Thread by @MacroAlf

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

1/n

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.