Safe Inside The Bubble

In the new week, market participants will have the luxury of watching the outside world fall apart from the safe confines of a bubble protected by five-foot-thick walls of policy support.

Enshrouded by cumulus clouds of nebulous policymaker promises, traders and investors will likely float along on a sea of liquidity, undisturbed. Volatility is “deceased” and at least on one simple measure, markets haven’t been this tranquil since Janet Yellen’s short vol bubble.

The next scheduled event with the potential to make waves is Jackson Hole. Although the number of trading days between now and then is small, a couple of weeks can seem like an eternity in a sleepy summer.

Although US long-end yields rebounded from lows hit during the June-July growth scare, 10s appear to be stuck loitering around ~1.30%. Friday’s disastrous University of Michigan sentiment print marked something of a contrast with the previous Friday’s ebullient July jobs report.

Again and again, we’re left to confront what, superficially, appear as ironic juxtapositions. Treasurys bull flattened in the wake of a dour read on sentiment which was at least partially attributable to the highest inflation expectations in years. Of course, it’s actually not ironic. There’s no mystery. The bond market believes the growth implications of an ebbing consumer mood will outweigh any steepening impulse associated with inflation. But it wouldn’t be prudent to read too much into the situation. Futures volumes were just ~75% of the 20-day average late last week.

“With the July core inflation data incorporated into the outlook and the refunding effortlessly absorbed, there is little to argue for decidedly higher yields from here,” BMO’s Ian Lyngen and Ben Jeffery said, on the way to delivering a characteristically incisive take on the near- to medium-term outlook. “The strong jobs growth in July [was] encouraging, [but] the upside surely reflected hiring decisions made prior to the increase in COVID cases linked to the Delta variant,” they wrote, adding that “this reality only serves to further emphasize the importance of evaluating the employment landscape based on the September-November data, a timeframe that was already in focus due to the expiration of the enhanced unemployment benefits that is now less than a month away.”

Apparently, folks lack conviction (figure below).

To be sure, calls for higher yields haven’t been subjected to any wholesale abandonment. Far from it. Most view the past several months as a mere setback. Don’t forget: There was doubtlessly a “false optic” dynamic in play, as positioning unwinds exacerbated the drop in yields. You can’t always believe your eyes.

Many analysts are now looking for the reflation trade to find its footing, both in bonds and related equities expressions. JPMorgan’s Marko Kolanovic called a bottom for US yields, for example, and although TD’s Priya Misra revised her year-end forecasts for global rates lower, she maintained a higher rate trajectory based on an assumed “solid recovery despite risks from Delta,” $3-4 trillion in expected fiscal stimulus in the US by year-end and the announcement of a Fed taper in December.

“With 70% of Americans having received at least one COVID vaccine, we believe the odds of extensive lockdowns which impact growth are relatively low,” Misra said, adding that “while the market is likely priced for the $550 billion [infrastructure] package, we believe the long-delayed $3.5 trillion reconciliation bill is not being priced in, potentially pushing rates higher and leading Treasurys to underperform this fall.”

You can write your own script. To help you along, the new week brings Empire manufacturing, retail sales, housing data, Philly Fed and the July Fed minutes.

Oh, and if you had vacation plans involving Kabul, you may want to reconsider. Same goes for Florida.