▪️ TP negative again after being positive for most of 2021
▪️ Excess yield investors require/receive to commit to holding L/T bond instead of series of S/T bonds has turned negative
▪️ Investors now willing to pay extra to hold L/T bonds
1/10
With 10y UST yield at 1.18% & TP at -0.10% => 1y yield is expected to avg ~1.28% over next 10 yrs
Term Premium?
▪️ Compensation investors demand for risk that S/T yields do not evolve as expected
▪️ 10y Nominal = expected path of S/T yield over next 10 yrs + Term Premium TP
2/10
▪️ Negative TP => investors willing to accept lower yield on L/T bond to avoid risks of rolling over their investments in series of S/T bonds with uncertain fluctuating interest rates
Thus higher Rates Volatility usually implies higher TP
Chart: ACM TP v/s MOVE Index
3/10
▪️ TP as compensation for possible deviation from "Expectations Hypothesis" that expected return from L/T bond until maturity equals expected return from rolling over series of S/T bonds
▪️ TP are highly correlated across countries but interest rate expectations are not
4/10
▪️ TP challenging to comprehend & difficult to measure as it requires estimation of investor expectations (not directly observable) of future course of S/T rates over lifetime of L/T Bonds
Any model is just useful simplifying tool; may not capture all real-life influences
5/10
▪️ Fed’s popular ACM Model (Adrian Crump & Moench 2013)
- Five-factor no-arbitrage term structure statistical model
- Characterizes yields as linear function of pricing factors / principal components
▪️ KW Model (Kim & Wright) also includes survey data on interest rates
6/10
Macro factors: TP can vary with:
🔹 Perceptions of uncertainty about inflation, real activity & monetary policy => recent TP collapse partly represents pricing of growth slowdown & virus resurgence
🔹 Business cycle as investors more risk-averse in recessions than in booms
7/10
🔹 Liquidity factors & ‘safe haven’ demand esp ard geopolitical risk=>investors may be willing to hold bonds even with negative TP
Correlations (2018):
- Slope more affected by unemp gap
- Level of interest rate strongly correlated with level of inflation but not unemp gap
8/10
🔹 Demand-supply mismatch (Treasury borrowing/supply v/s pension fund, insurance, Fed QE demand)
- Pension funds may consider L/T bonds less risky given their L/T liabilities while other investors may demand compensation
- Notable compression in TP since GFC
🔹 Normally Fed’s new uncertain AIT framework should have led investors to demand more compensation for risk of inflation (higher TP), but recent collapse in TP may partly highlight confidence that Fed will keep inflation & expectations well anchored around 2%
▪️ China oil imports from SA ~$45bn pa, ~1.75 mbpd
▪️ What can SA do with CNY received 1. Pay in CNY for Chinese imports/services 2. Diversify FX Reserves into CNY away from USD
2a. Invest back into China onshore say CGBs
+ve for CNY internationalization
[SAMA FXReserves $420bn]
▪️ (Oil in CNY) = (Oil in USD) x (USDCNY FX)
- Oil in CNY=>Shanghai International Energy Exchange, "Shanghai Oil" #SCPA
- Oil in USD=>say DME Dubai Oman Crude Oil #OQD
If Shanghai Oil in CNY is just an FX conversion of Dubai Oil in USD then Oil is still really priced in USD
3/5
#China: Back In Focus
▪️ Poor credit data: Agg Financing CNY 1190bn vs 2200bn exp=>MLF rate cut possible 15 Mar
▪️ Biggest Covid crisis since Wuhan as cases surge
▪️ China Tech & HK stocks beaten down
▪️ Geopol: U.S. warns China
▪️ #USDCNH jumps to break 1m consolidation
1/6
▪️ China reported 3,300 cases on Saturday - worst outbreak since early days
▪️ 17.5 million residents in Shenzhen placed in lockdown till 20 March
#USDJPY: Next big trade or just a puzzle?
▪️ In 21st century, USDJPY spiked up >2% when S&P dropped >2% in a wk only on 9 occasions - last wk was one of them - prob of such occurrence <1%
▪️ Last wk $JPY 114.82=>117.29, S&P -2.9%
▪️ Dethrone Long JPY as macro risk-off hedge? 1/9
▪️ Recent S&P drawdown -12.5% since 3 Jan'22 on hawkish Fed & Russian invasion but $JPY +1.0% with drawdown of only 1.4%
▪️ Regime change post Covid?
- Since Mar'20, $JPY vs S&P regression reveals significant -ve beta
- Previous Fed hikes (2004-06, 16-18) also showed low beta 2/9
#FX/#Rates thru 2016/18 episodes of 'Equity Tantrum' on hawkish Fed: Takeaways
▪️ Short USDJPY best FX trade in both periods
▪️ Short AUDJPY even better
▪️ Short EUR/Long DXY bad idea for risk-off
▪️ Gold/Silver good value here
▪️ Long USDEM not rewarding enuf
▪️ Bonds rally 40bp
In late 2018:
- S&P touched bear mkt in mid-Dec'18 (20% correction)
- Dropped 9% in Dec'18
- Dropped 2.5% on 3rd Jan'19
Then Powell did dovish pivot on 4th Jan'19: Fed "will be patient"
In 2022:
- S&P has dropped 7.73% in Jan'22
- Corrected 8.73% off peak