Second phase of recovery
As we forecast, the first phase of recovery from the supply side has pushed inflation higher and inflated growth expectations, and now the second phase begins, with consumers coming out of hibernation, we will see to what degree supply has overestimated the recovery, and the damage this has caused.
With data expected to deteriorate over the next month or so, bond yields should start to trade in a range for a while, which should take pressure off currencies and central banks not wanting to raise rates.
The key change in markets in 2021 has been the reversal of the Dollar, USDJPY recovering from 103 to 109, and this has been led by USDCNH reaching (our target) 6.42 and since rising over 10 big figures higher. This has started to redirect inflation pressures away from the US and into both developed and Emerging Markets.
It’s not so much that economic conditions won’t improve, it is the extent to which the improvement will develop against the consensus speculation that is built into market pricing. The importance of a strong and stable currency should not be underestimated, particularly in tackling inflation and in encouraging infrastructure investment.
Since August, when we first recommended shorting US 10 year Treasuries (0.68%), yields have risen over 1% higher to 1.75%, before dropping back to 1.60%, marginally above our medium term target of 1.55%. We expected a spike up from our 1.55% target and, in client consultations, have said that from 1.75%, a correction lower could develop, with selling Volatility and Skew opportunities.
- Bund Volatility traded above 6.00% as futures capitulated late February, and is now 4.15%
- US TYA Volatility was also 6.00% at the peak, and is now back to 4.75%
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