Friday, March 26Hamish Risk | March 26, 2021
Bond yields are on the rise and they aren’t going to stop until the Fed has finished tightening. That is the view of Trahan Macro Research which in this week’s Macro Briefing sets out why Fed tightening is a matter of when and not if and why short duration stocks are going to benefit in that scenario. Meanwhile Monetary Policy Analytics explains how the Fed has learnt its lesson from the taper tantrum and this time is going to be holding the market’s hand a bit tighter as it moves towards closing the liquidity taps, and Cornerstone Macro points out that so far, the Fed seems to be doing its job, given that it can find no sign of fear in the Treasury market of runaway inflation. Elsewhere, Eurizon SLJ busts the myth surrounding widely reported correlation between the yield curve and the dollar, and Stone X looks at the bigger picture, setting out the three factors that are going to drive a secular rise in inflation and transform global markets over the next decade
Equities Federal Reserve Trahan Macro Research
1. The Fed Trade nobody is talking about
Fed tightening is a matter of when, not if, despite the protestations of chairman Powell says Francois Trahan at Trahan Macro Research. In his latest note, he explains how the bond market is already pricing in that tightening, and sets out the likely effect on the equity market. Long duration stocks are unlikely to be attractive again until the end of the tightening according to Trahan, while short duration stocks – the ones that have been leading the market so far this year – are likely to prosper. His analysis of the S&P 500 shows 94 names that are likely to prosper from what he dubs this “Fed Trade”.
Fed policy Inflation Monetary Policy Analytics
2. Fed policy; Resolute dogma and inflation hyperbole
Former Fed governor Larry Meyer from Monetary Policy Analytics has put out a note outlining the likely tactics from the US central bank as it edges towards signalling that it will start to tighten US monetary policy. Meyer deftly pieces together the multitude of official statements and comments from officials to try and make some sense of the possible scenarios that will set in motion the process of tapering, runoff and liftoff. The FOMC is nowhere close to putting balance sheet reduction on the agenda yet, he says, but even so a number of officials have highlighted the view that after tapering ends there would likely be a period of time during which the Fed’s balance sheet would be nominally held constant before runoff begins. That said, Meyer explains that Fed officials have learnt the lesson from the Taper Tantrum in 2013 that caused reflationary panic and a spike in US yields, and are likely to avoid mentioning any calendar dates that the market can latch on to. Meyer has also published a note this week that dissects the narratives on inflation risks espoused by economic luminaries such as Larry Summers and Olivier Blanchard. Meyer suggests their arguments are hyperbole.
Inflation US Treasuries Cornerstone Macro
3. The Treasury market is not worried about inflation
Roberto Perli at Cornerstone Macro says one of the recurring themes in his conversations with clients is whether the combination of easy Fed policy, easy fiscal policy, and the reopening will result in a strong pickup in inflation. Yet, he says despite this obvious interest from clients, he finds no evidence in breakeven rates and survey data that the market is pricing a risk – let alone an expectation – of runaway inflation. The breakeven curve is inverted and not at a concerning level, says Perli, while the forward breakeven curve is similarly downward sloping at levels consistent with PCE inflation right around the Fed’s objectives.
fiscal policy US dollar Eurizon SLJ Research
4. Fiscal stimulus should make the dollar smile
The dollar is not just a safe haven currency says Stephen Jen at Eurizon SLJ. In his latest note, he explains his thesis of the “Dollar Smile”, which, put simply, says when the US economy significantly underor out-performs the rest of its DM peers, the dollar has tended to be strong, regardless of its poor structural fundamentals. Contrary to consensus thinking, Jen believes the dollar is about strengthen meaningfully as that relationship asserts itself as the US economy outperforms thanks to the aggressive US fiscal stimulus implemented by the Biden administration, Jen says that the widely reported correlations between the yield curve and the dollar – some of which somehow point to dollar weakness – are likely spurious and should be dismissed by investors.
Secular inflation StoneX
5. Three unconventional arguments for secular inflation
The current debate on inflation is so focused on the short-term that it misses the true drivers of secular inflation according to the latest note from the ever-readable Vincent Deluard. The case for secular inflation is rooted in the “great moderation” of the 1990s, he explains, when Asia effectively subsidised consumer prices in the West by over-investing in cheap manufacturing capacity. That is about to change as Asia abandons “growth-at-all-costs” policies, according to Deluard. Over the next decade, he says, Asia’s growth will slow dramatically, its wages will rise, its factories will close, its surpluses will melt and its currencies will rise sharply. For the rest of the world, says Deluard, this will be a massive and unexpected inflationary shock, which will only be compounded by the cartelisation of the US economy and the continued rise of the ESG movement.