Senior Fixed Income Strategist
Summary: There is plenty of reasons to remain cautious, especially in a day where thin liquidity might provide a distorting view on events. Yet, it's important to consider what a new wave of Covid means for markets now that central banks were set to enact less accommodative monetary policies. The Federal Reserve may remain hawkish as stimulating demand can produce stronger price pressures. However, if new restrictions and lockdowns are imposed, the market will need to cut back on growth expectations. Therefore, we cannot exclude an inversion of the yield curve.
This morning, the market was caught by surprise with the news of a new Covid variant coming from South Africa. Investors flew to safety in a typical “sell now, make questions later" fashion, pushing down bond yields, together with oil prices and the stock market.
The big question remains whether today’s flight to safety is justified or not. However, nobody can answer this question because there is too little information at hand. What we can do is to work with what we already know: central banks are concerned about inflation and are getting ready to tighten the economy. However, can they continue with their hawkish plans despite a new wave of infection that might cause countries to impose restrictions and lockdowns? The short answer to that question is yes. They will need to because a lockdown can further exacerbate inflationary pressures by worsening supply-chain bottlenecks. Easing the demand looks like the most sensible thing to do not to overheat the economy further.
Yet, in a day where liquidity is so thin, one has to be careful to overreact with what the market is “saying”. That’s why we believe that the deep drop of yields, especially in the belly of the curve, might be overdone, especially under the prospect that the Federal Reserve will accelerate the pace of tapering in December. At the same time, the market pushed back on interest rate hikes expectations. While yesterday it was expecting almost three hikes in 2022, today it is pricing only two. Yet, provided that a new wave of Covid will be temporary, it’s safe to assume that rate hikes will accelerate once that market sentiment normalizes.
Therefore, the front part of the yield curve might soon resume its rise. However, there is a chance that long-term yields will stabilize or even fall amid growth concerns. Hence, we are heading toward the risk to see the yield curve inverting.
The spread between 30-years and 5-year US Treasuries is well below 100bps. However, the spread between 30-year yields and 10-year yields it's even tighter -just 36bps. The spread between 10-years and the 7-years yields it's just 8bps. It means that we are not far off from an inversion scenario, which is often seen as a solid recessionary predictor.
There is plenty of reasons to remain cautious, especially in a day where thin liquidity might provide a distorting view on events. Next week, we will gain a better picture when the American market has digested the Thanksgiving turkey and liquidity is restored.
AI: The good, the bad, and the bubble
While a deep recession may not be iminent thanks to central bank policy, interest rates will have to stay high for longer, and this will be accompanied by volatility risk from the unwinding of bubbles, especially within AI.
Steen Jakobsen,
Chief Investment Officer
The emergence of advanced AI systems is by far the most surprising event this year, turning everything upside down, while risks and benefits are debated. AI will also become an arms race between the US and China.
Peter Garnry,
Head of Equity Strategy
As China navigates global fragmentation, its cycle of technology application, productivity enhancement, and growth is threatened by US breakthroughs in generative AI, limited computing power, and geopolitical tensions.
Redmond Wong,
Market Strategist
Japan’s expertise in semiconductors and robotic integration could be the foundation of AI dominance. Combining two of this year's themes, Japanese equities and artificial intelligence, brings a wave of opportunities.
Charu Chanana,
Market Strategist
The AI fever has turned the technology into a darling, pushing crypto further into no-man’s-land. There are striking similarities between AI and crypto, and if these are to come full circle, AI won't be spared for bubbles.
Mads Eberhardt,
Cryptocurrency Analyst
Stocks related to artificial intelligence (AI) have appeared on investors' radars. Expectations are high, but it may be necessary to consider how to get exposure to AI in a diversified way.
Hans Oudshoorn,
Trainer Academy
The USD is on its back foot as markets celebrate an eventual Fed rate peak and steady long US yields. The stakes are even higher for the Japanese yen if longer major sovereign yield curves have to price in economic acceleration.
John J. Hardy,
Head of FX Strategy
While commodities, broadly speaking, have faced some tough months, a partial reversal during June could signal that the asset class is getting back on its feet with energy holding up and precious metals with upside potential.
Ole S. Hansen,
Head of Commodity Strategy
As inflation remains high central banks face hard decisions about whether they should keep hiking interest rates or stop. Meanwhile, the rise of AI creates bubble-like conditions that only make the decision harder.
Althea Spinozzi,
Senior Fixed Income Strategist
Disclaimer
The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.
Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)
