Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
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Rates Update: BOE leaves room for Gilt yields to spike amid a Brexit deal. Federal Reserve decision leave Treasuries unchanged.
Althea Spinozzi
Head of Fixed Income Strategy
Summary: The Bank of England maintains monetary policy unchanged amid unusual uncertainty. It implies that Gilt yields are free to spike in case a Brexit deal comes through. Ten-year Gilt yields will easily break their resistance line at 0.45% in case of a Brexit deal, and they will continue to rise towards 1%, until the BOE steps in to slow them down. On the other side of the Atlantic, Treasury yields were muted yesterday after the FOMC meeting. The Federal Reserve didn't change its bond-buying program and gave better than expected economic forecast. Yet, ten-year yields continue to trade within their ascending wedge and are likely to break above the pivotal 1% as a fiscal stimulus is approved, and Biden enters in the White House.
Bond yields are poised to rise on both sides of the Atlantic.
The Bank of England didn't make any changes to its policy benchmark rate and QE purchases, precisely as expected by the market. It is therefore leaving Gilt yields free to rise in case of a Brexit deal, which should materialize in the coming days.
Let’s refresh some critical levels in ten-year Gilt yields:
- Brexit deal scenario: In case of a Brexit deal, yields will spike. By maintaining its monetary policy unchanged, the BOE has enabled yields to rise fast. Ten-year yields are poised to break above the 0.45% resistance line.
- Hard Brexit scenario: ten-year yields will fall and test their support line at 0.20%. Yields are likely to break this level easily (as they already did last week) and will continue to fall until they try the benchmark interest rate at 0.10%. In case the ten-year yields break this level, it means that the market heavily relies on a rate cut from the BOE, which at this point might even consider negative-rates.
On the other side of the Atlantic, Treasury yields were muted during the Federal Reserve decision yesterday. Even though the Fed didn't deliver on market expectations, ten-year yields went nowhere near the pivotal 1% level that we have been monitoring in the past few months. It was enough for the Fed to signal it will hold rates near zero until 2023, and that it will continue with its bond-buying program, to kill volatility in the bond market. The Fed specified that this program would continue until it does not see a "substantial" improvement in unemployment and inflation. The word "substantial" is vague, and for as much as the market knows, adequate unemployment numbers and inflation might be reached as fast as next year. I expect the reflationary narrative to find momentum as a stimulus bill is passed and Biden enters the White House.
Teb-year yield can only rise. At present, yields are trading on the lower part of the ascending wedge they have been trading in from August until today. However, if we consider that a democratic white house and a fiscal stimulus are coming, hence yields should break the pivotal 1% and test the upper resistance line above that level. Bond yields have an inverse relationship with bond prices.
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