In the 9 months since QE unwind started Fed has cut ~5% off the balance sheet. Since then:
- US Tsy real yields are at top of the QE range, 80bps at 10yr
- Tsy curve has flattened
- USD rallied
- BBB IG bond spreads to 1.6% vs 1.3%
- US high yield spreads seems to have bottomed
- EM tanked
- Liquidity has dried up at times in some areas of bonds markets as they reset to higher yield levels with not much market making to intermediate the move
- Global Prime Residential is in a bear market in many locations
- S&P equity breadth narrowed
- We had one volatility explosion in equities, and one in govvies (Italian 2yr) and several in EM FX/ equities.
Nevertheless with credit growth in Q1 at 18% of GDP annualised, main street USA is doing fine.
In Q4 balance sheet reductions will go to $50bn a month and next year they are targetting 15%/ $600bn in reductions and potentially 100bps more from here in Fed funds rate hikes which would take Libor to about 3.5%.
If the USD Treasury yield curve steepens on a reflationary policy outlook it could see the 10year at 3.5-4%.
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