Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Macro Digest: New lows in US yield indicate rising recession risk
Steen Jakobsen
Chief Investment Officer
Summary: Low in 30Y US yield & 2Y US yield > 30Y yield = Global recession risk
Updated August 15 for clarity and minor text edits
The probability of the Fed cutting rates, even inter-meeting, is rising significantly as a recession is more and more likely and recessions mean an average sell-off in equities of at least 25%.
Policy Response?
- The Fed needs to cut 50 bps and soon – maybe even inter-meeting
- The Fed is behind and has been since last September – to get ahead the Fed needs to cut more than the Fed near-term premium (3 month expected Fed rate less the 18 month expected Fed rate indicates: - 60 bps presently – this needs to shift back higher, meaning the Fed will need to cut more now rather than later - perhaps 100 bps through the December FOMC meeting to start getting there - now only around 70 bps of cuts priced
- An active weaker US Dollar policy is only week away – watch very closely as FX war starts its big engines
What to do?
- Long GOLD – negative yield feeds both “official buying” and hedge buying: 1600 $ and then 1700 $ target
- Underweight equity
- Hedge long risk with long JPY, gold, short-term bonds
- Keep a close eye on credit spreads which should widen (fall in price) : EUR High Yield & US High Yield
Comment
On the day that German GDP went negative, the world biggest exporter - The world biggest importer: The US saw new all time lows in long-term yield – Random? Hardly
The Fed is behind the curve and has been since last September – their speed reduced by their fundamental belief in inflation targeting (and that the present weakness is transitory) – and now into a macro context they call: Regret Analysis. Sad state of affairs, but the main point being G-7 central bank lost their ability to change direction of growth – end of story.
Despite this they will give it another try – i.e. force rates down again. The only way to “move” market now in my opinion being a rate cut between scheduled meetings to force the front end lower, faster. Rip off the band aid rather than taking it slowly!
Also note that everything is unfolding in the context of falling international cooperation – read: G7 – the odds of a full foreign exchange war as an extension to trade policy spats is more than 50/50 now. The main policy choice will likely be a very aggressive rhetoric talking down the US Dollar followed by Fed cuts.
Trend is clear: by Q4-2020 the entire US yield curve will be negative?
Yield curves screaming recession! 2yr-10yr and Fed near-term premium (3 month Fed policy rate less versus 18 month policy rate)
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