Below is a piece we put together about a month ago that was sent around to our network. Given recent market action and the thesis still largely playing out, we decided to share it, which we are likely to do more of in the future. If you like the work below, feel free to subscribe to our mailing list at the bottom of the page.
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The probabilities of US rates falling materially over the next six to eight months are the highest of the cycle. While global equities and commodities have begun to price in slowing growth, US rates are marginally off the highs – with the 10-year trading at 3.06%. The disconnect is likely due to supply and demand worries surrounding the Fed’s balance sheet run off, expanding US fiscal deficits, and the lack of demand from European and Japanese investors as hedged yields turn negative.
We see these concerns being largely priced into the market; however, the following line items seem they are not:
China will continue to pressure the global economy, with no real signs of stimulus coming through the system until the back half of 2019 under the assumption they will be able to expand credit at similar historical rates
The US economy will slow materially due to crude oil pulling down industrial production, as well as higher interest rates weighing on the consumer and US housing
US and Global Excess liquidity will drag equities lower, resulting in a bid for bonds
The Federal Reserve will likely get cold feet and backtrack as they recognize the economy is slowing
CTA and momentum players should continue to cover their shorts, in turn flipping momentum positive
Technically, US bonds are bottoming and have very favorable risk reward profiles over the following months
Given the above, we assign an 84% probability to 10 year rates falling to 2.3% from 3.06% over the next 6-8 months, before pausing and ultimately moving lower if our thesis is correct. Below we outline this thesis and seek to disprove the current bear argument.
WHAT THE MARKETS ARE SAYING
A large part of our process is relying on factions of the market to give us a pulse of the global economy, as well as our thesis. Currently, many of these market groups and ratios are indicating that rates should be materially lower. We can see this domestically via US leadership, as defensive sectors like utilities and staples have been …read more