iFund- A upside skew in short-term yield

2019-03-19 10:20
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We believe there is a clear upside skew to short term yield. Until Fed change its reaction function, we favour short duration and money market instruments.

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In December, every investor believed Powell is a white knight for financial markets. But anyone hoping that the FOMC would ride to the rescue of investors was surely disappointed by December’s policy announcement. True, the Fed has changed its growth forecast from 2.5% to 2.3% in 2019. Investors have been too optimistic about the rate hike path, suggesting that front-end yields were indeed mispriced.

Fed Dot Plot and Market Expectation (%)

Data Source: Noble Apex Advisors Ltd./iFund; Bloomberg

Fed overweight labour market than financial condition

If investor read whole the statement of FOMC meeting, it is easy to see why the Fed did not change much about its policy projection. The Fed believe economic activity that is “rising at a strong rate” and inflation forecasts that are “little change”. The tighten labour market and increasing wage growth suggest it continue its rate hike cycle.

Financial conditions are also an input into Fed’s macroeconomic models. Recent tightening has had an impact on those models’ output. However, Fed reactions are a lot more modest than most investors would like to believe.

The Fed do not care about your P/L

Although the statement and Powell’s comments affirmed that they are watching markets and how they impact the trajectory for the economy, it does not mean the Fed care about individual’s gain and loss. The Fed focus point is in broad terms.

The Fed did not respond to a modest forecast downgrade with a large downshift in policy expectation. That would have denoted a changing marginal reaction about how to react in different economic backdrops. Fed can still under deliver on the dot plot but it is going to take a further forecast to get there.

How to read Fed message in 2019?

There are always risks to an economic forecast, and it is surely the case that the skew of those risks may shift. If those risks materialize, the forecast will change again. The slowing growth rate may not sufficient for the Fed stopped its step in 2019.

It is more difficult to change the reaction function. Two reasons above may lead the Fed hawkish than market expected. We believe there is a clear upside skew to short term yield. Until Fed change its reaction function, we favour short duration and money market instruments.

3 Months Libor


Data Source: Noble Apex Advisors Ltd./iFund; Bloomberg

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