Why the Fed is the key to mixed bond market signals Why the Fed is the key to mixed bond market signals Why the Fed is the key to mixed bond market signals

Why the Fed is the key to mixed bond market signals

Bonds 5 minutes to read
Althea Spinozzi

Head of Fixed Income Strategy

Summary:  Today's Federal Open Market Committee meeting is critical for investors , given the huge influence of Fed policy on asset valuations worldwide. But what should bond investors watch out for in particular?


This week is a busy one with 14 central banks making monetary policy decision. The lion’s share of the bond market’s attention will go to the US Federal Reserve, where traders from around the world are looking to understand whether their positioning on corporate bonds and emerging markets was the right course of action amidst sluggish global economic growth.

The financial market is giving us conflicting messages: both the bond market and the equity market have been rallying since the selloff in equities at the end of last year. The yield on the 10-year Treasury yield, long regarded as a safe haven, has been falling from its high of 3.2% at the beginning of November to 2.55% at the beginning of January; since then it has been trading rangebound with a tendency to the bottom of the channel. 

In the meantime, the S&P has risen 16.5% from the beginning of the year, leaving many to wonder whether the bond market knows something that equities don’t. 

The rally seen since the beginning of the year was provoked by a radical pivot from hawkish to dovish at the word’s major central banks. The chart below shows that the rally began in earnest on January 4, when Fed chair Jerome Powell said that the Fed will be patient with monetary policy, suggesting that will not continue to hike interest rates at the pace outlined a month earlier.
Source: Saxo Bank
Fed policies do not only drive the valuation of dollar-denominated debt, but also support the valuation of risky assets worldwide, such as emerging markets and lower-rated corporates. This is why today’s Federal Open Market Committee meeting today is receiving so much attention. A dovish Fed means the difference between resilient markets and a widespread sell-off that hits the weaker parts of the economy disproportionately.

Today, we expect the Fed to keep interest rates unchanged until data show that the macro environment is well supported. The element of surprise this week concerns possible news on the ending of the balance sheet runoff. We believe that the Fed will take some time before revealing when is going to terminate its quantitative tightening, as that could provoke a contained sell-off in equities, EM and corporate bonds. However, if it decides to outline a plan to end its balance sheet runoff, we may witness to a last push higher in equities, EM and credits.

It has not been easy for fixed income investors to find buying opportunities in the credit space of late, but if the Fed does not announce the end of QT, or if the announcement is disappointing, this might me the perfect time to buy bonds amid a contained sell-off. 
We believe that with central banks staying supportive of the economy (against a looming recession threat), quality bonds will continue to rise in value; lower-rated credit, meanwhile, might rise in the short-term, but will be doomed to sensibly reprice as a recession approaches. 

This is why we recommend investors remain cautious and not take on unnecessary risk unless the fundamentals look particularly promising. But what should if the Fed is complacent regarding market expectations and outlines and end of QT, boosting asset valuations?

US two-year Treasury notes are trading at 2.45%, 5 basis points lower than the Federal Reserve benchmark rates, suggests that the market is indeed positioned for a more dovish message. Thus, current credit spreads could be poised to tighten further from here.
If this is the case, investors will have their hands tied as current valuations will most likely rise until the economy begins to enter into a recession. Still, this should not be an excuse to refrain from putting one’s money to work, particularly when the US yield curve offers good returns. Even parking some money in one- and two-year maturities will return more than 2%, and in the meantime investors will have all the time in the world to make up their minds.
Disclaimer

The Saxo 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 is not intended to and does not change or expand on this. 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 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 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 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 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 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-hk/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo or its affiliates.

Saxo Capital Markets HK Limited
19th Floor
Shanghai Commercial Bank Tower
12 Queen’s Road Central
Hong Kong

Contact Saxo

Select region

Hong Kong S.A.R
Hong Kong S.A.R

Saxo Capital Markets HK Limited (“Saxo”) is a company authorised and regulated by the Securities and Futures Commission of Hong Kong. Saxo holds a Type 1 Regulated Activity (Dealing in Securities); Type 2 Regulated Activity (Dealing in Futures Contract); Type 3 Regulated Activity (Leveraged Foreign Exchange Trading); Type 4 Regulated Activity (Advising on Securities) and Type 9 Regulated Activity (Asset Management) licenses (CE No. AVD061). Registered address: 19th Floor, Shanghai Commercial Bank Tower, 12 Queen’s Road Central, Hong Kong.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products may result in your losses exceeding your initial deposits. Saxo does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo does not take into account an individual’s needs, objectives or financial situation. Please click here to view the relevant risk disclosure statements.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-hk/about-us/awards.

The information or the products and services referred to on this site may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and services offered on this website are not directed at, or intended for distribution to or use by, any person or entity residing in the United States and Japan. Please click here to view our full disclaimer.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc. Android is a trademark of Google Inc.