The market is still digesting the information released by the Jackson Hole Global Central Bank Annual Meeting last week.
Fed Chairman Powell announced the result of the Fed’s policy framework reform at the time-focusing on average inflation (AIT), that is, changing the 2% inflation target into a long-term average 2% target. In the future, it will not be based on the job market to decide whether to raise interest rates or no.
Wall Street interprets this as a currency revolution of "stealing the merits".
The Fed silently revised the dual mission entrusted by Congress to maintain price stability (to achieve the 2% inflation target) and full employment.
When the policy anchor changes, the basis for asset allocation will also change dramatically, and the market can no longer make investment decisions through simple inflation and employment indicators.
"The stocks seem to be satisfied with the Fed’s implied promise to keep interest rates low for a long time, but the sharp fall in long-term U.S. debt seems to mean that the bond market rarely mentions Powell about asset purchases, yield expectations, or extended asset purchase durations. Disappointed. Driven by the simultaneous rise in inflation expectations and real yields, nominal yields have risen, while the U.S. Treasury yield curve has steepened due to the remote rise,” Standard Chartered Global Chief Strategist Eric Robertsen told China Business News. The reporter said, but the Fed will not be satisfied with the continued rise in yields, which will increase the pressure on debt interest payments.
The market is waiting for the Fed to give more details at the FOMC interest rate meeting on September 16.
Low interest rates and asset purchases will grow into long-term portfolios
According to calculations by Bank of America Merrill Lynch, if the PCE inflation rate remains at 2.1%, the Fed may be required to maintain the 42-year low interest rate level unchanged.
Mainstream institutions believe that this change in the policy framework means that low interest rates and asset purchases will form a longer-term policy portfolio.
Because it is not easy to increase inflation, and the challenges are increasing.
“Considering that there is a huge gap between actual inflation and the Fed’s 2% target, the Fed needs to redouble its efforts to achieve inflation overshoot. The Fed has not succeeded in achieving the inflation target for most of the past 10 years. Only in 2012 In the two brief periods of 2018 and 2018, the core PCE increased by more than 2%. Even in the extreme exception of 2018, the core PCE only maintained a level of 2.2% for a few months. Now the growth prospects are getting more difficult." Robertson said.
Another challenge is that the outlook for global inflation remains equally bleak.
The Asian economy, including China, accounts for two-thirds of global growth, but the region’s inflation rate is still extremely low.
For countries such as South Korea, Singapore and Malaysia, deflation is a more direct risk than inflation.
These all pose challenges for the Fed to increase inflation.
"The Federal Reserve announced the AIT, but did not promise to control long-end yields through yield curve control (YCC) or yield caps, which indicates that long-end interest rates may rise in line with inflation expectations." Morgan Stanley's chief US stock strategy Teacher Wilson (Michael Wilson) said.
Last week, the 10-year US Treasury yield jumped from around 0.6% to around 0.78% in one fell swoop.
Although inflation expectations have increased by 125 basis points (BP) from the lows in March this year, to maintain, the Fed needs to fulfill its promises. "We believe that the Fed’s new promise means that it will maintain policy interest rates at 0 and continue Expand the balance sheet until inflation reaches at least 2%," Robertson said. "We think the Fed is working hard to complete the new average inflation target and hope to make plans in the next two weeks."
Low real yields are bad for the U.S. dollar, bullish cyclical stocks and gold
Changes in inflation are of course important, and changes in actual bond yields are more critical for investment decisions, because the actual yield level will have a significant impact on stocks, bonds, and foreign exchange.
Whether the Fed will allow a substantial increase in bond yields because of this goal is another key, but most people think that the answer is no, because doing so will lead to a rapid increase in the interest cost of rising debt, which will increase inflation. Another side effect.
The economic recovery of many economies, including the United States, from the epidemic crisis depends to a large extent on easy financial conditions, which means that the yield of corporate bonds needs to be kept at a low level, and the spreads are narrowed. This means that mortgage interest rates remain low.
Standard Chartered believes that this is particularly important considering the significant increase in bond issuance by corporate and government issuers. It is estimated that in 2020, the net issuance of U.S. Treasury bonds will reach approximately US$4 trillion and US investment-grade bonds will reach US$2 trillion.
If the Fed wants long-term financing costs to be kept low to support the economy, it may need to expand its asset purchases.
Therefore, Robertson believes that the Fed needs to maintain a balance, not only to increase the market's implied inflation expectations, but also to reduce the actual rate of return, so as to keep the nominal rate of return at a low level, which means more asset purchases and forward guidance.
The actual negative returns will keep the dollar under pressure and support easy financial conditions.
As far as the foreign exchange market is concerned, the weak dollar is likely to continue.
The U.S. dollar index closed last Friday near the low of the week and the lowest level of 92 in 2020. It can be seen that the foreign exchange market seems to be more convinced that the Fed’s commitment to higher inflation will pressure actual earnings rather than trigger a surge in yields.
"After a period of adjustment, the euro, the Australian dollar and the British pound seem to continue their upward trend. The Australian dollar closed at a two-year high against the U.S. dollar last week. The euro rose above 1.20 against the U.S. dollar, which is its two-year high. It is approaching an 8-month high. The dollar has fallen by more than 10% from its March 23 high. We believe there will be more downside, and it is expected to depreciate at least 5% to the 2018 low." Robertson Said that although Asian currencies did not appreciate much against the U.S. dollar, the trend began to expand. For example, after a short period of consolidation, the U.S. dollar/CNY has approached 6.8, while the U.S. dollar/Indian rupee fell by about 2% to below 74 last week. .
The judgment that the actual rate of return is down rather than up means that gold still has a chance.
Recently, gold has fallen into a wide range below 2,000 US dollars per ounce, but the agency believes that 1900 US dollars per ounce is still a solid support level and it is expected that gold will resume its upward trend.
As far as the stock market is concerned, the outside world does not currently think that US stocks, which have reached new highs driven by technology stocks, will be disturbed too much.
At the same time, Morgan Stanley believes that early-cycle sectors such as banks will usher in opportunities.
Because the 10-year U.S. Treasury yield is so low, it is only natural that bank stocks underperformed before, but the magnitude of the underperformance has far exceeded the correlation between bank stocks and U.S. debt.
Morgan Stanley's interest rate strategy team predicts that the 10-year U.S. Treasury yield will be 1.3% in June 2021. If measured by the current correlation, the performance of bank stocks will change from the current -40% to next year +30% in June.
Although if Biden is elected president of the United States, banks may face stricter supervision, but in fact, the supervision of banks has not been substantially relaxed under Trump.
The U.S. and China monetary policy cycles continue to diverge
For China, this means that the US and China monetary policy cycles will continue to diverge.
The last round of Sino-US monetary policy differentiation occurred in 2015, but the trend is exactly the opposite of the current one.
At the beginning of 2015, the US-China interest rate differential was approaching a high of 200BP. At that time, the Fed was in the stage of planning to raise interest rates after cutting interest rates to zero since the financial crisis (the first rate hike in December of the same year), while the Central Bank of China started due to the huge stock market shock and fluctuations in exchange rate reform. After the easing cycle, the Sino-US interest rate gap narrowed to only 50BP at the end of 2016.
Since the beginning of this year, the spread between China and the United States has rapidly increased to around 250BP, reflecting the fundamental differences between the two countries.
After deleveraging in May and June, the People's Bank of China has been cautious in terms of quantity and price in liquidity operations since July.
Recently, China’s government bond yields are still trending upwards. Bond traders generally told reporters that the current funding situation is tight and the meaning of “debt bears” seems to be getting stronger.
On August 25, China's 10-year government bond yield broke through 3% again, and the 10-year government bond’s main contract fell 0.44% to 97.935 yuan, a record low since January 9.
Another focus of the current market is the issuance of new bonds for a period of time in the future. If the supply of government bonds does not decrease or even increase, the secondary market will be under pressure.
In addition, the Central Bank of China continues to carry out the 14-day reverse repurchase operation, which has caused the market to worry about the central bank's shortcomings, increasing the overall cost of funds, and disguised "interest rate hikes".
However, the agency believes that the current time has not yet come for a significant shift in monetary policy, and the central bank's continuous large-scale liquidity investment will gradually ease the pressure on funds. The fall of the month-end funding interest rate from the high point may reverse the market’s "interest rate hike" expectations and concerns. 10 The yield of annual Treasury bonds may fluctuate in the range of 3% to 3.2%.
A-shares will continue to be sought after by foreign investors due to their higher yields, and the trend will continue. However, institutions believe that it is necessary to pay attention to changes in liquidity expectations and disturbances caused by the increase in the number of IPOs. Future performance will become the main driving factor.
Author: 4. Alina Cho