The fixed income market is selling off and people are all over the place trying to interpret the move.
Let me help you out - what’s moving and why?
A quality thread for the nice FinTwit people
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Move in nominal yields can be decomposed into inflation expectations and real yields
10y US inflation swaps topped in May and have plateaued ever since - no move over the last days
All the action is in real yields (see pic) which were on the way up already before the Fed.
Higher real yields are generally healthy for markets if they reflect sustainably higher economic growth down the road.
But 2022 US GDP consensus estimates have recently been revised down (see pic), and the same goes for earnings growth forecasts.
So, why higher real yields?
In this case, it’s about the risk premium demanded by investors to own bonds rather than roll-over short term deposits.
The future path of short-term interest rates is more uncertain (post Fed meeting), hence more premium required.
See also implied volatility in the pic below
The Eurodollar market is also on the move, reflecting more probabilities the Fed will hike rates in 2022 and beyond.
Such a policy shift requires more risk premium (in the form of higher real yields) at the short-end.
Dec22 Eurodollar contract below
What about the long-end though?
The curve has been flattening aggressively and for good reasons.
If you require more risk premium at the front-end to account for a more hawkish Fed…well, it works the opposite way at the long-end.
Hence a flatter curve. Let me explain better.
A more hawkish Fed now - in the face of a fading growth impulse - means there is LESS uncertainty about the long term path for interest rates: stable or down
That’s because tightening today is generally seen as bad for long-term growth = lower yields, flatter 5s30s (pic)
So, the move is mostly in the front-end (higher real yields and implied vol to compensate for more uncertainty) while the curve flattens out.
Higher real yields due to risk premium rather than better growth prospects = something to watch out for in global macro multi-asset.
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The Fed hiked rates above 5%, and yet the US economy hasn't broken yet.
Here is why.
Thread.
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High interest rates are supposed to break something because an overly indebted economy will have to service a mountain of debt at expensive rates and it will have less money for income and spending.
The problem is that people are looking at the ''wrong'' debt.
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Private sector debt levels and trends are by far more important than governmment debt
Contrary to the government, the private sector doesn't have the luxury to print money: if you get indebted to your eyeballs and you lose your ability to generate income, the pain is real
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One day, the US Dollar will lose its global reserve currency status.
And it's going to be a huge event.
But here is some hard truth about the De-Dollarization.
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The big question is ''when''.
And the answer is: most likely not within any tradable horizon!
Here is why an orderly de-dollarization is nothing more than a fairytale.
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In a globalized economic system you want to trade with as many partners as possible in a seamless way.
When Brazil exports its commodities and the trade happens in USD, Brazil accumulates USD – it might also use them to buy goods or services it needs from other countries
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High interest rates are supposed to break something because an overly indebted economy will have to service a mountain of debt at expensive rates and consumption will slow.
High rates were supposed to break the US because of government debt, but that's not how it works.
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Private debt levels instead reveal the true macro fragilities of economies facing higher interest rates.
The private sector doesn't have the luxury to print money: if you get indebted to your eyeballs and you lose your ability to generate income, the pain is real.
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Ever wondered what's like to launch a macro hedge fund these days?
Here are the 7 key insights I got so far:
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A) If you think it will be hard, you are wrong: it will be harder
In the early steps of launching a hedge fund you are required to be the CEO, CIO, COO, head of investor relations, and so on.
It's really hard work.
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B) The package matters
Investors have upped their regulatory/infra requirements, and they understandbly demand you to be fully regulated/compliant/audited and have a solid trading infrastructure with a strong prime broker.
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