That implies that there will be upward pressure on rates over the course of the next four to six weeks that we expect will offset the flattening bias that remains in place and potentially bring 10 year yields back towards that 160 level and be accompanied with 30 year rates closer to 225. All of this with the backdrop of the five year sector under increasing pressure as forward rate hikes approach, simply through the passage of time.

Ian Lyngen:

All else being equal, we would like to say we're transitioning into an environment in which the technicals are of particular relevance. But the fact of the matter is, where there's still much headline risk associated with the movements in equity markets, the situation with Evergrande and more importantly we're entering a phase in which it appears that market participants will attempt to effectively re-trade all of the bond bearish influences that we saw in Q1. Specifically, this notion that we'll be reopening the economy soon, there's still plenty of stimulus in the system. The employment situation appears to be improving. We've now seen what is hopefully an inflection point in terms of COVID case counts as the number of new cases continues to decline.

Ian Lyngen:

And this at a point when September was considered a primary risk, given the return to in-person learning. So all of this will contribute to renewed optimism, which will ultimately translate through to at least an attempt to get 10 and 30 year yields back to the peaks that we saw in Q1. Again, our baseline assumption is that the market falls short of getting rates that high, but nonetheless, we continue to see the forward path for Treasury yields in the near to medium term as incrementally higher until the point where significant dip buying interest is revealed after which we would expect a period of consolidation and a drift back into what has become a very defined lower rate range for 10 and 30 year yields.

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 as the first full week of autumn arrives, yields are on the rise, reflation concerns are moderating, return to office plans are on hold and we're left to ponder what happens when the COVID 15 meets the Delta 10? It's probably good for retail sales and apparel inflation.

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. This show has been produced and edited by Puddle Creative.

Speaker 2:

This podcast has been repaired with the assistance of employees of Bank of Montreal, BMO Nesbitt Burns Inc 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 a 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 a 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 interest in you to the extent applicable will rely solely on advice from your qualified independent representative making hedging or trading decisions. This podcast does 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. 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.

Speaker 2:

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 BIMO and or its affiliates that is not reflected herein. BMO and its affiliates may have positions long or short 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