Macro Micro – Scratching the bond market itch

It’s like an itch you just keep scratching or a B grade movie you just keep watching just because or a moth to a flame – circling endlessly. The attraction to just keep watching the US 10-year and its march to 3% is mesmerising and aggravating all at the same time.

Look at this!

Source: Bloomberg


The possible reactions to crossing this psychological level are why it’s so captivating – will it create a market reaction similar to that of February 5th? Will it be more sustained this time? Will it drive a bear market in US bonds? And capital flight to Japan, Europe and elsewhere? So many questions!

(Quickly – macroeconomics of note: Europe is releasing CPI data and a raft of PMI pieces – the US releases its January CPI and final quarter GDP.)

However, this week – one thing maters (and is likely to be a trigger of 3% test) the first major testimony by new Fed Chair Jerome Powell.

What is his view on US growth (to hot, to cold or Goldilocks?), how will he interpret the growth in wages and the state of US employment? Does he see a material increase in inflation? And the main point – his views on US rate raises? Are the dot plots on the correct path?

He will need have to navigate his testimony with great skill as each question has the ability to severely impact money markets and currency markets. However, the questions should give clarity and a framework for his tenure at the head of the Fed.

Crossing the magical 3% threshold will test the mantle of investors as these factors come into play:

  1. The attraction of the risk-free rate.
  2. Borrow costs and refinancing
  3. Corporations’ abilities to fund new projects
  4. The impact on valuations and total returns.

Don’t forget approximately US$300 billion in additional funding approved by Capitol Hill (is) will flood the market over the coming weeks – at a time when the Fed is methodically reducing its balance sheet and nations such as China and Japan are reassessing their foreign reserves.

It’s a ‘buyer’s’ market – the new issuances could enter the secondary market with a 3% handle already if the issuance is short on bids.

This brings me to equities – how will equity markets view the risk-free rate at or above 3%?

Volatility has calmed in the past 2 ½ weeks – US reporting season just produced its best quarterly earnings in over 10 years on the EPS and revenue lines – fundamentals were able drown out the macro noise.

VIX Index over the past month – closed at 16.4 on Friday down 67% since the intraday high of 50.3
Source: CBOE


US reporting season however is finished and if Powell does highlight US inflation and the possibility rate rises in 2018 may be steeper and faster the fundamentals that suppressed volatility are likely to be shoved aside – pronto.

Itchy bear time….?


Evan Lucas is an expert guest contributor to Fairmont Equities.

Evan is founder of The Lucas Review. Prior to that he was Market Strategist at IG. He is well known as an expert commentator in finance media such as Sky News Business, ABC1, the Australian Financial Review, CNBC, and Reuters.

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