I’ll keep it short this week, mainly because I don’t have much new to say. I continue to think that the tug-of-war between markets and monetary policymakers in fixed income markets remains the key spectacle to watch, even if I concede that we have been watching it for a while. There are economists and strategists who will tell you that policymakers are perfectly happy with steepening yield curves, and that they in fact welcome them. To believe this, however, requires that you forget the initial stages of the pandemic-policy response in which central bankers solemnly pledged to print as much money as needed—via QE—to keep rates pinned across all maturities in order to support the monumental fiscal efforts needed to prevent economic disaster. If you’re telling me that this tacit agreement is now broken on the eve of the new US administration is about to shovel €1.9T into an almost fully vaccinated economy—that’s just shy of 10% of GDP for those wondering—I have to concede that yields can, and likely will, move a lot higher. But is that really what you’re telling me? It seems to me that observers have quietly pivoted towards the idea that central banks obviously accept, even want, higher bond yields to reflect the recovery. I am sorry, but that doesn’t pass the smell test. While a steepening yield curve sows the seeds of its own destruction via an ever more attractive roll and carry, especially with fwd guidance on the front end, there is always a risk that markets end up questing the commitment to low policy rates.
Read MoreFirst things first, I am GBP-based investor, which means that I need to think about both the value of currency and asset, when I dip my toe into US financial markets. With GBPUSD pushing 1.40 and the US 10y motoring bast 1.5%, I had to do something last week, and that something was to buy some duration in the US. I thought that I’d put that up front, because in what follows, I will sound like a broken record It is now getting feisty in bond-land. The sell-off in US duration got rowdy last week, and is now starting to pull up bond yields in Europe. What’s more, front-end curves are steepening too, which is to say that markets are now trying to bring forward rate hike expectations into market-relevant forecast horizons. As I have explained on these pages since the beginning of the year, investors and strategists are still debating whether this is all part of the plan—reflecting a desired increase in growth and inflation expectations—or whether it constitutes an undue tightening in financial conditions. Market observers remain undecided, partly because policymakers can’t seem to figure out where to draw the line either. Higher bond yields are good, so long as they don’t become a constraint on the recovery via a tightening of financial conditions. In principle, there is nothing wrong with this position, though it also invites the situation we now find ourselves in. Put simply, yields will motor higher until something breaks, or until policymakers call it quits.
Read MoreMarket observers and participants have been temporarily distracted in the past week by the battle between Reddit’s plucky retail investors and lazy short-selling hedge funds over the fate of Game Stop. It won’t be the last time the world stops to watch such an event in the same way that people, who would otherwise never watch a race, are glued to the screen when F1 drivers crash into the barrier or each other. Pundits have tried to turn this into more than it is, but until people turn up with actual pitchforks in front of Mr. Griffin’s $60M penthouse pad in Chicago, I am inclined to side with George Pearkes’ take on the matter; move on, nothing (much) to see . People with time on their hands, and a stimulus cheque(?), have decided to take a punt. On the face of it, they have been successful, but most will have bought and sold too late to avoid the gut-wrenching losses that are all but inevitable in the context of the kind of volatility, which Game Stop has exhibited recently. Meanwhile in the boring and dusty world of global macro trading, investors’ eyes are still focused on the long bond in the U.S., where it is, or isn’t, going, and what this means for other asset classes, the economy, not to mention the Fed’s reaction function? Friday’s NFP report was, as ever, a case in point.
Read MoreInvestors remain locked in discussion about the same issues they were mulling before the holidays. The rollout of the vaccine—however frustratingly slow in some countries—means that the light at the end of the tunnel for the economy is probably not an oncoming train. That’s great news, but the counterpoint is that markets have long since priced-in such an outcome, leaving investors vulnerable to the famous adage that if they’re buying the rumour, they’re also likely to sell the fact. In that vein, I am happy to double down on my comments at the end of last year that you should now be looking to stash away profits rather than putting new money to work. On that occasion I showed two charts to warn about incoming multiple contraction in equities, proxied by valuations on the S&P 500, and my in-house valuation score, which is also headed for the basement. The first chart on the next page shows that the six-month stock-to-bond return ratio in the U.S. remains pinned close to cyclical highs, also hinting that equities are about to give up some of their recent gains, with bonds rallying in appreciation. The second chart shows what happened the last time stock-to-bond returns were this stretched. It occurred in the run-up to the Flash Crash in 2010, before the swoon in the summer of 2011, ahead of the drawdown in May 2012, not to mention during the Taper Tantrum in 2013. Based on this albeit short sample, investors should brace for volatility in H1.
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