while we slept; upside convexity strikes back; 'Dreams of a Soft Landing, Fears of Hard Retirement'(party at Club 60-40 OVER); may the 4th be with us all...
Good morning …
Ahead of the FOMC meeting later on, a few words (REMINDER) from one of Global Wall Streets popular kids and author of a very early morning read from desk of a large German bank,
… Talking of age, if you're under 43, did 3 years at university and then joined financial markets then you won't have worked in an era of 50bps Fed rate hikes. This will very likely change tonight as the Fed are a near certainty to raise rates by 50bps. In fact it'll be the first time the Fed have hiked at consecutive meetings since 2006. So we enter a new era that won't be familiar to many.
In terms of what to expect later, our US economists are also calling for a 50bps hike in their preview (link here), which follows the comment from Chair Powell before the blackout period that “50 basis points will be on the table” at this meeting. Looking forward, they further see Powell affirming market pricing that further 50bp hikes are ahead, and our US economists believe this will be the first of 3 consecutive 50bp moves, which will eventually take the Fed funds to a peak of 3.6% in mid-2023. We’re also expecting an announcement that balance sheet rundown will begin in June, with terminal cap sizes of $60bn for Treasuries and $35bn for MBS, with both to be phased in over 3 months. See Tim’s preview on QT (link here) for more info on that as well…
… here is a snapshot OF USTs as of 716a:
… HERE is what another shop says be behind the price action, you know,
Treasuries are modestly higher with the belly slightly outperforming ahead of a big day for Treasury and Fed announcements. DXY is little changed while front WTI futures are notably higher (+3.8%) after the EU announced plans for a phased-in Russia oil embargo (see above). Asian stocks were mostly slightly lower (Japan and China still closed), EU and UK share markets are all modestly lower while ES futures are showing +0.4% here at 6:55am. Our overnight US rates flows saw a very quiet London morning session with some front-end buying and receiving in 10's noted. Banks have dominated the otherwise very quiet flows this morning according to the desk. Overnight Treasury volume was around 65% of average overall except in 30yrs (109%) where there was some relatively standout flow overnight.
… and for some MORE of the news you can use » IGMs Press Picks for today (4 May) to help weed thru the noise (some of which can be found over here at Finviz).
With this in mind and ahead of the FED this afternoon, a few things from global Wall Street’s inbox which caught MY attention and may be of some interest to you, too
Goldilocks on certain potential for DIP BUYERS — The return of upside convexity in fixed income markets
… Our view is that the return of upside convexity across fixed income markets, in isolation, is decompressionary in nature (i.e. supportive of outperformance of higher-quality investments vs. lower-quality). This is because improved valuations are likely to incentivize some investor cohorts (such as yield-based insurance buyers) to step off the sidelines and deploy capital…
Goldilocks ALSO noted, A Shifting Mix of Tighter Financial Conditions
CHARTS — 1stBOS asks IF there’s, A Top for US Inflation Expectations
… Importantly, 10yr US Breakevens look disconnected from two typically correlated markets, the S&P 500 and Copper, which are already trading close to their Q3/Q4 2021 lows, although this disconnect is less pronounced vs Oil.
For more out of the CHARTS Department, Double Top Deja Vu: Is Doc Copper Topping Again? Fed Hopes So!!! -Kimble
… As you can see, copper has reversed lower and broken through its 2 year rising up-trend line. This is concerning… and that concern will likely be realized if copper doesn’t hold neckline support at (1).
That support comes in at the $4 level. And if it fails to hold, Doc Copper could experience much lower prices. Stay tuned!
REMINDER — Inflation is a Tax -Mike Ashton (aka THE Inflation Guy)
REMINDER — We're In "Uncharted Territory" - Paul Tudor Jones "Can't Think Of A Worse Environment" For Bond & Stock Investors -ZeroHedge
And one final REMINDER — … The Party at Club 60-40 Is Over (John Authers)
Much is riding on 60-40 funds; the jargon name for funds that mechanistically balance stocks and bonds. The classic allocation is 60% stocks and 40% bonds, which is how they got their name, even though many will tend to have a higher equity allocation than this. The most popular variant on the theme is the target-dated fund, which has become the investment management industry’s best attempt to replace the old-style defined-benefits pension, which few private sector companies want to offer. The idea is that savers are offered a fund with a target date for retirement, and asset allocation will be kept at appropriate levels according to how long there is until retirement. Younger people will automatically be given a higher weighting in equities. Each quarter there is a rebalancing to return to the favored asset allocation, which in effect means selling stocks and buying bonds after the stocks have risen. Over the last decade this has guaranteed continuing flows into bonds, despite their low yields.
How important are they? Recent research by the Investment Company Institute and Employee Benefits Research Institute shows that such funds have become the backbone for retirement saving in the U.S. Much is riding on them:
Automatic asset allocation has been particularly useful in persuading younger people to sign up to pensions. In many ways, this replaces the old paternalistic model of defined-benefit plans, gently guiding people into sensible allocations:
The problem is that this is predicated on the notion that they will not fall at the same time. As shown in Mullarkey’s charts, we’ve become accustomed to the idea that as bond yields rise (and their price falls), so stocks will rise, and vice versa. But in this environment, it looks as though we should get ready for that relationship to change, which could shake confidence in retirement saving as it is currently practiced.
Here are the monthly returns on Bloomberg’s index of U.S. 60-40 investments, going back to 2007. Only the disaster months of October 2008 and March 2020 were worse than April of this year:
It gets worse. There is also a marked relationship between the Fed’s addition or removal of liquidity and the success or failure of 60-40 funds, as shown in this chart from MUFG Americas:
When the Fed is priming the pump with quantitative-easing asset purchases, 60-40 does well, and when it attempts to tighten with QT, 60-40 plans do badly. We learn today about what the Fed will do about quantitative tightening, and it’s likely to put even more pressure on retirement plans.
The irony is that higher bond yields have actually made life easier for defined-benefit plans, because they make the liabilities they have to guarantee cheaper. For people saving in target-date funds, any continued pattern of falling bonds and equities is going to look terrible, and could shake a generation’s faith in their retirement savings. It’s one of many risks with which the FOMC must contend.
… THAT is all for now. Off to the day job…