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Rates Market: Ready for the Fed fireworks - ING

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Dec 15, 2015.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

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    FXStreet (Delhi) – Padhraic Garvey, Global Head of Rates and Debt Strategy at ING, suggests that the Central bank meetings will remain central drivers over the turn of the year, with attention now switching to the upcoming FOMC meeting, although ramifications from the recent ECB meeting are also key.

    Key Quotes

    “With respect to the ECB, a priority phrase from Draghi was that “we are doing more because what we are doing is working”. The markets got ahead of themselves, reading too much into last month’s verbal communication. The ECB is implicitly calling for a build in inflation expectations in the next few quarters.
    This also leaves the European markets a tad more vulnerable to the Fed’s upcoming hike. The correlation is now with the macro up trend (US) and headline inflation uplift than the downtrend one and dis-inflation.

    As we see it, there are some obvious winners and losers. Regional debt, Euro longs by non-domestics, Duration shorts and, eventually, Inflation longs are winners. Losers would include Euro domestic longs in negative rates, Fixed rate receivers, Risk assets, and high correlation plays versus Bunds.

    In the US, the delivery of a 25bp hike on 16 December appears to be baked in now. Remember that the Fed dots still sit well above the funds strip, which leaves plenty of room for the market to revise upward rate hike expectations should US robustness flow well into the business end of 2016.

    The big issue now is the terminal value for the funds rate. We think it’s in the area of 2.5%, which is above the current 10yr rate. The evolution of a term premium on top of that would sit comfortably with a 10yr yield topping out in the region of 3%, which is a comfortable 75bp above current levels.

    We view actual delivery of hikes as crucial to this view, and while we actually don’t have a 10yr 3% number in official ING forecasts until 2017, any notion that the market begins to agree with this view could easily see it accelerated in terms of market price action.

    We are comfortable in the 30yr, though, which is already at 3%, and can flatten completely versus the 10yr going forward. As a consequence, we also like emerging market and high yield credit exposures in the ultra longs, where the credit story as opposed to the beta story is more relevant. In the 10yr, there is larger beta effect to be concerned with and much larger still in the 5yr when duration weighted.

    A flatter curve is discounted in the forwards. We think actual flattening will be more aggressive from the front end in the coming quarters. The big uplift risk for the back end comes from a projected headline inflation uplift as a central driver in the coming quarters, with consequent duration short and fixed rate payer strategies to the fore.”
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