a few sell side observations
I’m cleaning up inbox ahead of holidays and a few sell side observations (in addition TO all I noted HERE) may be of interest and worth a look … in NO particular order, the following struck me as things one in global macro / rates might be interested in:
BNP on FED, US Federal Reserve: Patience running thin where it is noted in their MARKETS VIEW SECTION, they believe
…the market is underpricing the upcoming Fed hiking cycle with real fed funds priced below -1.3 in 3years and a terminal fed funds rate of 1.60-1.70%. 2022 is well priced relative to our central scenario of three rates hikes, but the potential distribution of outcomes could see more priced, especially under a faster taper. We target 2y UST at 1.50%, and a much flatter 2s10s UST curve at 50bp at the end of 2022…
But wait, there’s MORE from BNP in latest GLOBAL OUTLOOK, 2022: Bullish ‒ selectively
Global growth: While many see a risk of stagflation, we are more bullish. We expect global growth to exceed both consensus expectations and its trend rate in 2022 and 2023.
… G10 rates: Volatility is likely to remain high due to uncertainty about central bank policy normalisation. While we expect the UST curve to continue to flatten, the Bund curve is likely to steepen in H1 2022, given the policy outlook.
GS weighing a winter wave — keeping in mind this is NOT specifically about German experience which has been source of overnight bid for USTs (following bid for BUNDS as things appear ominous THERE). Goldilocks
“In this week’s Trader, we note that while concerns around a winter Covid wave have clearly risen, US yields have thus far remained resilient, having risen on data strength and the renomination of Chair Powell. We ultimately see continued diminishing of resource slack and firm inflation, rather than choice of Fed chair or the winter Covid wave, pushing yields higher. The October surge in front-end volatility appears to have been amplified by deteriorating liquidity conditions at that part of the curve in particular, while signs of dislocations along the UST curve have also materialized alongside the start of tapering. Steepness of the real curve may allow front-end real yields to reprice higher alongside more stable intermediate and longer-term forward points, which we expect to move higher only gradually. We reiterate our preference for pairing EDZ3 shorts with BAZ2 longs on the view that there is more room for hawkish repricing to extend in 2023-2024 pricing in the US, while 2022 CAD pricing looks already quite elevated. In Europe, we mark-to-market recent ECB emphasis on QE flexibility, and continue to think that without actual purchase commitments, sovereign spreads are skewed wider. We expect funding pressures to endure into year-end given the near-term supply backdrop. In the UK, key data inputs specified by BoE Chief Economist Pill point to a December hike. This week’s Riksbank’s meeting bears watching for any indication of an earlier lift-off signal…”
DB fleshes out some things which FEDs new and improved dynamic duo may very well be watching for signs of EASING inflationary pressure,
“Participation primed for a pop or will the pandemic keep parents sidelined? … Overall, our work reinforces our view from prior analysis that Covid remains the biggest driver of labor force participation. Until the pandemic is under control to an extent that allows potential workers to predictably forecast caregiving needs, prime age participation will remain short of pre-Covid highs. While that certainty appears unlikely in the near-term, our results present a more optimistic view on participation once the pandemic is behind us … should Covid cases get to a level that significantly reduces uncertainty around childcare, there is all the reason to think that prime age participation could return to near previous highs. Indeed, the potential additional labor supply coming back on line just from caregiving constraints easing represents an additional roughly 750k workers. This would help to limit wage and price pressures, allowing the Fed to be more patient in terms of rate hikes.”
DB also addressed, Which recession signal should we trust, the curve or consumer?
The recent flattening of some yield curve metrics and collapse in measures of consumer sentiment have caused some consternation about future growth prospects and the potential for elevated recession risks. In this piece we conduct an empirical assessment of which indicators – yield curve or consumer survey – are most reliable for gauging recessions risks.
Our two approaches -- including both sets of indicators in traditional recession probability models and a more comprehensive receiver operating characteristic (ROC) framework – both suggest that yield curve metrics are the more reliable set of indicators. Based on these findings, we would conclude that recession concerns focused on consumer sentiment indicators may be overblown. This conclusion is reinforced by the fact that one of the best yield curve recession indicators – the Fed forward spread – has steepened significantly of late as the market has moved to price more near-term Fed rate increases.
Based on DBs conclusion, I suppose we then should STICK WITH PREDICTIVE POWERS OF THE YIELD CURVE … Which I noted the folks at Liberty Street was kind enough to address …
MSs 2022 Global Macro Strategy Outlook: The Journey Toward Tighter Financial Conditions
In 2021, central banks and governments drove an easing in financial conditions with extraordinary stimulus. In 2022, macro markets will begin a journey toward tighter financial conditions accompanied by protection from still abundant liquidity. We see rates and the US dollar rising further.
In as far as RATES go, well, you prolly could have guessed it
…In the US, we look for higher yields in 2022, led by intermediate maturities. A combination of strong growth, receding but above target inflation, and a patient Fed will lead the market to push out rate hikes, and price a higher terminal rate. 10y yields end 2022 at 2.10%. We suggest U2Z3 steepeners, and short 7s on 2s7s20s butterfly
The journey TO these conclusions and ideas is one well-worth your time … a HIGHER than expected NEUTRAL RATE, risk for a quicker taper and less buying by the Fed. All and more covered within. Separately, MS asks / answers, the call when asked about the GREAT Resignation
“What If...The "Great Resignation" Doesn't End? 36% of Europeans earn additional income through content creation platforms, of which 25% plan to leave their job within six months and 41% within two years. This is not churn; these people are exiting the corporate workforce. Even if 1 in 10 sees these ambitions through, wage inflation looks set to persist.”
AND then there’s NWM Strategy: Year Ahead 2022: The Post-Pandemic Economy where you may find the following topical comments/ideas of interest
Stubborn inflation in 1H will lead markets to worry about more rate hikes. Core PCE's expected plateau at 2.9% will be a challenge for the Fed and the markets. We think inflation tail risks in the US will lead investors to demand further protection for US inflation. Front end US CPI swaps should remain well supported.
Bear flattening to continue. Inflation pressures should lead the market to price in more uncertainty around the Fed’s reaction function. We think the Fed will remain credibility within its new framework, implying a front end driven bear flattening. An accelerated pace of taper leading to a faster bear flattener is a risk.
Fiscal spending is likely to slow. Supply and demand presents a more balanced picture. Covid remains an omnipresent risk. Split government after 2022 midterm elections could gridlock government spending. Treasury’s supply cuts will roughly be balanced out by taper, but the demand side remains less certain as the Fed enters a hiking cycle.
With that noted, here are NWMs rates f’casts (in GRID form which leaves ME thinking not THAT bearish, at least NOT incrementally so)
I will say the appendix included comparing 2021/2 and the 2016/18 analog worth mention
… When we initiated our bearish belly trades in May of 2021 (5s at 0.80%, 5s10s flatteners at ~80bps, short 5s on 2s5s10s at -10bps), we were emboldened by the view that the 2021 cycle would have echoes of the 2016-2018 cycle. In brief, both cycles began with large expectations of growth and fiscal stimulus that led to an early bear steepening, only to shift to a bear flattening as those expectations were validated (at obviously different speeds).
Of course no cycle is the same, and we recognize there are stark differences in the global inflationary outlook as well as the fact the Fed is likely to not be raising rates on its own in 2022, thus global yields may rise along with US Treasury yields (and all the FX implications that arise from that).
But even so, we continue to see similarities: namely that flattening should continue and like in that cycle, after an initial bear move, a second bear move should emerge. But as with all bear moves and bear trades that tend to be negative carry, timing is critical, which is why we have turned neutral for now and look to re-enter outright duration shorts after a period of consolidation.
With all this in mind, we present a series of charts below to show how the two cycles have tracked, with strong similarities.
As always, what you make of an excerpt vs full context can / will be different. I’d highly suggest taking any / all input with grain of salt and only AFTER you’ve digested in full context…