Negative Real 'Safe Asset' Returns - Will the FED blink?
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Let’s get into it.
Short note today
The FED are in a tricky spot. OIS Curves are inverted.
2s10s OIS
5s30s OIS
The bond market isn’t reacting, as it has previously, to the withdrawal of liquidity. Top panel: 10y OIS Bottom panel: 2y Rate of Change in the FED Balance Sheet
The normal correlations to higher rates like bank outperformance have stalled suggesting rates moves are becoming destructive within the economy.
White Line: KBE/SPY Blue line: 5y UST Yield
This recent leg in rates seems to be a material surge in inflation expectations (TIP/IEF) relative to where the underlying economy is trading (JNK/IEF). Blue line: TIP/IEF White Line: JNK/IEF
Another way to look at this is looking at ISM New Orders (top panel) peaks and troughs vs. 10y OIS (bottom panel)
This is putting financial asset market returns under significant pressure. Below is a chart of the Vanguard Retirement Income Fund deflated by Core PCE (top panel) and the lower panel is the 1y Rate of Change.
Every one of these arrows have been a FED pivot or the end of a rate hike cycle
Summer 2006 - End of 04-06 Hiking Cycle
2008 - Rates cut to 0
2016 - Yellen pivots and pauses hiking cycle after 1 hike
2018 - End of 15-18 Hiking Cycle
2020 - Rates cut to 0
2022 - TBC
This scenario is forcing investors to underweight fixed income and overweight cyclicals to compensate currently. Given that rates now seem to be having a detrimental effect on the underlying economy - this seems like a highly risky position.
Yet if the FED were to pivot today - there is a risk that the market expectations for inflation could become unanchored.
Cash is trash and the market is sitting on a lot of it.
This leaves precious looking quite interesting in my opinion. Gold/ADXY
Good Luck