Fed framework change was a catalyst
May 24, 2021
–Over the past month TYM has pretty much traded from 131-28 to 132-20, currently at the upper end of that range at 132-17. On Friday ten year cash yield ended at 1.628% nearly unchanged from Thursday. Implied vol has compressed and is now at the low end with July at 4%. Tremendous usage of the Fed reverse repo operations with $369 billion on Friday, indicate that excess reserves are smothering the system. Three month libor posted a record low on Friday at just 14.7 bps. Against this backdrop of forced liquidity, it’s difficult for risk assets to sustain lower moves. Even bitcoin, which traded as low as 31280 yesterday is back above 36k this morning. Auctions of 2, 5, and 7 year notes this week are likely to see solid demand.
–A post on ZeroHedge outlines David Rosenberg’s thesis that inflation will be transitory, that by Q4 the stimulus surge will wear off at the same time supply chains are being repaired. He notes that M2 money supply growth has not been correlated to inflation and cites longer term inflation breakevens to conclude that higher expectations have not taken hold. All legitimate arguments that could end up being right. I am much more inclined to note that curves began to steepen almost immediately after the Fed changed the policy framework in August. In hindsight one can see that many commodities started their run around that time. Ordinary conversations indicate that inflation expectations have increased. The regulatory burden of the new administration is likely to bolster instincts to hoard, perhaps exemplified by the push for a global corporate tax of 15%. The US previously was under a disinflationary cloud due to a weak yuan and cheap manufactured goods from China. Now US military officials have been repeatedly rebuffed in attempting to communicate with Chinese counterparts. Is that a signal of frictionless global trade? Can we be certain that chip supply out of Taiwan will be completely reliable? The yuan has consistently strengthened against USD for a year, from 7.1 last summer to 6.43 now, and of course USD has lost value against all basic commodities. Fiscal and monetary stimulus in the wake of covid have been overwhelming and have unwittingly been successful in changing consumer and corporate psychology in the US. I think that’s what Rosenberg misses, but even if he’s right, does a ten year yield of 1.63% with deeply negative real rates make sense for the US?
–All I am saying is that this was probably a pretty fun wedding to attend
