Market commentary from Eric Vanraes, portfolio manager of the Strategic Bond Opportunities Fund at Eric Sturdza Investments, on the Fed’s monetary policy.
- With the deal to raise the US debt ceiling, a Treasury-bill windfall is imminent
- The US economy is far from recession metrics, making another Fed rate hike inescapable next week
- Treasury-bill investors should closely watch the Bank of Japan’s yield curve control policy
US long rates under pressure
Last week, Torsten Slok (partner and chief economist at Apollo Global Management) mentioned a phenomenon that should not be underestimated. In his view, the biggest threat to US long rates is the Bank of Japan’s monetary policy. If the BoJ suddenly abandoned its yield curve control (YCC) policy, Japanese bond yields would soar. As a result, Japanese investors could then start selling Treasuries in order to buy their own government’s bonds. A sell-off in US long rates from Japan may happen eventually, and the conclusion is clear, holders of long US bonds should closely follow BoJ policy.
At this time, US long yields are bending but not breaking, and a further rate hike by the Fed should not, in theory create any major movements. We have repeatedly pointed out that a bearish flattening puts the 2-5 year part of the yield curve at risk, with the 30-year rather spared. However, we remain vigilant, especially in the case of bonds with durations close to 18 years, where any misjudgment will be costly.
Debt ceiling drama
The US debt ceiling and its default soap opera is finally behind us. A solution seemed entirely feasible, but needed ratification. Now signed, markets can continue to shoot for the sky. Even if that does not solve the fundamental problem that US debt is unsustainable. The issue of trillions of dollars in Treasury bills offers an opportunity to invest risk-free cash at 5.5%. Equities and bonds will have to come up with solid arguments to encourage investors to prefer them to such a windfall. Of course, an attractive nominal rate is much less so when expressed in real terms, but this applies to all asset classes.
The US job market remains solid with no signs of slowing wages and disinflation seems to be stalling. With some 339,000 new jobs created in May, and April’s number revised to +294,000, we are a long way from the 180,000 new-jobs mark that was supposed to herald an economic turning point towards a slowdown and then a recession.
In the circumstances, what else could the Federal Reserve do but raise rates by a quarter-point on 14 June? Unless in inflation data scheduled before that meeting throws up surprises, a decision to hike rates again looks inescapable next week, taking the Fed funds rate to 5.25%-5.50%.