Markets
Risk Markets are taking a short breather from last week risk-off. Oil is stabilizing, Still, the swift moves in yields showed the Fed's complacency around upcoming inflation might have unintended and lasting consequences, Its busy week ahead, so the pause makes sense as markets will continue to digest the reopening boom and higher yields cycle through the lens of a series of crucial and timely PMI releases. There will also be a healthy heaping of Fedspeak this week, including two appearances by Fed Chair Powell, which will be sure to keep investors on their toes.
Despite the decidedly-dovish outcome of last week's FOMC meeting, bond market pricing for Fed funds lift-off remains notably at odds with the median policy forecasts laid out in the latest SEP. A pivot around the US 10y: 2/10 steeper 10/30 flatter is becoming the consensus view (if not 'trade'). In the wake of the Fed's meeting, the street is still of the opinion the 10-year yields have a fair way to go yet. The statistical effects in data, plus reopen and super strong growth to come, are all seen as driving yields much higher.
Short-end rates have already adjusted but remain vulnerable to hawkish Fed regional presidents. Long-end yields should rise as term premium is priced back in. Higher real yields will strengthen the dollar. The combination supports equity prices, although tech faces some challenges.
Comparisons are inevitably drawn with the sell-off in risk assets and the USD's appreciation during the 2013 taper tantrum. June 19, 2013, meeting elicited a ~5% sell-off in the S&P 500 within a week and a 2.5% rally in the broad-based USD amid a 40bp rise in 10Y yields, with 2s10s bear steepening 30bp over that period.
The key difference between June 2013 and today is that Fed Chair Bernanke talked about economic recovery and justifying pulling back on asset purchases later in the year. By contrast, the current Fed’s evidence-based approach leaves bond markets in the judgement seat as to whether the Committee’s ‘wait-and-see approach is appropriate into a period of rapidly-improving economic data.
Higher yields will continue to test the Fed's comfort levels; investors long the most rate-sensitive equities and USD shorts. Falling correlations between rates vis-à-vis equities and the USD would hint at greater comfort, but like last week so fat today, cross-asset price action suggests that stage isn’t in reach yet for the market to flay higher.
Turkey on the menu but not contagion
USD/TRY is now +12.6% on the day (8.12), after rallying as much as 17.3% at the day’s high, following the replacement of Naci Agbal by Sahap Kavciouglu as CBT governor.
The CBT’s inflation-fighting credibility was enhanced during Agbal’s very short tenure since November 2020. Agbal’s CBT adopted a more orthodox monetary policy, capped off by a 200bp rate hike last Thursday, taking cumulative tightening in the policy rate in his tenure to 875bp.
Turkey aside, where the focus will be on signs of increasing deposit dollarization and portfolio outflows, broader EM contagion is fairly limited so far. External balances are healthier across EM than preceding the 2013 taper tantrum, although Turkey and Brazil’s rate hikes last week show that some EM central banks will have to hike rates to get combat rising US long-end yields.
Rates continue to move from valuation tailwinds to headwinds in China, and No SLR extension could change the way US banks do business.
China LPR Unchanged
In line with the consensus view, the People's Bank of China kept the March LPR on hold with 1y at 3.85% and 5y at 4.65%. Its steady hand suggests that authorities are likely satisfied with China's economic recovery pace and reasonably ample onshore liquidity since March.
So now rates could turn from a valuation tailwind to a headwind in China.
US SLR
The Fed, the FDIC and the OCC are putting reserves/Treasuries back into the SLR calculation. While not an enormous problem on April 1, but as reserves soar due to QE and the rundown of Treasury cash at the Fed, it should be a problem soon. Term funding/ should be impacted immediately, as banks won’t know exactly when reserves will rise enough to be a problem, so they should be reluctant to lock in deals for a long horizon as banks immediately begin adjusting how they are conducting lending business
US Rates
The US market hopes that persistently low level of short-term rates would continue. In light of large fiscal stimulus and the prospect of higher inflation this year, that view is getting challenged at virtually every market corner as the street continues to fight the Fed on this one.
Gold
Gold and silver faded their recent recovery at the open, struggling as yields stayed firm and the USD advanced above its one-week high. Vaccine shortages, the geopolitical risk from Turkey and technicals - the 20-day moving average in gold and the 100-day moving average in silver - should provide some support.
Gold needs a sustained break higher before confronting the November 2020 lows near $1765
In the main, not much has changed as US Bond yields should continue to rise, WTI settlement disrupts the oil market, TRY collapses as the best FX carry goes up in smoke.
Markets
It should be an exciting week ahead as markets will continue to digest the reopening boom and higher yields cycle through the lens of a series of crucial and timely PMI releases. There will also be a healthy heaping of Fedspeak this week, including two appearances by Fed Chair Powell, which will be sure to keep investors on their toes.
With the surge in yields post FOMC, and with no end in sight to the current levels of rates volatility which has been very disruptive to pockets of risk markets, it is likely to no rest for the weary as there will be no escaping the rough and tumble inflationary "Lather, Rinse and Repeat" debate cycle where the level of daily dissonance remains highly unsettling to investors. Believe it or not, "inflation" in Google Trend is at the highest level since 2004
In the main, not much has changed as Bond yields should continue to rise, supporting the dollar, equities will make the most of the economic recovery, but mega-cap tech will be troubled by yields, and so the weekly beat goes on.
VLXTL, a measure of volatility for Treasuries, is now higher than the VIX and has been the major exporter of risk across most assets as the swift moves in yields last week showed the Fed's complacency around upcoming inflation might have unintended consequences
Markets quickly moved from a risk-on dovish Fed narrative to concerns about vaccines, renewed European lockdowns, tense US-China trade talks, equity rotation out of tech, and falling oil prices.
The dramatic drop in oil prices on Thursday has stabilised, but the after-effects remain in other markets. US Treasury yields are calmer possible due to lower oil prices which have alleviated some inflation concerns.
Still, as long as stocks remain resilient and the data is good, nothing stops the market from continuing the repricing in fixed income; it will happen because growth and inflation expectations turn up after all.