Month: January 2021

Recovery Reckoning

Treasury

Pennant formation, likely to go back to 1% if Biden’s fiscal proposal/reflation expectation fail to come to fruition.

The past week has been a short one with the Treasury yields moving in small range above 1.07% and below the local high of 1.186%. A consolidation that would be characterized as a pennant formation. From a technical perspective, it would historically be consistent with a breakout toward higher rates.

However, Ian’s bias was that with all the major bearish inputs have occurred during the first two weeks of January, the delayed blue sweep, the push for the reflationary trade, a bunch of supply come to the Treasury market and still 10 year struggled to get to that one 1.25 level. And as looking to the balance of January and through February, a lot of those assumptions are going to be challenged. How much of the $1.9 trillion fiscal proposal from Biden will actually make it into law? Especially considered Democrats’ slimmest possible senate control. A lot of the repricing was based on expectations that have yet to come to fruition, whether that’s on the reflationary side or the fiscal stimulus side. One thing is safe to assume, if nothing that drove rates to 1.19 comes to fruition, we’ll be back to 95 basis points in relatively short order.

Inflation

Realized inflation is likely to drop, while expectations go for cycle highs.

We all get it that at some point, all of the stimulus coming from the Fed as well as Washington will eventually lead to higher consumer prices. But in the near term, the base effects created by the March, April and May drop in prices as the most tangible input to see a near term spike in realized inflation. The difference between actual realized inflation and inflation expectations need to be emphasized, which might ultimately leave the market in a situation where core inflation continues to grind along at a benign pace while break evens continue to push to cycle highs.

Equity

So far so good, keep monitoring for signs of reevaluation.

The one asset class that has delivered relatively consistent performance thus far in 2021 has been the domestic equity market, and given the relevance of equity volatility to financial conditions and ultimately the Fed’s path of monetary policy, Ian’s team will continue to monitor closely for any wobbles or any evidence that the backup in rates has led to a reevaluation.

Update

Realized yield move of the week Jan.25th, 2021

The Time Has Come, Steepener Thrives

Yes, inflation expectation have been roaring lately marked by the 1oY breakevens touching the amazing 2.0%. Worries over inflation run roughly parallel with concerns that the Fed will tighten policy sooner than expected.

Minutes of the Federal Open Market Committee December 15–16, 2020

The markets were focused on discussion surrounding the Fed’s asset purchase program. Currently, the central bank has been buying at least $120 billion in treasuries and mortgage-backed securities each month. As expectation for higher inflation is in place, markets were looking for signals whether and when the Fed would change in the pace of purchases.

As the December minutes showed,

“Once such progress had been attained, a gradual tapering of purchases could begin and the process thereafter could generally follow a sequence similar to the one implemented during the large-scale purchase program in 2013 and 2014.”

Though the committee voted to keep the current buying pace until it sees “substantial further progress” towards its goals regarding inflation and employment. It’s worth remembering that the last time the Fed cut back on its asset purchases in 2013, it triggered a “taper tantrum” in the market, sending the 10-year yield rising around 140 basis points in the span of four months. There is a good reason that the officials would do what they can to avoid it this time, which I believe is exactly what they are doing now, beginning to lay the groundwork for a taper, managing exceptions.

The treasury markets sure sensed it.

BTW, You know when’s the best time to short Bitcoin? 😉

Update on Jan.12th,

In the week, Fed’s Raphael Bostic said that he would be open to beginning the wind down of purchases as early as the end of 2021, which contributed at least on the margin to 10-year yields run up to that 1.19 level.

But here was also offsetting comments from Vice Chair Clarida, who noted that the size and composition of QE is going to remain stable throughout the year. That corresponded with when rates peaked and a bit of flattening start to re-emerge in the Treasury market.

Note to Self:

Since August, in speaking of real rates, I felt there have been a lot more uncertainties than I could imagine, fiscal stimulus, fed’s policy, presidency election, vaccine development…To be perfect honest, it’s exhausting and I know there is a little piece of me that just wanted to complain and kept questioning whether the decision to trade at high levels and in times of uncertainty was wise. It has been pointed out by a friend who I see as a mentor, that I started with a highly certain trend, captured the opportunity perfectly, true, but in fact the case was rare as well. Now it’s just about time to move on and adapt to the tremendous uncertainties with a more dynamic mindset. Touche. Isn’t the reality always the most complicated? Isn’t the future always full of uncertainties?

2021, a brand new year, maybe a new chapter of my learning journey too?