Sive Morten
Special Consultant to the FPA
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Fundamentals
Well, it's not a secret that today we take a detailed look on recent Fed statement that seems to be a clue to medium-term markets performance - not only bonds, but Forex, Gold as well. Market society shows controversy around Fed decision and argue whether it was proper and is it really not a time yet for harder steps. Today we talk about inflation, rising yields and its perspective for the markets and FX market in particular. First is, lets take a look briefly what has happened this week:
Week overview
There was nothing interesting until Wednesday, actually as all investors were sitting on the hands and just waiting for the Fed - so important it was. Thus, most events have happened on the Fed statement and after. Here are major points of the Statement:
_____________________________________________________________________________________________________________________________________________________________________________
One-time increases in prices likely to have only transient impact on inflation and transitory rise in inflation above 2% will not meet standard for raising rates. Economy is a long way from employment, inflation goals and not time to start talking about taper yet. Fed promises to provide as much advance notice of taper as possible and when we see data that shows we are on track to achieving substantial progress, we will say that.
Powell says ‘strong bulk’ of FOMC is not showing a rate increase through 2023, but we will have something to announce on leverage ratio in coming days. Fiscal policy overall will have really helped us to avoid much of scarring we were concerned about and it will accelerate return to max employment.
Fed leaves key overnight interest rate unchanged at 0-0.25%, says committed to using full range of tools to support economy. Fed will continue to increase bond purchases by at least $80 bln/month of treasuries and $40 bln/month of mbs.
Indicators of economic activity and employment have turned up recently following a moderation in the pace of the recovery but inflation continues to run below 2 percent. Policymakers continue to see no rate hikes through 2023 as four Fed policymakers see liftoff in fed funds rate from zero in 2022, seven see liftoff in 2023.
Fed Chair Jerome Powell dampened speculation the stronger economic outlook could propel the central bank to wind back its stimulus. The Fed sees the U.S. economy growing 6.5% this year, which would be the largest annual jump in gross domestic product since 1984. Inflation is expected to exceed the Fed’s 2% target to 2.4% this year, although officials think it will move back to around 2% in subsequent years.
_______________________________________________________________________________________________________________________________________________________________________________
In two words speaking - Fed treats current interest rate spike as temporal, that mostly indicates sentiment and wishes of investors rather than real situation in economy, employment and inflation. In general, statement is more in favor of further US Dollar and interest rates appreciation.
Spiking U.S. bond yields boosted the dollar on Thursday, helping it to revive from two-week lows, after the Federal Reserve pushed back against speculation over interest rate hikes. U.S. 10-year Treasury yields rose to their highest levels in 13 months early in London trade, climbing above 1.70% for the first time since Jan. 24, 2020.
“The question remains whether the Fed can actually arrest the latest spike in U.S. Treasury yields, especially given that the improvement of U.S. fundamentals will continue,” Valentin Marinov, head of G10 FX research at Credit Agricole in London, said. “The renewed spike of UST yields should continue to support the dollar versus low-yielders like the euro, yen and the Swiss franc. Marinov said the Fed meeting had disappointed dollar bulls and the currency may be “nursing its wounds versus risk-correlated and commodity currencies in the very near term”.
The safe-haven U.S. dollar strengthened again on Friday, supported by higher Treasury yields and falling stock markets, as investors continued to digest the Federal Reserve's pushback against expectations of any early interest-rate hikes.
"After some navel gazing," bond investors "concluded that the Fed is not (posing) any challenges or discomfort for longer-dated UST yields to keep pushing higher," National Australia Bank's senior FX strategist Rodrigo Catril wrote in a client note. The USD regained its mojo."
While AstraZeneca vaccinations are poised to restart in Germany, France and other European nations, the region's growth outlook was dinged as Paris went into a month-long lockdown.
The Fed announced on Friday it would let expire on March 31 a temporary rule directing larger banks to hold more capital against their assets, such as Treasuries. The Fed had put the rule in place to encourage bank lending as American households and businesses were hurt by lockdowns.
“News that the U.S. Treasury SLR exemption is not being extended has given the dollar a little support, again largely via the rise in U.S. Treasury yields,” said ING in a research note. The near disorderly rise in U.S. Treasury yields at some points this year have certainly undermined a market biased to buy activity currencies on dips. The SLR news certainly adds an element of caution here.”
So, in fact, Fed has made double dovish impact on the market - denied any speculations concerning too high interest rates and that they might be the storm-bringer of inflation spike, and second it lets banks to contract reserves, closing SLR programme. Banks usually form reserves by buying US Treasuries and now they could sell the excess part, that should push rates even higher. It seems that Fed absolutely sure with its view, but what the foundation might be for this assurance?
Possible background of Fed's outlook
It seems that riddle could be explained by this Fed statement - "Inflation is expected to exceed the Fed’s 2% target to 2.4% this year, although officials think it will move back to around 2% in subsequent years". Other words speaking, Fed indeed sees inflation currently but mostly relates it to temporal jump in demand (overdemand) for goods and its transfer across the Globe. And they are not along with this position.
Five-year inflation expectations are currently running at 2.1%, as noted in Exhibit 1.
As consumers emerge from lockdown, supported by government stimulus, the surge in demand for products may not be immediately satisfied, thereby potentially driving up prices.
This tightness can already be seen in the shortage of shipping capacity as well as in commodities data which is ticking up as shown in the top pane in Exhibit 2. Furthermore, the producer price index for manufacturing in China has started to pick up, surpassing early 2019 levels, as demonstrated in the bottom pane.
Such pressures are, however, likely to be temporary given that firms take time to ramp up incremental capacity. Furthermore, the continued low employment participation rate in the U.S. compared to the 1990s and early 2000s, indicates significant slack in the labor force.
Another reason why inflation is highly unlikely to lead to 1970s-style rates is that the wage price spiral – where rising inflation expectations drove workers to bargain for higher nominal wage increases – took place in a relatively closed economy.
Today, the U.S. economy is three times more open than it was during the 1970s. Greater trade openness places far more downward pressure on nominal wages given that tradeable goods and services can be offshored if wages become too uncompetitive. This also goes some way to explaining the general frustration with globalization from many sections of the electorate.
Given that the inflation outlook remains subdued, investors are faced with a further conundrum as equity prices in February bounced back to all-time highs despite the economic slump. The quarterly Credit Capital Advisory dashboard indicates that construction, manufacturing and trade remain negative. The trade sector is likely to be impacted by a massive jump in new business starts, which may dampen future profit growth. On the plus side, financials show robust growth and business services including technology is also showing a slight increase, although the regulatory outlook for big tech remains challenging.
Alternative view on the problem
Alternative view on ongoing processes in economy and bond market comes from investors. Yields on U.S. Treasuries have surged to their highest level in more than a year from record lows hit in 2020, as Federal Reserve commitments to hold rates near zero for years to come encouraged investors to bet economic growth and inflation will heat up. Though yields remain low by historical standards, a rapid rise can ripple through to affect assets ranging from equities and commodities to housing prices.
Effects on individual pocketbooks can be seen most directly in the housing market. The interest rates charged on fixed-rate mortgages tend to shadow moves in Treasury yields and have already begun moving higher. Savers could start to see rates increase in high yield savings accounts again.
In recent months, breakthroughs in developing COVID-19 vaccines and fiscal stimulus have raised expectations the economy will bounce back. Improving risk appetite has encouraged investors to buy riskier assets such as stocks rather than bonds. Expectations of inflation have also jumped, driving bond prices lower and yields higher. Weaker demand for debt was evident in last month’s disappointing auction of seven-year U.S. Treasury notes that helped push up yields.
Investors generally believe yields will climb more in 2021, though some think the Fed could move to cap a rise in yields that it views as extreme enough to threaten the economic recovery. Some analysts think this could happen if 10-year Treasury yields rise much above 2% without substantial economic improvement.
The recent pace of the rise in yields in the U.S. Treasury market has been unsettling, according to several major bond fund managers who worry the market could be viewed as disorderly if the pace of rises continues. Some analysts have compared the rise in yields to the 2013 “taper tantrum”, when 10-year yields jumped 136 basis points to 3.06%, according to Rabobank.
Investors have also been worried about a possible repeat of the “taper tantrum” that markets experienced in 2013, when yields jumped on expectations of a tapering of stimulus. In 2013, this occurred after then-Fed Chair Ben Bernanke told lawmakers the Fed could reduce its pace of purchases of assets that had been propping up markets.
While long-term rates are likely to continue their upward march in line with better economic projections, higher inflation and rising Treasury supply, the question is how fast they move.
The Fed “has now calmed down potential market anxiety about a taper tantrum, and I think it buys time and paves the way for financial conditions to remain relatively loose and for the recovery to gather pace,” said Daniel Ahn, chief U.S. economist and head of Markets 360 North America at BNP Paribas.
"The chairman has been quite clear that he’s happy about the pace of recovery increasing, but that doesn’t change their framework and it certainly isn’t going to force their hand to tighten policy sooner than they deem necessary,” said Michael Lorizio, senior fixed income trader at Manulife Investment Management in Boston.
Indeed, Powell could be comfortable with a steeper yield curve that bolsters private banking, said Venk Reddy, chief investment officer, Zeo Capital Advisors. I don’t see how we don’t end up with a very steep upward sloping yield curve over the course of time here,” Reddy said.
Though Powell’s comments may have temporarily assuaged those concerns, they are likely to creep up again if burgeoning economic growth continues to fuel speculation of sooner-than-expected monetary tightening.
“This isn’t a market for bond math and market geeks,” said Gregory Peters, head of multi-sector and strategy for PGIM Fixed Income. “It’s not so much the rise in interest rates as it is the volatility and swiftness that’s unsettling. There is real momentum around it. Peters, who initially estimated the 10-year yield would drift in range of 1.25%-1.5% this year, said there was a “momentum to take rates higher here from a markets standpoint in a way that I underappreciated.”
Yields have soared past market expectations. A Reuters poll in December of over 60 strategists showed they expected the U.S. benchmark yield to edge up to 1.2% in the following 12 months.
“(The 10-year yield) could go as high as 2% and that’s really not more than a few trading days away at this point,” said Gregory Whiteley, a portfolio manager at DoubleLine. Fed Chair Jerome Powell has thus far brushed off concerns that the recent surge in U.S. Treasury yields might spell trouble for the central bank’s extended easy monetary policy. But a rapid move higher, which can raise borrowing costs for companies and consumers, could eventually compel them to reconsider, said Whiteley. A rate rise that continues at the pace we’ve seen in the last six weeks will at some point come to be seen as a disorderly market that needs a response from the Fed,” said Whiteley.
Bond managers attributed some of the force behind the move to speculators who are significantly short longer-dated Treasury futures, according to recent data from the U.S. Commodity Futures Trading Commission.
“The momentum right now is in the hands of the shorts,” said Andrew Brenner, head of international fixed income at National Alliance, describing them as “bond vigilantes” - investors who sell debt holdings to pressure central banks to change monetary policy they view as inflationary.
Bond managers also cited poor liquidity and price dislocations as recurring issues in the market. The bid-ask spread on the 10-year Treasury note, a measure of liquidity which shows the difference between offered and accepted bids, on Thursday reached its widest since Feb. 26, the day after a weak debt auction which sent the 10-year yield 20 basis points higher.
One factor that has grabbed investors’ attention in the recent move has been a faster rise in yields on longer-dated bonds compared with those on shorter-dated debt, as seen in the gap between yields on two- and 10-year Treasury notes. Yields on longer-dated bonds tend to outpace shorter-term yields when the market expects an environment of stronger growth, higher inflation or interest-rate increases by the Federal Reserve. Right now the spread is the widest it has been since 2015.
Higher yields could also boost the attractiveness of the U.S. dollar relative to other major currencies. The dollar index, which is down about 10% from late March last year, has seen a limited boost so far. Persistently higher yields along with a rise in “real” yields - adjusted for inflation - could provide a lift to the dollar, helping the dollar index pull away further from the near 3-year low touched in January.
Overall, investors have low confidence level to the Fed, suggesting that they will have to change its mind sooner, rather than later.
“To me it feels like it is a coiled spring,” said Mark Cabana, head of U.S. rates strategy at Bank of America. The Fed “is signaling that it wants to see an overshoot, it wants to see inflation and employment run quite hot.”
Rick Rieder, BlackRock’s chief investment officer of global fixed income, tweeted on Thursday that the Fed would likely be able to taper asset purchases “sooner than most expect: perhaps before the end of the year, which suggests to us that communicating the plan could come as early as the June meeting.”
Andrew Brenner, head of international fixed income at NatAlliance Securities, wrote in a note on Thursday that the next big move for benchmark 10-year yields would be 2%. “So when should we hit 2%? ... At this rate maybe next week,” Brenner wrote.
COT Report
Meantime, recent CFTC data shows that investors worry on Fed anemic statement and keep running out of the EUR. Market open interest drops for ~ 12% in a week, showing massive contraction on net long positions. Market sentiment alone should hold us aside from taking any long-term bullish position on EUR right now.
Source: cftc.gov
Charting by Investing.com
Thus, we provided in-depth view on the interest rates issue that is a cornerstone for FX market as well. I do not see many things to comment as everything should be clear from our analysis. Personally, I'm gravitating to agree with Fund managers of big banks that interest rates will rise more, getting the "green light" from the Fed, but I'm not sure that the rally will be "temporal" as we have solid background as fundamental as technical in a way of Dollar Smile Theory that we've explained earlier. Besides, markets somehow ignored 1.9 Biden's pack - neither FX market, nor gold have shown any reaction in this pack, which is, to be honest, is rather large. If Biden will push through the Congress doubling of minimal wage - even most lazy person could thing about job finding and employment accelerates, maybe in excess of Fed expectations. Thus, personally I like Black Rock Fund suggestion that Fed will change the mind and earlier than it seems now. This perspective promises nothing good to the EUR in medium-term perspective, especially on a background of EU own problems. Current processes that we see significantly diminish chances on return to 1.24 area and especially its breakout in excess of 1.25.
Next week to watch
Following a rather muted response to rising Treasury yields so far, the dollar could be woken from its slumber if yields close in further on the 2% threshold.
The U.S. currency is up around 2% year-to-date, while yields on the benchmark 10-year have risen from around 0.90% at the start of the year to 1.75% in recent days. Higher yields typically make the dollar more attractive to income-seeking investors.
A series of upcoming Treasury auctions will provide important clues on how much further the recent surge in yields can run. The Treasury will auction $60 billion of two-year notes and $61 billion of five-year notes. A $62 billion offering of seven-year notes on March 25 follows last month’s disappointing auction in that maturity, which helped fuel the bond selloff.
The euro area March flash purchasing managers index on Wednesday could give markets a fresh steer on the economic outlook. Europe, off to a slow start in the COVID-19 vaccination race, faces new hurdles that risk further slowing the post-pandemic recovery. Brussels is at loggerheads with AstraZeneca over supplies; a number of countries suspended its vaccine on reports of unusual blood disorders.
Germany, France and others will now resume its use, but the stop-and-start are a blow to a faltering inoculation campaign while many countries are fighting a third COVID wave. Deutsche Bank cut its 2021 euro zone growth forecast to 4.6% from 5.6%; Morgan Stanley warns Europe could be looking at another lost summer tourist season.
Also we have SNB meeting on March 25, and PBOC meeting on Monday.
Technical analysis stands in the next post below.
Well, it's not a secret that today we take a detailed look on recent Fed statement that seems to be a clue to medium-term markets performance - not only bonds, but Forex, Gold as well. Market society shows controversy around Fed decision and argue whether it was proper and is it really not a time yet for harder steps. Today we talk about inflation, rising yields and its perspective for the markets and FX market in particular. First is, lets take a look briefly what has happened this week:
Week overview
There was nothing interesting until Wednesday, actually as all investors were sitting on the hands and just waiting for the Fed - so important it was. Thus, most events have happened on the Fed statement and after. Here are major points of the Statement:
_____________________________________________________________________________________________________________________________________________________________________________
One-time increases in prices likely to have only transient impact on inflation and transitory rise in inflation above 2% will not meet standard for raising rates. Economy is a long way from employment, inflation goals and not time to start talking about taper yet. Fed promises to provide as much advance notice of taper as possible and when we see data that shows we are on track to achieving substantial progress, we will say that.
Powell says ‘strong bulk’ of FOMC is not showing a rate increase through 2023, but we will have something to announce on leverage ratio in coming days. Fiscal policy overall will have really helped us to avoid much of scarring we were concerned about and it will accelerate return to max employment.
Fed leaves key overnight interest rate unchanged at 0-0.25%, says committed to using full range of tools to support economy. Fed will continue to increase bond purchases by at least $80 bln/month of treasuries and $40 bln/month of mbs.
Indicators of economic activity and employment have turned up recently following a moderation in the pace of the recovery but inflation continues to run below 2 percent. Policymakers continue to see no rate hikes through 2023 as four Fed policymakers see liftoff in fed funds rate from zero in 2022, seven see liftoff in 2023.
Fed Chair Jerome Powell dampened speculation the stronger economic outlook could propel the central bank to wind back its stimulus. The Fed sees the U.S. economy growing 6.5% this year, which would be the largest annual jump in gross domestic product since 1984. Inflation is expected to exceed the Fed’s 2% target to 2.4% this year, although officials think it will move back to around 2% in subsequent years.
_______________________________________________________________________________________________________________________________________________________________________________
In two words speaking - Fed treats current interest rate spike as temporal, that mostly indicates sentiment and wishes of investors rather than real situation in economy, employment and inflation. In general, statement is more in favor of further US Dollar and interest rates appreciation.
Spiking U.S. bond yields boosted the dollar on Thursday, helping it to revive from two-week lows, after the Federal Reserve pushed back against speculation over interest rate hikes. U.S. 10-year Treasury yields rose to their highest levels in 13 months early in London trade, climbing above 1.70% for the first time since Jan. 24, 2020.
“The question remains whether the Fed can actually arrest the latest spike in U.S. Treasury yields, especially given that the improvement of U.S. fundamentals will continue,” Valentin Marinov, head of G10 FX research at Credit Agricole in London, said. “The renewed spike of UST yields should continue to support the dollar versus low-yielders like the euro, yen and the Swiss franc. Marinov said the Fed meeting had disappointed dollar bulls and the currency may be “nursing its wounds versus risk-correlated and commodity currencies in the very near term”.
The safe-haven U.S. dollar strengthened again on Friday, supported by higher Treasury yields and falling stock markets, as investors continued to digest the Federal Reserve's pushback against expectations of any early interest-rate hikes.
"After some navel gazing," bond investors "concluded that the Fed is not (posing) any challenges or discomfort for longer-dated UST yields to keep pushing higher," National Australia Bank's senior FX strategist Rodrigo Catril wrote in a client note. The USD regained its mojo."
While AstraZeneca vaccinations are poised to restart in Germany, France and other European nations, the region's growth outlook was dinged as Paris went into a month-long lockdown.
The Fed announced on Friday it would let expire on March 31 a temporary rule directing larger banks to hold more capital against their assets, such as Treasuries. The Fed had put the rule in place to encourage bank lending as American households and businesses were hurt by lockdowns.
“News that the U.S. Treasury SLR exemption is not being extended has given the dollar a little support, again largely via the rise in U.S. Treasury yields,” said ING in a research note. The near disorderly rise in U.S. Treasury yields at some points this year have certainly undermined a market biased to buy activity currencies on dips. The SLR news certainly adds an element of caution here.”
So, in fact, Fed has made double dovish impact on the market - denied any speculations concerning too high interest rates and that they might be the storm-bringer of inflation spike, and second it lets banks to contract reserves, closing SLR programme. Banks usually form reserves by buying US Treasuries and now they could sell the excess part, that should push rates even higher. It seems that Fed absolutely sure with its view, but what the foundation might be for this assurance?
Possible background of Fed's outlook
It seems that riddle could be explained by this Fed statement - "Inflation is expected to exceed the Fed’s 2% target to 2.4% this year, although officials think it will move back to around 2% in subsequent years". Other words speaking, Fed indeed sees inflation currently but mostly relates it to temporal jump in demand (overdemand) for goods and its transfer across the Globe. And they are not along with this position.
Five-year inflation expectations are currently running at 2.1%, as noted in Exhibit 1.
As consumers emerge from lockdown, supported by government stimulus, the surge in demand for products may not be immediately satisfied, thereby potentially driving up prices.
This tightness can already be seen in the shortage of shipping capacity as well as in commodities data which is ticking up as shown in the top pane in Exhibit 2. Furthermore, the producer price index for manufacturing in China has started to pick up, surpassing early 2019 levels, as demonstrated in the bottom pane.
Such pressures are, however, likely to be temporary given that firms take time to ramp up incremental capacity. Furthermore, the continued low employment participation rate in the U.S. compared to the 1990s and early 2000s, indicates significant slack in the labor force.
Another reason why inflation is highly unlikely to lead to 1970s-style rates is that the wage price spiral – where rising inflation expectations drove workers to bargain for higher nominal wage increases – took place in a relatively closed economy.
Today, the U.S. economy is three times more open than it was during the 1970s. Greater trade openness places far more downward pressure on nominal wages given that tradeable goods and services can be offshored if wages become too uncompetitive. This also goes some way to explaining the general frustration with globalization from many sections of the electorate.
Given that the inflation outlook remains subdued, investors are faced with a further conundrum as equity prices in February bounced back to all-time highs despite the economic slump. The quarterly Credit Capital Advisory dashboard indicates that construction, manufacturing and trade remain negative. The trade sector is likely to be impacted by a massive jump in new business starts, which may dampen future profit growth. On the plus side, financials show robust growth and business services including technology is also showing a slight increase, although the regulatory outlook for big tech remains challenging.
Alternative view on the problem
Alternative view on ongoing processes in economy and bond market comes from investors. Yields on U.S. Treasuries have surged to their highest level in more than a year from record lows hit in 2020, as Federal Reserve commitments to hold rates near zero for years to come encouraged investors to bet economic growth and inflation will heat up. Though yields remain low by historical standards, a rapid rise can ripple through to affect assets ranging from equities and commodities to housing prices.
Effects on individual pocketbooks can be seen most directly in the housing market. The interest rates charged on fixed-rate mortgages tend to shadow moves in Treasury yields and have already begun moving higher. Savers could start to see rates increase in high yield savings accounts again.
In recent months, breakthroughs in developing COVID-19 vaccines and fiscal stimulus have raised expectations the economy will bounce back. Improving risk appetite has encouraged investors to buy riskier assets such as stocks rather than bonds. Expectations of inflation have also jumped, driving bond prices lower and yields higher. Weaker demand for debt was evident in last month’s disappointing auction of seven-year U.S. Treasury notes that helped push up yields.
Investors generally believe yields will climb more in 2021, though some think the Fed could move to cap a rise in yields that it views as extreme enough to threaten the economic recovery. Some analysts think this could happen if 10-year Treasury yields rise much above 2% without substantial economic improvement.
The recent pace of the rise in yields in the U.S. Treasury market has been unsettling, according to several major bond fund managers who worry the market could be viewed as disorderly if the pace of rises continues. Some analysts have compared the rise in yields to the 2013 “taper tantrum”, when 10-year yields jumped 136 basis points to 3.06%, according to Rabobank.
Investors have also been worried about a possible repeat of the “taper tantrum” that markets experienced in 2013, when yields jumped on expectations of a tapering of stimulus. In 2013, this occurred after then-Fed Chair Ben Bernanke told lawmakers the Fed could reduce its pace of purchases of assets that had been propping up markets.
While long-term rates are likely to continue their upward march in line with better economic projections, higher inflation and rising Treasury supply, the question is how fast they move.
The Fed “has now calmed down potential market anxiety about a taper tantrum, and I think it buys time and paves the way for financial conditions to remain relatively loose and for the recovery to gather pace,” said Daniel Ahn, chief U.S. economist and head of Markets 360 North America at BNP Paribas.
"The chairman has been quite clear that he’s happy about the pace of recovery increasing, but that doesn’t change their framework and it certainly isn’t going to force their hand to tighten policy sooner than they deem necessary,” said Michael Lorizio, senior fixed income trader at Manulife Investment Management in Boston.
Indeed, Powell could be comfortable with a steeper yield curve that bolsters private banking, said Venk Reddy, chief investment officer, Zeo Capital Advisors. I don’t see how we don’t end up with a very steep upward sloping yield curve over the course of time here,” Reddy said.
Though Powell’s comments may have temporarily assuaged those concerns, they are likely to creep up again if burgeoning economic growth continues to fuel speculation of sooner-than-expected monetary tightening.
“This isn’t a market for bond math and market geeks,” said Gregory Peters, head of multi-sector and strategy for PGIM Fixed Income. “It’s not so much the rise in interest rates as it is the volatility and swiftness that’s unsettling. There is real momentum around it. Peters, who initially estimated the 10-year yield would drift in range of 1.25%-1.5% this year, said there was a “momentum to take rates higher here from a markets standpoint in a way that I underappreciated.”
Yields have soared past market expectations. A Reuters poll in December of over 60 strategists showed they expected the U.S. benchmark yield to edge up to 1.2% in the following 12 months.
“(The 10-year yield) could go as high as 2% and that’s really not more than a few trading days away at this point,” said Gregory Whiteley, a portfolio manager at DoubleLine. Fed Chair Jerome Powell has thus far brushed off concerns that the recent surge in U.S. Treasury yields might spell trouble for the central bank’s extended easy monetary policy. But a rapid move higher, which can raise borrowing costs for companies and consumers, could eventually compel them to reconsider, said Whiteley. A rate rise that continues at the pace we’ve seen in the last six weeks will at some point come to be seen as a disorderly market that needs a response from the Fed,” said Whiteley.
Bond managers attributed some of the force behind the move to speculators who are significantly short longer-dated Treasury futures, according to recent data from the U.S. Commodity Futures Trading Commission.
“The momentum right now is in the hands of the shorts,” said Andrew Brenner, head of international fixed income at National Alliance, describing them as “bond vigilantes” - investors who sell debt holdings to pressure central banks to change monetary policy they view as inflationary.
Bond managers also cited poor liquidity and price dislocations as recurring issues in the market. The bid-ask spread on the 10-year Treasury note, a measure of liquidity which shows the difference between offered and accepted bids, on Thursday reached its widest since Feb. 26, the day after a weak debt auction which sent the 10-year yield 20 basis points higher.
One factor that has grabbed investors’ attention in the recent move has been a faster rise in yields on longer-dated bonds compared with those on shorter-dated debt, as seen in the gap between yields on two- and 10-year Treasury notes. Yields on longer-dated bonds tend to outpace shorter-term yields when the market expects an environment of stronger growth, higher inflation or interest-rate increases by the Federal Reserve. Right now the spread is the widest it has been since 2015.
Higher yields could also boost the attractiveness of the U.S. dollar relative to other major currencies. The dollar index, which is down about 10% from late March last year, has seen a limited boost so far. Persistently higher yields along with a rise in “real” yields - adjusted for inflation - could provide a lift to the dollar, helping the dollar index pull away further from the near 3-year low touched in January.
Overall, investors have low confidence level to the Fed, suggesting that they will have to change its mind sooner, rather than later.
“To me it feels like it is a coiled spring,” said Mark Cabana, head of U.S. rates strategy at Bank of America. The Fed “is signaling that it wants to see an overshoot, it wants to see inflation and employment run quite hot.”
Rick Rieder, BlackRock’s chief investment officer of global fixed income, tweeted on Thursday that the Fed would likely be able to taper asset purchases “sooner than most expect: perhaps before the end of the year, which suggests to us that communicating the plan could come as early as the June meeting.”
Andrew Brenner, head of international fixed income at NatAlliance Securities, wrote in a note on Thursday that the next big move for benchmark 10-year yields would be 2%. “So when should we hit 2%? ... At this rate maybe next week,” Brenner wrote.
COT Report
Meantime, recent CFTC data shows that investors worry on Fed anemic statement and keep running out of the EUR. Market open interest drops for ~ 12% in a week, showing massive contraction on net long positions. Market sentiment alone should hold us aside from taking any long-term bullish position on EUR right now.
Source: cftc.gov
Charting by Investing.com
Thus, we provided in-depth view on the interest rates issue that is a cornerstone for FX market as well. I do not see many things to comment as everything should be clear from our analysis. Personally, I'm gravitating to agree with Fund managers of big banks that interest rates will rise more, getting the "green light" from the Fed, but I'm not sure that the rally will be "temporal" as we have solid background as fundamental as technical in a way of Dollar Smile Theory that we've explained earlier. Besides, markets somehow ignored 1.9 Biden's pack - neither FX market, nor gold have shown any reaction in this pack, which is, to be honest, is rather large. If Biden will push through the Congress doubling of minimal wage - even most lazy person could thing about job finding and employment accelerates, maybe in excess of Fed expectations. Thus, personally I like Black Rock Fund suggestion that Fed will change the mind and earlier than it seems now. This perspective promises nothing good to the EUR in medium-term perspective, especially on a background of EU own problems. Current processes that we see significantly diminish chances on return to 1.24 area and especially its breakout in excess of 1.25.
Next week to watch
Following a rather muted response to rising Treasury yields so far, the dollar could be woken from its slumber if yields close in further on the 2% threshold.
The U.S. currency is up around 2% year-to-date, while yields on the benchmark 10-year have risen from around 0.90% at the start of the year to 1.75% in recent days. Higher yields typically make the dollar more attractive to income-seeking investors.
A series of upcoming Treasury auctions will provide important clues on how much further the recent surge in yields can run. The Treasury will auction $60 billion of two-year notes and $61 billion of five-year notes. A $62 billion offering of seven-year notes on March 25 follows last month’s disappointing auction in that maturity, which helped fuel the bond selloff.
The euro area March flash purchasing managers index on Wednesday could give markets a fresh steer on the economic outlook. Europe, off to a slow start in the COVID-19 vaccination race, faces new hurdles that risk further slowing the post-pandemic recovery. Brussels is at loggerheads with AstraZeneca over supplies; a number of countries suspended its vaccine on reports of unusual blood disorders.
Germany, France and others will now resume its use, but the stop-and-start are a blow to a faltering inoculation campaign while many countries are fighting a third COVID wave. Deutsche Bank cut its 2021 euro zone growth forecast to 4.6% from 5.6%; Morgan Stanley warns Europe could be looking at another lost summer tourist season.
Also we have SNB meeting on March 25, and PBOC meeting on Monday.
Technical analysis stands in the next post below.
