Althea Spinozzi

Althea Spinozzi

According to Althea Spinozzi, it's clear that inflation remains Fed most significant focus

According to Althea Spinozzi, it's clear that inflation remains Fed most significant focus

Althea Spinozzi Althea Spinozzi 11.05.2023 17:43
Summary:  Inflation, monetary policy, and a recession. Nobody is entirely sure of what's going to happen. Thus, it is critical to gain perspective and commit to a view. Here we discuss the inverted yield curve and how it can be traded depending on what you believe will happen in the foreseeable future. After one year of maternity leave, I return to the office to hear the same thing from clients and colleagues: it’s a challenging market. Amid an ever-changing macroeconomic backdrop and monetary policies, putting money at work in a classic 60/40 style portfolio has become impossible. Nowadays, markets require investors to be tactical.There is a problem, though: it's hard to be tactical when nobody knows what’s coming next.The inflationary problem brought by the pandemic is unique in history. The world is shaping to be very different than pre-2020, and markets reposition frequently amid uncertainty. Some investors call for a soft landing, others for a recession. Some say rates will remain high, while others believe they’ll soon drop back close to zero. And the yield curve is a mess!There is only one way to go: gaining perspective and positioning for the outcome that makes sense primarily to you.In other words, I'm not here to tell you what will happen. I am here to display some market convictions and discuss how actionable they are in the bond market. Why is the yield curve important? Because it signals investors' feelings about risk and impacts investment returns.Today’s inverted yield curve is a product of aggressive rate hikes, and it tells us that monetary policies today are more restrictive than they will be in the medium/long term. As the hiking cycle ends, it’s natural to expect it to steepen. Yet, it’s unlikely that the steepening process will be painless.As many know, an inverted yield curve generally precedes a recession. In the past forty years, we saw an inverted yield curve only three times: before the Gulf War recession, before the dot-bomb recession, and before the great recession. If it's true that history repeats itself, we can rest assured the same thing is likely to happen also this time around. What do you believe is going to happen? You are in line with market expectations. You believe that the Federal Reserve tightening cycle has come too far and that the economy will fall into a recession forcing the Fed to cut rates by 75bps by the end of the year despite firm inflation. This environment would give an edge to steepeners over outright longs. The most pronounced steepening will happen with short and middle-term Treasuries against the longer part of the yield curve, while the 10-year areas will serve as a safe haven. In this case, it's worth looking at 2s30s (ZT versus ZB) and 5s30s (ZF versus ZB) steepeners. Please refer to Redmond Wong’s article to learn how to trade steepeners with bond futures.Because you’d expect a recession, buying the 10-year US note outright is also an option (US91282CHC82).In the Saxo platform you can also find the Lyxor US Steepening 2-10 UCIT ETF (STPU:xmil), which rise as the yield curve steepens.  You believe inflation will be sticky and that markets must push forward interest rate cuts. Following the latest FOMC meeting, it’s clear that inflation remains the central bank's most significant focus. Thus, a tightening bias persists, and the Fed might not deliver interest rate cuts this year. In this case, it's too early to engage in curve steepeners. You might look to short the 3-month SOFR contract (SR3) or the 30-day Federal Funds future (ZQ) to express your view that the Fed won’t cut rates at the time the market expects. In this scenario, it’ll be tempting to buy underpriced short-term TIPS. Yet, as the Federal Reserve holds rates, it might be time to turn to T-bills rather than floaters. For more information, please refer to this page. In either case, the belly of the yield curve tends to outperform as hikes end. A recent Bloomberg Intelligence report finds that the belly of the Treasury curve has outperformed before Fed easing cycles over the past five interest rate cycles. The report clarifies that the outperformance began about two months before the last fed move.If rate cut expectations accelerate for 2024, the belly of the yield curve might outperform significantly.In this scenario, one should look for outright US Treasuries with a maturity that ranges from 3 to 6 years. It's possible to use the Saxo screener to find a list of bonds that matches these criteria (please refer to the below). Source: Saxo Platform. It's also possible to use bond futures to gain exposure to the belly of the yield curve. One of the most used strategies for this purpose is the butterfly strategy, which consists of buying two times the belly and selling the wings.Let’s assume the 5-year (ZF) bond futures contract is going to surge faster than the 2-year (ZT) and the 10-year (ZN) contracts. Therefore, our butterfly would look like following: B = 2*ZF – ZT - ZN However, to ensure that the butterfly moves only as the yield curve changes, it’s key to neutralize duration through a hedge ratio as described in Redmond’s article.Once the weighting is correct, we’d insert two trades:1. Sell ZT and Buy ZF2. Sell ZN and Buy ZF Source: Trading an inverted yield curve why and how | Saxo Group (home.saxo)
Focusing On US CPI, Fed, Commodities and Bank Of Japan - Saxo Market Call

We Might Say Next FED Moves Are Not Obvious As Some Factors Differentiate Circumstances

Althea Spinozzi Althea Spinozzi 17.02.2022 12:45
Bonds 2022-02-17 12:15 Summary:  We believe that it will be nearly impossible for the Federal Reserve to avoid a tantrum in credit markets. If the central bank doesn’t do enough to fight inflation, markets will face the possibility of an inflation tantrum. However, we might face a taper tantrum if it is too aggressive in tightening the economy. The recent acceleration in real yields, the spike in the MOVE index, and the widening of the HY-IG spread indicate we might not be far from a widespread selloff in credit markets. We recommend investors remain cautious as we approach the March FOMC meeting. It has arrived the time to consider the possibility of an upcoming tantrum in credit markets. Since the beginning of the year, junk has overperformed quality as interest rate risk eroded value faster than credit risk. Bonds with higher duration, hence better-rated credits, have dropped in value faster than bonds with lesser duration. Triple C credits lost only -3.29% year-to-date, while investment-grade bonds fell nearly double. However, credit risk perception might change as monetary policies become more aggressive, and financing conditions tighten fast.Source: Bloomberg and Saxo Group. The Fed’s posture is clear: inflation needs fighting. According to markets, that will be possible only through an aggressive interest rate hiking schedule, possibly combined with a balance sheet runoff. It means that interest rates will continue to rise, contributing to a capital loss in older bonds as prices fall below par. At the same time, we’ll see the issuance of new bonds with bigger coupons in the primary market. The faster that happens, the bigger the tantrum. High inflation makes a key difference compared to the macroeconomic backdrop during the 2013 taper tantrum. Inflation is a threat to the bond market as it erodes the present value of fixed coupon and redemption payments. Therefore, the central bank needs to hike rates to avoid an inflation tantrum. However, suppose the central bank does too little to fight inflation. In that case, bonds will lack protection against it, and markets will need to raise their future rate hike bets, creating the conditions for a selloff. Yet, if the Fed is too aggressive in tightening the economy, it might result in a taper tantrum anyway. Thus, the Federal Reserve is walking a fine line, and a tantrum is nearly inevitable as monetary policy can be too much or too little aggressive at markets’ discretion. Real yields are one of the best tools to forecast a tantrum. As the central banks prepare for a tightening cycle, nominal yields will inevitably surge, while breakeven rates will adjust lower, accelerating the rise of real yields.  One can argue that real yields remain in deeply negative territory, leaving financing conditions still highly loose. However, that was also the case in 2013, but things started to go south as real yields accelerated their rise to 0%. We could say that the 2013 taper tantrum was all due to an acceleration in real yields.Source: Bloomberg and Saxo Group. Now that real yields rose above -0.5% and the probability of a 50bps rate hike in March is growing, it’s inevitable not to forecast an acceleration in real yields around the Fed’s March meeting. Such a rate hike is likely to tighten financing conditions quickly and it might provoke a tantrum within risky assets as it happened in 2013. Other elements suggest we might not be too far off from a tantrum. On Tuesday, the MOVE Index rose to the second-highest level since the 2013 taper tantrum and the highest since the beginning of the Covid pandemic. The move index is the “fear index” for the bond market, like the VIX index is for equities. During the 2013 Taper Tantrum, it peaked at 117, while now it's shy of 100.Source: Bloomberg and Saxo Group. Another helpful metric to look at is the spread between high-yield and investment-grade corporate bonds. Despite the spread between the two remains low compared to pre-pandemic levels, it has widened substantially since the beginning of the year. If the spread continues to widen, it would be an indication that investors start to reconsider credit risk, as they would sell junk to buy high-grade corporates.Source: Bloomberg and Saxo Group.
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Fixed income market: the week ahead

Althea Spinozzi Althea Spinozzi 22.11.2021 14:23
Summary:  This week it's all about a surge of Covid-19 cases and inflation. The debt ceiling issue will keep long-term yields in check in the United States while spurring volatility in money markets. Lack of collateral and new lockdown measures are also compressing spreads in the Euro area. Yet, policymakers' engagement to the idea of less accommodative monetary policies on both sides of the Atlantic indicates that yields will not remain rangebound for long. Once the lid is lifted, inflationary pressures will push yields higher. Therefore, it's safe to assume a continuous bear flattening of yield curves. US Treasuries: volatility in money markets will keep long-term yields in check. Yet, inflation concerns continue to grow, pointing to higher rates once the debt ceiling issue is resolved. This week, investors will need to focus on the Fed Minutes released on Wednesday, inflation numbers, and the White House's announcement concerning the Federal Reserve Chair nomination. The Fed’s minutes might unveil details regarding the decision that led to tapering this month and whether FOMC members begin to fret about inflationary pressures. Last week, several Fed’s speakers opened up about accelerating tapering and hiking interest rates in 2022. Among them, Fed Vice Chair Richard Clarida called for a discussion to expedite tapering to enable the central bank to hike interest rates sooner. At the same time, if Biden nominates Leal Brainard as Fed Chair, it could advance inflation worries. Brainard is known to be more dovish than Powell. In the case of her nomination, the market could anticipate interest rates to remain low for longer, implying stickier inflation, provoking a selloff in bonds. The Personal Consumption Expenditure Index, one of the inflation data most looked at after the Federal Reserve, will be released on Wednesday. The PCE core deflator index YoY is expected to rise to 4.1%, the highest in more than 31 years. As we mentioned in earlier editions of “Fixed income market: the week ahead”, we expect inflationary pressures to continue to rise and higher rents, housing and wages to make inflation stickier, putting at odds policymakers’ transitory narrative. Therefore, although the US yield curve has already flattened substantially, we cannot expect anything else than more flattening. The only difference is that once the debt ceiling issue is resolved, long term yields will need to rise together with short term yields, putting at risk weaker credits. The debt ceiling will be a crucial topic for December. Janet Yellen has said that the US Treasury will run out of cash soon after the 3rd of December if an agreement over the debt ceiling is not found. However, money markets have started to price a default during the second half of December. Indeed, last week's 4-week T-Bills auction was priced with a yield of 0.11%, more than double the Reverse Repurchase facility rate. We expect volatility in money markets to continue to remain elevated until the debt ceiling is lifted or suspended. Until then, the long part of the yield curve will serve as a safe haven causing yields to remain compressed. Yet, once the debt ceiling hurdle has cleared, long-term rates will resume their rise. European sovereigns: lack of collateral and a surge in Covid-19 cases will keep yields compressed. Yet, something is changing among policymakers. In Europe, governments are imposing new lockdown measures due to increasing Covid-19 cases, causing yields to drop significantly. Yet, inflationary forces have already been set into motion. Another lockdown might exacerbate inflation further as consumption will switch from services to goods, putting more pressure on prices. Meanwhile, policymakers have started to open to the possibility that upside inflation risk might remain throughout winter. Therefore, near-term hikes expectations are unlikely to reverse despite new lockdown measures. Yet, lack of collateral in the euro area contributes to keeping short-term yields compressed across the euro area, including the periphery. At the same time, swaps with the same maturity have widened as the market prices earlier interest rate hikes. Demand for collateral will remain strong until the end of the year. However, 2022 opens up to widening risk, as demand for bonds will start to wane, and the front part of the yield curve will shift higher according to interest rate hikes expectations. Source: Bloomberg and Saxo Group. However, it looks too early to call for higher yields in the Euro area, as a lot still depends on yields in the US and December's ECB meeting. Suppose more governments across the euro area impose lockdown measures. In that case, the central bank might look to extend the PEPP bond-buying program after March, compressing yields further. The next few weeks preceding Christmas are going to be critical to set direction in European sovereigns. Economic calendar: Monday, the 22nd of November  Spain:  Balance of Trade United States: Chicago Fed National Activity Index, Existing Home Sales (Oct),  2-year Note Auction, 5-year Note Auction Eurozone: Consumer Confidence Flash (Nov) Tuesday, the 23rd of November Germany: Markit Composite, Manufacturing and Services PMI Flash (Nov) Eurozone: Markit Composite and manufacturing PMI Flash (Nov) United Kingdom: market/CIPS Composite, Manufacturing and Services PMI Flash (Nov) United States: Markit Manufacturing PMI flash (Nov), NY Fed Treasury Purchases TIPS 7.5 to 30 years, 2-year FRN Auction, 7-year Note Auction Wednesday, the 24th of November New Zealand: Interest Rate Decision, RBNZ Press Confidence France: Business Confidence Germany: Ifo Business Climate (Nov), 15-year Bund Auction United States: Durable Goods Orders (Oct), GDP Growth Rate QoQ 2nd Est (Q3),  Continuing Jobless Claims, Corporate Profits QoQ Prel (Q3), Durable Goods Orders (Oct),  Goods Trade Balance (Oct), Initial Jobless Claims, Jobless Claims 4-week Average, retail Inventories Ex Autos (Oct), Core PCE Price Index (Oct), Michigan Consumer Sentiment Final (Nov), PCE Price Index (Oct), Personal Income (Oct), Personal Spending (Oct), FOMC Minutes, 4-week and 8- week bill auction Thursday, the 25th of November New Zealand: Balance of Trade Japan: Foreign bond Investment, Coincident Index Final, Leading Economic Index Final (Sep) Germany: GDP Growth Rate YoY Final (Q3), GfK Consumer Confidence (Dec) Sweden: Monetary Policy Report, Riskbank Rate Decision France: Unemployment Benefit Claims Canada Average weekly earnings YoY Friday, the 26th of November Australia: Retail Sales MoM Prel (Oct) South Korea: Interest Rate Decision France: Consumer Confidence Switzerland: GDP Growth Rate YoY (Q3) Italy: Business Confidence (Nov)

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