All posts in category: Interest Rates (6)

The Unreal, Real Yield

Friday, September 16th, 2022

Inflation expectations in the US are still too low.

There is a big mismatch in US inflation expectations, with 10-year breakeven rates anchored around 2 percent, survey data at 5 percent and core CPI at over 6 percent. We think the latter figures are far more realistic, which means that the US fixed income and equity markets could be in for a nasty shock. We also think that global currency markets are becoming disorderly and that the yen, euro and sterling will all test historic lows against the dollar. It’s not a “sell-everything” strategy, but it is closely related. There may soon be an interesting opportunity in EM Equities and EM Bonds. The last bull market in EM Equities started about three months before the dollar index hit its last high in late 2001 and we see other historical parallels which spark our attention,

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The Great Undiscounted Risk

Friday, August 5th, 2022

Our models expect a bear-steepening in the US yield curve

There is a widespread and unspoken assumption that the Fed will curtail QT if the US economy starts to suffer and that there are no circumstances in which it would accelerate it. We think this assumption needs to be tested. Our models suggest a bear-steepening in the US yield curve is more likely than continued inversion or a bull-steepening. If we are right, this can only be bad news for US and global equities, because our models suggest that the equity rally is completely explained by the recent collapse in 10-year yields. Indeed, equities have underperformed bonds on a risk-adjusted basis since the end of June. If the bond market becomes less supportive later this year, we think there is another significant down-leg in store for equities.

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Approaching a Turn in USD

Friday, December 10th, 2021

The consensus for a strong dollar is more fragile than it appears

Our asset allocation models have been significantly dislocated by the strength of the US dollar. Our previous note – Currency First Is Second Best – showed that we had a model for working round the problem, even if it was difficult to know when to use it. This note introduces our G7 currency model, which we have been live-running for about two years. We don’t use it to make trade recommendations because we think the risk-adjusted returns are normally unattractive compared to those in other models, but it is occasionally useful in times of extreme market stress. The model itself is based on a mean-reversion approach and it is now close to its largest underweight position in USD over the last two years. This time last year, it was close to a two-year maximum overweight, when the consensus view was the dollar would be weak in 2021. If we were forced to commit capital, we would position for a weaker USD, but we think the right time to do this is January, not December.

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Walking, Not Charging

Wednesday, September 27th, 2017

The bull survives if the Fed can keep volatility low

If we understand Janet Yellen correctly, there are no constraints in the real economy which critically affect the speed at which US interest rates can rise. But there must be a critical constraint, and we believe it is the requirement not to upset the low volatility environment in US equities. If we are right, the Fed wants an environment where single digit returns from equity are seen as risk-efficient, and a correction does not turn into a bear market. If they manage this, the bull market can carry on, but it will be walking not charging.

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The Uncrowned King

Wednesday, December 7th, 2016

Cash compared with a balanced mandate

Nothing illustrates the cumulative distortions QE has imposed on US financial markets, better than the historic returns of a balanced 50/50 portfolio relative to cash. The current upswing has lasted almost eight years in an unbroken trend, as opposed the usual five. Our probability indicators suggest that we are getting close to a break of trend. If the Fed raises rates by more than expected in 2017, cash may yet be king.

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In Praise of Cash

Wednesday, November 30th, 2016

What happens if the Fed surprises on the upside

US cash deposits are a neglected asset class. Our models suggest that US Treasuries, Gold and Investment Grade bonds have a low or no-better-than-evens chance of beating cash on a risk-adjusted basis. If you don’t have to own them, you should be reducing your exposure. Our numbers do not include the risk the Fed decides to surprise on the upside in 2017.

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