THE CAPITAL OBSERVER

Fixed Income Related Articles 2017 

January 2017 (published on the 17th January)

As the economy decelerates, Bond Yields should top and start to retrace (p10-11)

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We then expected that the H2 2016 rise in interest rates was nearing the end of a first leg up, and that there seemed to be limited potential left on short term tenures, while, the long end could extend into late February / early March resulting in the yield curve steepening a bit further. In general the above was very correct and out of consensus at the time, although on the Bund, it was slightly too negative (the Bund bounced in February and made slightly higher lows early March).

March 2017 (published on the 22nd March)

Mild flattening of the Yield Curve, before it steepens again in H2 2017 (p7-11)

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We then believed that we had reached the eye of the storm as far as reflation goes, and expected some retracement of reflation trades until late Q2 2017 (oil, long term yields, yield curve). Following that, we then expected that a second leg of the reflation trend should materialize in H2 2017 (“Reflation II”), fueled by a new rise in oil prices, a weakening Dollar, higher inflation expectations and a maturing business cycle. We believed it should ultimately lead to further steepening of the yield curve (which has been weak, as the DIP in reflation trades and the yield curve spread was eventually deeper than we had anticipated. However, in general, the projection was very forward looking, and warned readers of the retracement to come on the yield curve spread and long term yields).

April 2017 (published on the 28th May)

The Yield Curve may flatten further before it bounces later in H2 2017 (p41-43)

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We expected the Yield Curve to continue its rapid flattening into midyear, possibly making a low towards late June, July or even August (it was ultimately December, but the general direction was correct). US 10Y yields was then holding up slightly better, yet we then pointed that they needed to hold 1.9% to justify a linear continuation of the uptrend initiated in 2016 (these levels were almost tested in early September 2017 and that support point pretty much sparked the rally into year-end). Shorter term, we were expecting a bounce on US10Y yields and the Yield Curve that could last a week to 10 days, which was very correct. Finally, looking at the US Equity to Bond ratio, this scenario was associated with a risk-off period between early/mid May until end June (which was rather flattish in the end – line consolidation from Mid May to end June).

July 2017 (published on the 28th July)

Yields and the Yield Curve remain soft until September, yet the downside is limited from here (p20-24)

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We had seen US 10 Years Treasury Yields have started to react up in June, yet believed that they could still retest during the Summer probably within their recent range. From late August / September onwards, we expected them to accelerate up until early 2018. German Yields confirmed this positive picture following some retracement into August. The US 10Y – 3M spread had flattened aggressively since December and was then testing last year lows. We believe that it had reached a “Low Risk” situation that should see it rebound into 2018 (we expected one last downside retest into August). We were correct in identifying the late August / September turning point on US long term yields, although still too aggressive in calling the re-steepening of the yields curve from late August /September (that said, as of end July, we will still expecting more flattening during August).

August 2017 (published on the 30th August)

The reflation trade is still bouncing-off and retesting its retracement lows, the bottoming process could extend into late October / November (p11-14)

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We were expecting that US long term yields, (US equity market) or High Yield Bonds may be getting ready to bounce into September (very correct). Yet, this move up on yields may be relatively short lived. It could start to reverse back late September and re-test lows into end October / early November (too conservative, it topped late October and then consolidated at high levels into late November). Meanwhile, we expected (US equity and) US High Yields to extend up into early October and even make new highs. That said, their Risk/Reward was stretched and we also expected a new risk-off period for them into late October / early November (on High Yield the bounce into October almost made new highs and then corrected sharply into mid November). More generally we correctly identified the support point and the following bounce on yields late August / early September.

September 2017 (published on the 29th September)

Reflationary assets may retest down in October, but should re-accelerate up towards year-end (p20-25)

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Although we expected Inflation breakevens (TIP/IEF ratio) and Credit (HYG/LQD ratio) to resume their uptrend towards early 2018 (which was very correct), we were still expecting the yield curve to flatten a bit further, possibly until late October/mid November (it was ultimately December, even January on the US10Y-3Y spread, yet the direction was correct) . We thought that both tenures, US 10Y and US 3Y, would correct down until November, but that previous lows would probably hold on both the tenures, or at worse be slightly broken. This was incorrect on the US3Y, which continued up. The US10Y topped out slightly higher late October and then consolidated back down to its late September levels (in the end the US10Y was pretty much flat between end September and late November).

November 2017 (published on the 1st November)

The Yield Curve is still flattening, yet a short term bounce may materialise from late November into early 2018 (p 20-27)

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The US Yield Curve was still flattening and we expected that it may continue to do so over the coming weeks (which was correct). More generally, the US Yield Curve may continue to flatten well into 2018. Shorter term however, it may now find an intermediate low mid/late November (still a bit premature) and initiate a 2 to 3 months bounce (which may have started to materialise between December and January). We still believed that both the US3Y and the US 10Y could retrace some towards the levels last seen late September 2017 (this was pretty much the case on the US10Y, but the US3Y continued up).

December 2017 (published on the 4th December)

The Yield Curve is temporarily Oversold, it should bounce into Q1 2018, at the latest from early January (p20-25)

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We believed that the Yield Curve was heavily Oversold, and our Weekly and Daily graphs suggested that an intermediate low was then being made. We would expect a bounce that could last into February / March. It may take until early January to really get started (a bounce did indeed materialise during this period). On US10Y and US3Y Yields, we had expected an intermediate top mid December, some retracement until early January and then an re-acceleration into end February / March with a target towards 2.6 – 2.8% range on the US10Y (this was less aggressive than what actually materialize, but at the time was already much more aggressive than consensus).

January 2018 (published on the 10th January)

Since September, Inflation and Growth expectations have finally been pulling long term rates up, how long is this uptrend sustainable? (p18-23)

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For Q1, we were still very positive on the reflation trade (less so today as of end February). That said our bullish projection on yields was very correct: we expected an environment of rising yields (towards 2.8% on the US 10Y), accompanied by rising inflation breakevens (TIP/IEF). Our expectations for rising equity and probably a stronger US Dollar were incorrect for now. Our perspective for Q2 are still split between two scenarios, one where markets start to distribute, US equities and yields first correct down, then re-retest up towards mid year, yet will not necessarily make new highs, the other, where the reflation trade follows through relatively unscathed into Q2, and ends with a late cycle Commodity blow-off, with US 10Y yield reaching above 3% (still open for now). In general, the article was very correct on the fixed income side, yet the cross asset consequences of the rapid rise in interest rates and inflation expectations were not fully anticipated.