The Rearview Mirror: February 2018


The starting point is the GDP data released by Commerce Department on Friday: the US economy grew up 2.6% in the last quarter of 2017 below the 3% estimated by analysts but reinforcing the solid growth pattern. On top of it, some categories of the GDP are, by definition, more volatile. In particular, the difference between imports (13.9%) and the less reactive exports (6.9%) dented the overall measure as well as a fall in inventories was a negative contributor.

Havin said that, the following price action suggested a very optimistic mood for risky assets. The US indexes recorded new highs, also due to the superior performance of Tech and Health Care names. Investors are starting to price in the Tax Reform benefits meanwhile several CEOs are planning to increase their investments. On the other hand, the US government curve continued to slowly reprice a higher yield scenario, but still it is the short end that appears to be more reactive, pricing already 2.5 rate hikes for the 2018. The long-end still sluggish to incorporate higher inflation expectations and higher structural growth.

But the situation could rapidly change.
Here below we identified 3 main reasons why we could experience a steepening of the yield curve.

a) Pressure dynamics into the job market. Although companies are planning to invest in more machinery and robots in order to boost their productivity, the upcoming data could reiterate a trend that will push the unemployment rate even below 4%. Overall, it is getting harder and harder to find new qualified employers. The average hourly payment should benefit from these dynamics and consequently push higher the inflationary expectations.

b) Technical triggers related to the issuances plan of new debt. At the moment, the risk is mispriced and in some way undervalued for the long-end of the Treasury curve. According to the several banking studies, any increase of more than 1bn dollars for the 10s and 30s buckets of the curve for the upcoming auctions would cause a steepening effect. Hence, the combination of the reduction of the FED balance sheet within the increase of fiscal deficit, could ample the need of financing with long maturity.

c) Without talking about the commodities effect, which now is clearly affecting the price pressure but can suffer some volatility due to a possible dollar appreciation, I would like to focus on something that is already signaling an alert. The difference between the 30yr Treasury and the correspondent fixed rate of 30yr interest swap rate is narrowing. Precisely the swap spread is highlighting the fear perceived by investors of greater issuances.

To sum up, if the economic data are still supportive, with a fiscal cut and deregulation that is approaching to the market, the equity will continue to benefit until we do not experience a full repricing of the yield curve that could undermine the pile of debt of single corporates.

 Christian Zorico: LinkedIn Profile

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