Select Language

Search

Insights

No match found

Services

No match found

Industries

No match found

People

No match found

Insights

No match found

Services

No match found

People

No match found

Industries

No match found

Halftime Show - The Week Ahead

FICC Podcasts June 25, 2021
FICC Podcasts June 25, 2021


Ian Lyngen and Ben Jeffery bring you their thoughts on the U.S. Rates market for the upcoming week of June 28th, 2021, and respond to questions submitted by listeners and clients.


Follow us on Apple Podcasts, Google Podcasts, Stitcher and Spotify or your preferred podcast provider.


About Macro Horizons
BMO's Fixed Income, Currencies, and Commodities (FICC) Macro Strategy group led by Margaret Kerins and other special guests provide weekly and monthly updates on the FICC markets through three Macro Horizons channels; US Rates - The Week Ahead, Monthly Roundtable and High Quality Credit Spreads.

Podcast Disclaimer

Read more

Ian Lyngen:

This is Macro Horizons episode 126: Halftime Show presented by BMO Capital Markets. I'm your host, Ian Lyngen, here with Ben Jeffery to bring you our thoughts from the trading desk for the upcoming week of June 28th. And as the first half of the year comes to a close, we're reminded that not all halftime shows require Pyrotechnics, but they help.

Speaker 2:

The views expressed here are those of the participants and not those of BMO Capital Markets, it's affiliates or subsidiaries.

Ian Lyngen:

Each week, we offer an updated view on the US rates market and a bad joke or two, but more importantly, the show is centered on responding directly to questions submitted by listeners and clients. We also end each show with our musings on the week ahead. Please feel free to reach out on Bloomberg or email me at ian.lyngen@bmo.com with questions for future episodes. We value your input and hope to keep the show as interactive as possible. So that being said, let's get started.

Ian Lyngen:

In the week just past the Treasury market received a fair amount of information to help further refine expectations. The highlight being the initial repricing, lowering rates as the FOMC meeting continued to be digested. We saw 10 year yields dip as low as 135 during the overnight session on Monday morning, although yields have since drifted higher. The stabilization rate appears to be between 145 and 150 in tens, with 30 year yields drifting toward 2%.

Ian Lyngen:

This certainly reflects a material challenge to the cheaper and steeper narrative that many investors brought into the beginning of the year. It's also consistent with the seasonal patterns that tend to be constructive, favoring lower yields over the course of the summer. The fundamentals behind the price action certainly resonate. We've seen the Fed transition to being incrementally less dovish than was previously assumed, and while that doesn't mean that the Fed is going to be hiking rates in 2021, the reality is that by communicating to the market that the Fed does stand ready to bring forward the lift off rate hike if the inflation data warrants such a move, and as a result, the market believes if a better understanding of how the Fed will behave in the new framework.

Ian Lyngen:

Let us also not forget the relevance of the employment landscape in the current environment. We have now seen two back-to-back higher than expected initial jobless claims prints, one of them being for non-farm payroll survey week. So as we look forward to the June BLS data, the error bands around estimating NFP are wide enough that market participants will be sure to approach the event with a reasonable amount of caution.

Ian Lyngen:

Overall, risk assets have continued to outperform. We've seen record high equity prices, which were only reinforced by the drift lower in longer Treasury yields, as valuations, as lofty as they might be won't be challenged in the near term by higher risk-free rates. The administration is also apparently making progress toward an infrastructure deal. There's a bipartisan agreement for a deal worth roughly $1 trillion in infrastructure spending.

Ian Lyngen:

Now, thus far, financial markets have met this information with a collective shrug, and that's very consistent with the idea that, unlike direct fiscal stimulus to the consumer, the $1 trillion infrastructure plan will be rolled out over the course of a decade, and therefore the immediate impact on the real economy will be comparatively limited. Nonetheless, it is worth keeping in mind that an infrastructure deal was considered one of the key bearish risks for the Treasury market. And now that we effectively have it in hand, and 10 year yields are still below 150, there is an increasing probability that we see a collective capitulation on the reflationary outlook.

Ben Jeffery:

So Ian, we came into this week with 10 year yields touching 135 and 30 year yields reaching 192. While short, some of that bullishness was walked back as the week went on. Clearly there's still a bit for Treasuries.

Ian Lyngen:

Yeah, there's certainly demand for Treasuries, particularly overseas because that's where we saw that final leg lower in rates that actually occurred on a high volume move during the Asian trading session. Now, some of that was challenged when London came online on Monday, but the fact of the matter is that there remains solid underlying demand for Treasuries from overseas participants. Even after we have seen a stabilization in the rates market, 10 year yields are still below 150, and 30 year yields just slightly above 2%. All of this suggests that the next stage of trading monetary policy expectations is going to be characterized by a flattening bias.

Ian Lyngen:

Now, part of that is a function of simply repricing the very front end of the market to the updated dot plot. But the more interesting aspect of it is what had been Greenspan's conundrum is now simply the accepted operating procedure further out the curve.

Ben Jeffery:

And I think we're both on the same page that the flattening we saw this week was somewhat rare and that it was defined by unchanged or maybe even slightly lower long end yields, while the front end of the market was a bit more bearish following rhetoric from Bullard, Bostic and Kaplan that they would like to see policy normalized sooner rather than later. Bostic explicitly said that he sees one rate hike by the end of 2022, and two more rate raises in 2023. So in this context, I think it makes sense that we're seeing the two, three, even five-year sectors underperform while clearly some of the longer term uncertainty is weighing on 10 and 30 year yields.

Ian Lyngen:

Something worth highlighting in the context of Fed speak is that while the market will certainly respond to each incremental update, in terms of opinion, from the variety of Fed speakers when we think about the overall direction of monetary policy it really does come down to the chair, the head of the New York Fed and the vice chair of the board.

Ben Jeffery:

And on that topic, while we heard from the hawks, we also heard from the doves this week via Powell and Williams, most notably, but also Mester, who all seemed to be in the camp advocating for more patience on the journey towards normalization.

Ian Lyngen:

On that, my take away from what we've learned from the Fed over the course of the last couple of weeks is that we are on course to have a tapering announced officially in the fourth quarter implemented in the first quarter of 2022 with normalization, with a liftoff rate hike at some point, either very late in 2022 or over the course of 2023. What is notable in this context is that that is reasonably consensus, and so from here movements in the rate market will be a function of anything that challenges those expectations.

Ian Lyngen:

One of the other takeaways from the FOMC was, even under their new framework, they are more responsive to the risk of inflation heating up then I think they had initially telegraphed when they transitioned into an average inflation targeting regime. So the increase in the 2023 dots, while it might be easily dismissed as allowing the Hawks to have their say, the fact of the matter is that the market interpreted the communication as suggesting a willingness to respond should inflation start to push up against the upper bounds of what's perceived as control.

Ben Jeffery:

And a perfect example of this in the wake of the Fed, and over this past week has been the moves and the tips market. We've seen breakevens continue to drift lower while real rates have remained generally steady in very negative territory, but off the extremes that we've seen set earlier in this cycle. So while the more dovish members of the Fed have pointed to vaccination progress and a better than expected recovery thus far, in terms of their backing for the tapering dialogue, if not necessarily lift off those more hawkish on the committee are seemingly a bit more concerned on the specter of inflation that challenges that upper bound of whatever acceptable may be.

Ben Jeffery:

And this underlying Fed dynamic was fairly apparent in this week's front-end supply series. Twos, fives, and sevens all were generally met with fairly solid demand, but sevens were clearly the outperformer, which again reinforces this idea that as normalization and a more hawkish or less super dovish Fed start to make their way into pricing, that's going to at the expense of the front end and shorter part of the belly of the curve. It's also worth highlighting that twos tailed half of a basis point in an environment when we're seeing usage at the reverse repo facility continue to climb to record highs.

Ben Jeffery:

We're now well beyond $800 billion overnight at the Fed receiving five basis points, and in a conversation with a client this week they made the observation that maybe the Fed's tweak to the RRP rate from zero to five basis points actually has led some investors to simply take five basis points overnight at the Fed, rather than moving out into the longer parts of the bill curve or even short coupons.

Ian Lyngen:

That logic certainly does resonate. And it also begs the question, how much capacity is there in the RRP program? If we're pushing up against $1 trillion, is there a point at which the Fed starts to step back and get a little nervous?

Ben Jeffery:

Given the number of counterparties and $80 billion per counterparty limit, I think capacity constraints are less of a concern at this point, although that certainly doesn't rule out a conversation on increasing capacity down the road. But as it currently stands, there's roughly $10 trillion of capacity, and while we're well off that limit, what we've heard from the Fed thus far is that they're content with this massive amount of usage and it's exactly what they expected. So through that lens, it's not unreasonable to anticipate if in fact there needs to be more offered from the RRP monetary policy makers would be willing to offer it.

Ian Lyngen:

And to be fair, Ben, as you point out, this is what this program is designed to do. The establishment of the RRP was in fact to alleviate some of the pressure that might have otherwise translated through to effective Fed funds. So as another release valve for the massive amount of cash that's flowing around in the very front end of the market, it shouldn't be all that surprising to see some of these staggering figures come through our RRP.

Ben Jeffery:

Unrelated to monetary policy, but maybe more relevant for the long end of the curve. Let's not forget, we do have June's jobs data on deck. And for now the more dovish rhetoric we've heard is emphasizing further gains across every part of the labor market as the justification to begin pulling back on some of the accommodation that's currently being offered.

Ian Lyngen:

And there's no question that at this point in the cycle all eyes are on the labor market. We've seen the three month moving average of NFP creation come in at 541,000 a month. The current consensus for June's figure is roughly 700,000 jobs. This reflects an underlying optimism that as the economy continues to reopen sidelined workers will be brought back into the fold. At this stage we're skeptical that we're going to see another million plus jobs figure comparable to what we saw in March, and rather that the runway toward full and ultimately maximum employment just got a lot longer given the information that we learned in the second quarter.

Ben Jeffery:

And remember, during the NFP survey week in June, we actually saw a fairly significant increase in initial jobless claims. Add onto this fact that there's still 14.6 million people receiving some form of unemployment benefits, whether that be the special programs related to the pandemic or the normal state level claims, and clearly there's still a great deal of damage persisting in the labor market.

Ian Lyngen:

And this brings up the topic of wages and how what is ostensibly a tight labor market has led to increases in realized wages, particularly in the lower wage sector of the economy. The anecdotes of fast food restaurants needing to offer bonuses to bring workers back in from the sidelines abound. And while we have yet to see that translate through to an increase in overall wage growth, that's one of the key underlying assumptions for the reflationary argument.

Ben Jeffery:

And over the next several months it's going to be a real challenge to interpret the wage data, just given the compositional issues that we've seen play out throughout the pandemic. As lower wage jobs are reintroduced into the labor market that mathematically is going to drag down the overall average hourly earnings figures. And conversely, the longer those lower wage jobs stay out of the market naturally the wages that do exist are going to be higher, offering a "artificial" boosts to take home pay. So as we start to get June, July and August's data, there's going to be a fair amount of noise, which I think lends itself to more of a sideways move in the US rates market than any decided new trend.

Ian Lyngen:

On net, assuming that us rates are going to be in a range over the course of the next couple of months certainly does resonate given the fact that to a large extent, the macro narrative has been put on hold until the US economy returns from summer break in September. That said, the seasonal patterns continue to be constructive for Treasuries, which would bias us, all else being equal toward a gradual drift lower in yields from here. The range that we're tracking in 10 year space at the moment is roughly 135 to 159, with the chances of revisiting the lower bound at 135 increasing as we get deeper into the summer months. And the data continues to show the recovery in the labor market is good but not great.

Ben Jeffery:

So are we ever going to get back to two handle tens?

Ian Lyngen:

The fabled land of two handled tens. To be fair, we are going to get back to two handle tens, but at the moment we're at two handle thirties, Ben. Isn't that enough? In all seriousness, we do think the 10 year yields will eventually drift back above 2%. As with all things in the market, it simply comes down to a matter of timing. In 2022, it's very reasonable to expect a repricing higher in Treasury yields with a two handle being realized in the first half of the year. While the Treasury market continues to grapple with how much should or should not be priced in, in terms of tapering, we ultimately expect that the moment for a taper tantrum has already passed, and upon realization tapering in the Treasury market will ultimately be a non-event.

Ben Jeffery:

So, really the non event of the season.

Ian Lyngen:

Non event of the season. What would I wear to that?

Speaker 2:

Probably a blue shirt.

Ian Lyngen:

Good call.

In the week ahead the Treasury market really has one primary factor to consider and that's the non-farm payrolls print on Friday. The event will be in a truncated session because of the recommended early close. And we also do have month, quarter and first half into considerations mid week. That said, the macro narrative continues to be defined by the pace of jobs creation, what that means for labor market participation and ultimately to wage gains that could translate through to sustainably higher inflation.

Ian Lyngen:

As it presently stands as evidenced by the price action, the market does appear to be buying into the Fed's characterization of the increase in realized inflation as transitory. And we suspect that the market will be content with this characterization until after the summer months have passed. Part of this has to do with moving beyond the base effects, and another aspect of it has to do with the pockets of inflation that we have seen thus far, particularly in the auto sector won't ultimately prove to be replicatable, at least not for more than a few months.

Ian Lyngen:

All of this leaves the market and what has become an all too familiar range beyond simply focusing on the 10 and 30 year sectors themselves. The shape of the curve has become a lot more interesting in the wake of the Fed. The move higher in two, three and five year yields has proven much more sustainable than any choppy price action further out the curve, and this simply reflects pricing to the updated dot plot. There is no reason for us to assume that that gets challenged in the near term, especially because the July FOMC will be a non event. There's no updated SEP, and there's very little reason for the Fed to attempt to pivot monetary policy at this point. So from the perspective of the Fed, expectations are simply on-hold until Jackson Hole, where investors anticipate a clear reiteration of the tapering timeline.

Ian Lyngen:

As for jobs specifically, with the consensus close to 700,000 our take is that ambitions are skewed a bit high in this regard. And if anything, we expect that the Thursday before NFP Friday we'll see a give back from any month end buying as a setup to the payrolls report, but are ultimately on guard for a repeat of the data apathy that has characterized the last several employment reports. We've reached a point in this week's episode where we'd like to offer our sincere thanks and condolences to anyone who has managed to make it this far. And for those who look forward to the final joke of the podcast, thanks for appreciating that if you can't laugh with us, you can always laugh at us.

Ian Lyngen:

Thanks for listening to Macro Horizons, please visit us at bmocm.com/MacroHorizons. As we aspire to keep our strategy effort as interactive as possible, we'd love to hear what you thought of today's episode. So please email me directly with any feedback at ian.lyngen@bmo.com. You can listen to this show and subscribe on apple podcasts or your favorite podcast provider. This show and resources are supported by our team here at BMO, including the FICC Macro Strategy Group and BMO's marketing team. This show has been produced and edited by Puddle Creative.

Speaker 2:

This podcast has been prepared with the assistance that employees of Bank of Montreal, [inaudible 00:18:54] Incorporated, and BMO Capital Markets Corporation. Together, BMO, who are involved in fixed income and foreign exchange sales and marketing efforts. Accordingly, it should be considered to be a product of the fixed income and foreign exchange businesses generally, and not a research report that reflects the views of disinterested research analysts. Not withstanding the foregoing, this podcast should not be construed as an offer or the solicitation of an offer to sell or to buy or subscribe for any particular product or services, including without limitation, any commodities, securities, or other financial instruments. We are not soliciting any specific action based on this podcast. It is for the general information of our clients. It does not constitute a recommendation or suggestion that any investment or strategy referenced herein may be suitable for you.

Speaker 2:

It does not take into account the particular investment objectives, financial conditions, or needs of individual clients. Nothing in this podcast constitutes investment, legal, accounting, or tax advice or representation that any investment or strategy is suitable or appropriate to your unique circumstances, or otherwise it constitutes an opinion or a recommendation to you. BMO is not providing advice regarding the value or advisability of trading in commodity interests, including futures contracts and commodity options or any other activity which would cause BMO or any of its affiliates to be considered a commodity trading advisor under the US Commodity Exchange Act. BMO is not undertaking to act as a swap advisor to you, or in your best interest in you to the extent applicable will rely solely on advice from your qualified, independent representative making hedging or trading decisions. This podcast is not to be relied upon in substitution for the exercise of independent judgment.

Speaker 2:

You should conduct your own independent analysis of the matters referred to herein, together with your qualified independent representative, if applicable. BMO assumes no responsibility for verification of the information in this podcast, no representation or warranty is made as to the accuracy or completeness of such information. And BMO accepts no liability whatsoever for any loss arising from any use of, or reliance on this podcast. BMO assumes no obligation to correct or update this podcast. This podcast does not contain all information that may be required to evaluate any transaction or matter, and information may be available to BMO and, or its affiliates that is not reflected herein. BMO and its affiliates may have positions long or short and affect transactions or make markets in insecurities mentioned herein, or provide advice or loans to or participate in the underwriting or restructuring of the obligations of issuers and companies mentioned herein. Moreover, BMO's trading desks may have acted on the basis of the information in this podcast. For further information, please go to BMOcm.com/MacroHorizons/legal.

Ian Lyngen, CFA Managing Director, Head of U.S. Rates Strategy
Ben Jeffery US Rates Strategist, Fixed Income Strategy

You might also be interested in