Yesterday we observed the biggest 2-day steepening in the 2s30s yield curve since the Trump election, following a confluence of events which we discussed in this post, and which resulted in a generous payday for at least one rates trader.
So has the long-awaited moment of a long-end selloff arrived? Or, as SocGen's FX strategist, Kit Juckes, put it, are "Bonds on the run?" Maybe not so fast, especially since much of the recent increase in yields has been for breakevens. Here are his thoughts.
Bonds on the Run?
The Tax Bill is still moving towards the Oval Office, and even critics concede that it boosts growth a bit (more from the corporate tax cut than from the income tax cuts). While the relationship between growth, economic slack and inflation remains as much a mystery as how Father Christmas gets down the chimney, an uptick in breakeven inflation and in 10-year Note yields isn’t shocking. The more breakevens rise, the less real yields rise, the less this affects the dollar, unless or until it triggers a wholesale rethink on where Fed Funds are headed. So far, the market remains convinced the destination is 2-point something. Bearish bond bets may make sense, but FX conclusions are messier. We like short yen trades for now, but as with any carrybased FX trades, it feels a bit like picking up pennies in front of a present-loaded sleigh...
Sometime over the holidays, perhaps while digesting an absurdly large meal and instead of watching the Christmas Special of some TV programme or over, I’m going to re-read Why so low for so long, a paper published this month by Claudio Borio and others at the BIS that rather debunks the idea that real interest rates are a function of shifts in desired saving and investment rates. It suggests, to me, that we can just get stuck in low, medium or high real rate regimes for a protracted period. At the moment, the market believes the world’s in a low rate world because the Fed believes it. Everything from Bitcoin to housing market excess and the EM economic recovery is linked to that.
What happens if the tax bill revives inflation and makes the FOMC question what kind of policy regime we’re supposed to be in? Maybe we revert to the pre-GFC order, or maybe we have a new version of the taper tantrum and a very temporary spike in rate expectations that simply reinforces the low-rate regime.
So before you go all in on that 30Y short, maybe sleep on it for a day or two, also known as two lifetimes in today's algo-driven, ADHD dominated market...