Lighting and Volt, Fed and yields

Mizuho Daily – Vishnu Varathan, Head, Economics and Strategy, Asia and Oceania Treasury Department, Mizuho Bank, Ltd.,

Who says lightning does not strike twice? Trump going down in history as the only US President to get impeached twice flies in the face of received wisdom. The more interesting point is that for reason of expedience, Trump’s impeachment was a work of curation; requiring lawmakers to look past a litany of potential misdeeds to only raise Trump’s incitement of the insurrectionist mob at Capitol.

The worry is that with the impeachment, Trump and Make America Great Again (MAGA) die-hards pose an even greater threat to security ahead of Biden’s inauguration.

Unbelievable as it sounds, it echoes Voltaire’s wisdom that “those who can make you believe absurdities can make you commit atrocities“.

But, there was nothing electrifying in the markets in response to with Trump’s second impeachment passed by the House. Partly as Senate Majority Leader McConell rejected an expedited Senate trial, which will now have to await Biden’s inauguration.

Politically, though the impeachment remains a lightning rod in a deeply divided country. After all, despite widespread denouncement of violence Trump supporters have not flinched.

The logical fallacies indulged in to deflect accountability on false premises of healing and unity are as rich as they are ironic.

Dangerous too! In Voltaire’s words, “the more often a stupidity is repeated, the more it gets the appearance of wisdom“.

Markets though are not swayed by partisan politics today, instead likely to be seduced by stimulus. Of which, Biden’s fiscal boost to a pandemic-stricken economy is one.

Crucially, the Fed’s guidance on keeping its pedal on stimulus (especially QE) through nascent recovery will be key in determining where UST yields head from here.

But, as Voltaire will warn, parsing policy talk, of for that matter the utterances of politicians, is not open and shut as “one great use of words is to hide our thoughts“.

And a slightly firmer USD (sub-1.22 EUR, pre-0.78 AUD stall, USD/JPY bounce towards 104 and USD/SGD above mid-1.32) despite slightly softer yields speaks to underlying caution.

Voltaire’s grim warning: “think(ing) money does everything, (we) end up doing everything for money” resonates with policy over-reach; as yields are dictated by Fed money.

Fed Stands in the Way of Sustained & Imminent Yield Surge

The recent swell in UST yields is not unexpected in the wake of vaccine optimism and “Blue Wave” fiscal boost expectations triggering reflation reaction.For the record, 10Y UST yields have surged ~30bps since December to as high as 1.15% in recent days; and remain elevated despite easing off highs (sub-1.1%) overnight.

But scope for further ascent in long-end UST yields is constrained by;

i) the pace of unfettered demand recovery expected ahead, corresponding to inflation expectations, and;

ii) the Fed’s shifts in policy calculus, determining UST-Inflation swap spreads.

With reflation from vaccine positives and stimulus hopes outpacing demand recovery, further upside in UST yields premised on inflation expectations is limited.

That is, unless distinct monetary policy shifts allow for UST yields to catch up. But this is unlikely to materialise before H2 or late-2021 given the lags of phased vaccine rollout and uncertainties about immunity temper and interrupt demand recovery; which in turn will invariably defer any shift in Fed stance given the abundance of caution.

The upshot being, the Fed stands in the way of sustained and imminent restoration of 10Y UST yields to 1.5-1.8%, which may be phased over Q3/Q4 2020 (assuming adequate recovery); with 2% ascent contingent on Fed taking its foot off the QE pedal.