Senior Fixed Income Strategist
Summary: Demand for inflation linkers is falling as investors anticipate inflation expectations to adjust lower amid an aggressive Federal Reserve. Yet, if the Fed disappoints net week, TIPS might rebound briefly, supporting risky assets. However, inflation is likely to remain well above the Fed’s target in the long run. Thus, the central bank will need to keep hawkish for longer, making the rise in real rates inevitable.
While US Treasuries were benefitting from safe-haven demand yesterday, a ten-year TIPS auction showed that investors are unwilling to buy inflation protection at the current yield level. Ten-year TIPS sold with a yield of -0.54%, tailing by 2.6bps. The bid-to-cover was the lowest since July 2020, and indirect bidders were down to 59.3%, the lowest since May.
Investors are unwilling to take on inflation protection securities as the Federal Reserve becomes more aggressive and inflation expectations are adjusting lower. Today, the 10-year breakeven rate is recording the biggest drop since January last year, provoking an acceleration in real yields that are taking them close to test resistance at -0.5%.
Although risky assets show more resilience than instruments that carry high duration, we expect things to change as real rates break resistance at -0.5% and rise quickly to -0.35%. Indeed, by that time, 30-year TIPS yields would have already turned positive, indicating that financing conditions are tightening fast, threatening risky assets.
So far, duration has been a bigger villain than credit quality. Year to date, US Treasuries with 20+years maturity (TLT) have fallen -4.2%, investment grade USD bonds (LQD) dropped -3.4%, and emerging market hard currency bonds (EMB) -3.7%. At the same time, junk bonds that carry much shorter durations have proven more resilient, with junk in the US (HYG) falling -1.8% and Europe (IHYG) only -1.1%.
However, next week's FOMC meeting could support real rates if the Fed doesn't sound as hawkish as the market expects. So far, the market is pricing four interest rate hikes, with some market players expecting two rate hikes in the March meeting. Any indication of fewer hikes might produce a drop in nominal yields and a rise in breakeven rates, translating into lower real rates.
Bond. Long Bond(s)
With real rates being too positive, we see three scenarios: Opportunity to lock in rates at cycle high, government overreach to keep the economy afloat or a complete reset of the economy.
Steen Jakobsen,
Chief Investment Officer
Is a bond bull market ahead? Inflation still poses a risk for investors, but the moment for increasing duration to your portfolio may be approaching towards the end of the year, when central banks might be forced to cut interest rates.
Althea Spinozzi,
Senior Fixed Income Strategist
The furious rate hike cycle has brought gains in the US dollar, but with stagflation risks in Europe and the UK and weakness in the Chinese economy, USD may have more room to run. But a strong dollar could also have repercussions for US growth, emerging markets and commodity prices.
Charu Chanana,
Market Strategist
With the cost of capital rising painfully, stagflation fears are back, illuminating the fragile state of the green transformation, while giving a tailwind to nuclear power, and threatening the growth of AI-related stocks.
Peter Garnry,
Head of Equity Strategy
With supply tightness not only in energy but all commodities, the momentum in commodity prices may continue, pressuring central banks to lower real rates. That could be a good setup for precious metals, including gold, silver and potentially platinum as well.
Ole S. Hansen,
Head of Commodity Strategy
As the pandemic showed, even the US Treasury can experience seismic shifts. With the government increasing the pace of issuing bonds to support fiscal spending, the complex Treasury market and regulatory constraints could spark a liquidity event.
Redmond Wong,
Market Strategist
The tide has turned for bonds. Given the current yields, bonds have become an attractive investment, with added benefits including lower risk than stocks, increased diversification and a steady stream of income unaffected by economic changes.
Peter Siks,
Investment Coach
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)
