We saw some serious reduction in positions this week, and by some measures, net leverage had declined to levels not seen since early this year. This allowed for some reason to return to the market. For instance, 30s are no longer trading below 2%. While there’s nothing stopping them from going back there next week, what’s important is to remember not to infer too much about policy based on every basis point move in the market. Leverage, volatility, regulations, and mandates matter as much, if not more sometimes.
The BoE went the way we thought it would – without much of a noise. Haldane dissented in his last meeting. Can’t say I will miss him much, but best wishes Andy! Also, welcome Dr. Mann. I have not seen anyone classify her as a hawk or dove, so I am going with a centrist. The next meeting will be important, because we may hear something about the sequencing of policy tightening, which seems to be shaping up as the next big debate. It’s already cast a shadow on the way some of the calendars are trading in Fed Funds. The question is – what comes first, rate hikes or end of QE/reinvestment?
In my opinion, the path is tapering, end of bond-buying, rate hikes, and end of reinvestments/selling. The argument is simple – raising rates before getting done with QE will defeat the point of the hike – because rate hikes will try to tighten the very financial conditions that are eased by bond buying. Hence rate hikes follow the end of QE. And they precede the ending of reinvestments/selling of bonds because the pass-through to activity is greater, and also helps escape the zero-lower bound sooner.
Fed speaks this week failed to offer much in terms of insights that could aid positioning. Views range from inflation will most likely prove transitory to how it may not. There was some support for waiting for full employment, which reinforces the view that the curve shouldn’t invert at these levels. They released the results of the stress tests, with fairly promising returns, that would allow banks to return capital to shareholders next month. That’s good for bank stocks and good for those short Treasuries.
In other central bank news, the RBI rejected all bids for the benchmark 10-year bond at the weekly auction and got underwriters to buy shorter-maturity bonds. On the other hand, Banxico raised its key rate to 4.25% in a split decision, to the surprise of many in the market. Eventually, the RBI will probably have to join, especially if oil continues to rise, which seems not so unlikely given the pent-up mobility demand, rising private car usage, CAPEX cuts, and shift to ESG investing. The biggest risk to this view is a new strain of virus, like the delta-plus variant which has been found across 11 states in India. Hopefully, this proves less lethal.
The other news worth following here is the infrastructure bill in the US. Biden has managed to get a deal together that may be acceptable to enough Senators to not require reconciliation. However, not only is this, not a given that this gets passed any time soon, it’s not as big a deal (hah) either. That would be the deal they hope to pass via reconciliation, which could go north of USD 4tn.
Next week have US payrolls and a litany of PMIs. A lot of central bank speeches as well, but then, only Bailey stands out as someone we have not heard from in a while. Waiting to hear only from Brainard and Clarida, now. A beat on the 700k consensus expectations seems difficult but is exactly what would drive selling across the curve. Third time lucky, they say? 😊