while we were asleep (volumes of 342%...), it's different this time, BBG RULE points to more, faster rate hikes and REALZ
Given what appears to have happened overnight — selling and lots of it — continued with absolutely NO bargain hunting or POSITION SQUARING (ie buying) and in fact, TECHNICALLY MOTIVATED sellers with what looks to be fresh shorts and essentially a full court press ahead of NFP …
30yy DAILY
30yy HOURLY, YTD
Overnight, then — from RTRS
MSCI Asia ex-Japan falls nearly 1.5% in afternoon trade
European shares extend slump further
Fed minutes point to quicker rise in U.S rates
Omicron variant spread further weighs on sentiment
Rising U.S. yields support dollar; gold fades
Overnight and today, ahead from BBG
Treasuries Hold Losses, S&P Futures Steady; Fed Speakers Ahead
Treasuries extended selloff over Asia session and broadly hold losses into early U.S., leaving yields cheaper by 3bp to 4bp across the curve vs Wednesday’s close. S&P 500 futures little changed following Wednesday’s steep drop after FOMC minutes release. Session focus remains on IG issuance, where $54b has already been priced this week, while busy data slate and Fed speakers are also scheduled.
U.S. 10-year yields sit toward top of daily range at around 1.735%, cheaper by 3bp on the day; spreads steady with yields across the curve higher by similar amounts
Estoxx50 lower by 1.3% in early Europe session while Nikkei dropped 2.9% in Asia
IG dollar issuance slate includes IADB 5Y SOFR; eleven borrowers priced almost $20b Wednesday, taking weekly total to more than $54b vs $40b projected
Three-month dollar Libor +0.57bp at 0.23129%
U.S. economic data slate includes December challenger jobs cuts (7:30am), November trade balance, initial jobless claims (8:30am), December ISM services, November factory orders and durable goods orders (10am)
Fed speakers include Daly (11:30am) and Bullard (1:15pm)
No U.S. coupon auctions until next week, when 3-, 10- and 30-year sales are scheduled
Overnight flows from BMO
Treasuries were under further pressure during the overnight session with 10-year yields reaching 1.742% as 30s touched 2.13%. The belly of the curve weakened further with 5s reaching 1.468%. Overnight volumes were particularly high with cash trading at 342% of the 10-day moving-average. 5s and 10s were tied as the most active issues, each taking 30% marketshares. 2s and 3s combined to take 22% at 10% and 12%, respectively. 7s managed 11%, 20s took 1%, while 30s managed 6%. We’ve seen two-way flows in 10s and buying in 30s.
With what happened overnight in mind, one of Germany’s largest banks favorite analysts comes latest edition of IT IS DIFFERENT THIS TIME.
This year is different
Fed QT is a big deal. We highlighted how the potential unwind of the Fed balance sheet was the major underappreciated issue for the market earlier this week and the FOMC minutes overnight confirmed it is a more “live” debate than assumed. While we spent most of last year dismissing the taper debate as immaterial (very well expected, precise timeline was of little relevance in notional UST terms and treasury issuance was declining one-for-one anyway), the QT debate is different: the amounts involved are far bigger and therefore the details (timing and re-investment caps) matter hugely. Equally important is how the US Treasury adjusts its issuance in response to reduced Fed reinvestments (do they just issue more bills) and until all of this is clarified it will create significant bond/equity negative uncertainty for the market. Personal view of this author is given how incredibly well behaved the bond market has been for the many reasons we highlighted last year, there is scope for the Fed to initiate QT as soon as mid-year.
All change in real yields. We argued last year that the single most important question for the market in 2022 was the outlook for real yields. It has been the "glue" that has held the market regime together and 5-year US real yields have finally broken out of their post-COVID range this morning. The Fed very clearly wants to push real yields higher and this will provide the true resilience test for risk appetite in 2022. It will also provide an answer as to just how high terminal rates can go: the bigger and earlier the tightening in financial conditions via equities, credit spreads and the long-end the less the Fed will ultimately have to do, and vice versa. This in turn will impact just how much the dollar can rally. The Fed can tighten financial conditions but it is the market that will determine via which asset class this happens and it is the economy that will determine how much is needed. We have written plenty on how the weakness in the supply-side of the economy is the most important factor that will ultimately constrain how much the Fed can and should tighten.
Other central banks. While the Fed is rightly at the center of attention, other central banks will also be important as the year kicks off. The Bank of Canada meets ahead of the Fed in three weeks' time: with the market nearly pricing five hikes this year, a rate hike will be taken as an important signal on the direction of travel for global central banks. On the opposite spectrum is China where the maintenance of a FILO (first-in-last-out) zero COVID strategy is now setting the stage for very significant monetary policy divergence with the Fed. Finally, don't ignore Japan, with news wires yesterday reporting that the BoJ's assessment on inflation could be changed for the first time in nearly a decade and where balance sheet reduction could well start before the Fed given the expiration of COVID loan support schemes. With the BoJ being the most dovishly priced central bank in the world, it's one to watch.
As rules of thumb are meant to be broken, here’s another rule to consider, from Bloomberg,
U.S. Eco Brief: BE Rule Flags Risk of 6 Fed Hikes in 2022: The Bloomberg Economics monetary policy rule sees the committee’s latest forecasts for the unemployment rate and core inflation as consistent with six hikes this year; The minutes of the Federal Reserve’s December meeting showed the FOMC is coalescing around the view the economy is ready for a broad-based removal of monetary accommodation, and the omicron variant is unlikely to slow it down; Global food prices declined from near a record high at the end of last year, offering some respite to consumers and governments facing a wave of inflationary pressures.
The median forecaster in Bloomberg’s survey of analysts anticipates the FOMC will raise its policy rate twice this year and three times next. Our house view is that policy makers will be a little more aggressive, with one additional hike each year. The Bloomberg Economics monetary policy rule underscores that risks to both forecasts are weighted to the upside.
The Bloomberg Economics rule, a modified version of the Taylor rule which captures key characteristics of the FOMC’s new policy approach, sees the committee’s latest forecasts for the unemployment rate and core inflation as consistent with six hikes this year and another three in 2023, leaving the rate at the end of next year just shy of 2.5%. (The highest forecast among participants in the Bloomberg consensus is 2.0%.)
The rule would have the funds rate reaching its neutral level in 2024. The FOMC has the rate remaining below neutral at the end of 2024 despite inflation slightly above the 2% target and unemployment below its longer-run sustainable level.
The uncertainty surrounding any forecast three years ahead is vast. Investors and policy makers need to be prepared for a wide range of possible outcomes. But the rule strongly suggests that the anticipated path of the funds rate is more likely to be revised up than down.
…Relative to the previous iteration of the BE rule’s view - which was based on the FOMC’s September 2021 projections:
The rule now sees liftoff happening two quarters earlier -- in 2Q 2022 rather than 4Q 2022 -- due to the sharper-than-expected decline in the unemployment rate over the past three months. (Between its September and December 2021 meetings, the FOMC revised down its forecast for the 4Q 2021 average unemployment rate by 0.5 percentage point.)
The rule now sees rate hikes proceeding after liftoff with greater urgency due to the worse near-term outlook for inflation. (The FOMC revised up its projection for core PCE inflation by 0.4 percentage point in 2022 but did not change its forecasts for 2023 and 2024.)
Together, these factors cause the rule to anticipate six hikes this year rather than the two it foresaw based on the September Summary of Economic Projections forecast. The rule sees another three hikes next year, bringing the rate to 2.4% at the end of 2023, up from 1.6% based on the September SEP.
The projected rate at the end of 2024 is a little higher than before (2.6% rather than 2.1%) because of the earlier liftoff and steeper initial ramping-up.
The road ahead is undeniably uncertain. The FOMC reports 70% confidence intervals for its inflation forecasts of +/- 1 percentage point. Those intervals would be relevant in normal times. In these extraordinary times they are almost certainly too narrow. The implications of omicron have yet to play out; supply chains remain snarled; and who knows what the next variant will bring. All 18 FOMC participants reported in December that they perceived inflation uncertainty as exceeding the average over the past 20 years.
Amid all that, the message from the BE rule is clear: risks are firmly tilted toward more rather than fewer hikes, and perhaps a lot more…
Now we know. One final thought from BBG and it is pertaining TO REALZ and cross asset (love / hate) relationship …
For global risk assets, the destabilizing threat of a disorderly surge in real yields is back. The benchmark U.S. inflation-adjusted yield has now jumped 20 basis points in just 4 days -- a pace not seen since the height of pandemic fears in March 2020. A good rule of thumb for a risk-off trigger is a four-week change in real yields of plus 40 basis points. Rising real yields eat into the positive backdrop for risk assets, threatening equity valuations and stocks’ relative attraction to bonds. So there's no surprise to see the highest valued stocks leading U.S. equities lower on Wednesday. The pace of the jump suggests investor concern about an over aggressive Federal Reserve choking off the U.S. recovery -- something reinforced by the yield curve which flattened again overnight. Risk asset bulls need the real yield surge to cool down -- to a gentle rise which would point to improving prospects for the U.S. economy.
AND … that is it for now. Off to the day job crossing all fingers hoping N’Easter headed our way ONLY brings 2-4” promised … We KNOW how good they are at these predictions, though, after Monday swing-and-a-MISS. Stay safe!