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The Weekly Track halfway

- The Weekly Track - Halfway by Bob Savage
http://track.com/articles/the-weekly-track-halfway/

Make hay when the sun is shining. Central Bankers are responding to the coordinated global recovery by talking up rate normalization perhaps in hope of changing rates ahead of the next crisis. Moving from QE and negative rates to having a rate cushion sufficient to offset the next shock tests the belief in markets returning to normal where liquidity traps no longer dominate trading. The US Fed got ahead of this process and is near its level for “normalization” seen by many as 1.5% - halfway to 3% terminal rates. The balance sheet normalization is another thing to consider but that has yet to start and its effect on bonds is unknown. The lessons for the rest of the negative interest rate nations will be in shifting slowly from forward guidance to data dependency to rate normalization. Defining the half-way point matters to everyone but how to set that market seems more art than science. The role of wage inflation and NAIRU, labor productivity and demographics, rea
l potential growth and output gaps – all these factors play a role in setting the right level for new normal rates globally. What this means for the US markets is that divergence that supported US bonds and the USD is shifting. Many see the next 2 months as an excuse to further unwind the “risk-parity” trade. Lower volatility has promoted excessive holding of longer duration bonds, higher risk equities and the carry trade. Central bankers promoted that low volatility with their NIRP and forward guidance to keep it there. This last week changed the paradigm and makes the search for halfway more than one about the 2017 calendar. The facts and figures that artificially set the marks still matter but need to be seen through the new lens of normalization. Notable in this narrative is the shift away from politics as the driver for uncertainty. The hope for a fast shift up in growth aided by fiscal stimulus and deregulation has passed like the Spring rains. The new hop
e is that EM will support any slowing in DM. The heat is on now for the present set of politicians to deliver anything – which means the summer ahead will be focused on French President Macron getting labor reform started, UK PM May will be judged by the Brexit talks, US Congress by its ability to get anything done before the August recess and US President Trump by what he does with trade talks from NAFTA to the threat of Steel Tariffs. The upcoming G20 discussions next week will be seen as the start for all of these political drivers and how they interact with markets and central bankers. The hope for 3Q rests on the balance of growth from EM and stability from DM allowing investors to climb the wall of worry.