Sunday 29 April 2018

Macro and Credit - The Seventh-inning stretch

"It's easier to resist at the beginning than at the end." -  Leonardo da Vinci

Watching with interest the better than expected US 1st quarter GDP print up 2.3%, vs 2.0% expected despite a slowdown in consumer spending, with wages and salaries up 2.7 percent in the 12 months through March compared to 2.5 percent in the year to December, and (PCE) price index excluding food and energy increasing at a 2.5% being the fastest pace since the fourth quarter of 2007, leading many pundits to usher more and more the dreaded "stagflation" growth (real negative growth), when it came to selecting our title analogy we decided to tilt our choice towards a baseball one given the growing signs of the lateness of the credit cycle. The Seventh-inning stretch is a tradition in baseball in the United States that takes place between the halves of the seventh inning of a game. Fans generally stand up and stretch out their arms and legs and sometimes walk around. As to the name, there appears to be no written record of the name "seventh-inning stretch" before 1920, which since at least the late 1870s was called the "Lucky Seventh", indicating that the 7th inning was settled on for superstitious reasons. While all thirty Major League franchises currently sing the traditional "Take Me Out to the Ball Game" in the seventh inning, several other teams will sing their local favorite between the top and bottom of the eighth inning. In the current state of affairs of the credit cycle, as we pointed out in our last musing, the debate on where we stand in regards to the credit cycle is still a hotly debated issue particularly with the US 10 year Treasury Notes passing the 3% level before slightly receding as of late.

In this week's conversation, we would like to look at potential headwinds for credit markets in the second half of 2018 given the markets have become much more choppier in 2018 thanks to higher volatility and rising yields. 

  • Macro and Credit - Switching beta for quality? 
  • Final chart -  More and more holes in the safe haven status of the CHF cheese

  • Macro and Credit - Switching beta for quality? 
As we pointed out in our early April conversation "Fandango" when we quoted our friend Edward J Casey, Flows and outflows matter more and more as many are dancing closer and closer towards the exit it seems in this gradually tightening environment thanks to the Fed's hiking path. Rising rates volatility have whipsawed credit markets in 2018, upsetting therefore the prevailing "goldilocks" environment which had been leading for so long in credit markets thanks to repressed volatility on the back of central bankers meddling with asset prices. With rising dispersion as we have pointed out in our recent musings, credit markets have become more choppy and less stable to that effect, more a traders market one would opine. It has become therefore more and more important as pointed out by our friend to monitor fund outflows but as well foreign flows coming from Japanese investors to gauge the appetite of investors for specific segments of the credit markets. It appears to us more and more that there is somewhat a growing rotation from high beta towards more quality, moving up the ratings spectrum that is.

When it comes to assessing flows, we read with interest Bank of America Merrill Lynch's Follow The Flow note from the 27th of April entitled "Pressure On, Pressure Off":
"Another week of the same? Not exactly.
While HY and equity flows remained on the negative side it seems that the "risk off" flows trend is turning. Last week’s outflow from government bond funds was the first in 15 weeks.

Note that the asset class has seen a significant inflow trend so far this year on the back of the rise in yields and but more importantly on the back of a bid for "safety". With rates vol still close to the lows and spread trends improving on the back of a more moderate primary and with geopolitical risks and trade war risks moderating, we think that high grade fund flows trends are set to continue to improve.
Over the past week…
High grade fund flows were positive over last week after a brief week of outflows.
High yield funds continued to record outflows (24th consecutive week). Looking into the domicile breakdown, US and Globally-focussed funds have recorded the vast majority of the outflows, while the European-focussed funds flow was only marginally negative.
Government bond funds recorded their first outflow in 15 weeks and the second of the year. All in all, Fixed Income funds flows were negative for a second week.
European equity funds continued to record outflows for a seventh consecutive week. Over those seven weeks, the total withdrawal from the asset class funds was close to $19bn.
Global EM debt funds saw outflows for the first time in four weeks. Commodity funds on the other hand continued to see strong inflows for a fourth week.
On the duration front, long-term IG funds were the ones that suffered the most last week, as outflows were recorded on that part of the curve. Mid-term and short-end funds both recorded inflows." - source Bank of America Merrill Lynch
Are we seeing the start of a risk-reduction trend in high beta namely high yield in favor of quality, namely investment grade thanks to the support of foreign flows following the end of the Japanese fiscal year with investors returning to US shores on an unhedged currency risk basis? We wonder.

It would be hard not to take into account the change in the narrative given the Fed is clearly becoming less supportive, though we would expect Mario Draghi to remain on the accommodative side until the end of his tenure at the head of the ECB. While clearly credit markets investors have recently practiced a "Seventh-inning stretch" as we pointed out last week, we do not think the credit cycle will be decisively turning in 2018 given financial conditions remain overall still very loose.

But, no doubt that the credit game is running towards the last inning with leverage above average and credit spreads at "expensive" levels particularly in Europe where as of late Economic Surprises have experienced a significant downturn. On the subject of leverage and inflows into credit markets we also read with interest Société Générale's Equity Strategy note entitled "Rising yields and debt complacency spell trouble for equity markets" from the 23rd of April:
"Leverage is high as spreads have narrowed substantially
Both in Europe and in the US we observe that leverage levels are above their respective historical averages. While on a net debt to EBITDA ratio, US companies (1.6x) appear less leveraged than European companies (2.0x), both regions are at levels only seen during the worst of the TMT bubble (2001-03), or the financial crisis (2008-09). Indeed, it seems as though companies have tried to take advantage of the low yield environment by leveraging their balance sheets (Apple is good example of this). However, while the balance sheet of an IT company is not significantly at risk from higher bond yields (cash rich), some other segments of the market may be more at risk.
Since 2009, the corporate bond market has benefited from massive inflows. Despite the change of volatility regime and releveraging of corporate balance sheets, credit spreads are still ultra low. SG credit strategists expect more challenging conditions for the credit market in the second half of the year, with the end of the EU’s Corporate Sector Purchase Programme (CSPP) and rising government yields.
Mutual Fund Watch - exceptional outflows from credit
The latest outflows from European credit funds are exceptional in the sense that they mark a clear break from previous trends. This is easily observed in the charts below: the four-week trailing series are well below zero (overall net outflows over the last four weeks) and have crossed the lower band of two standard deviations below the long-term average. That is exceptional, especially given that we find the same picture in the US.
The outflows from European credit funds follow a similar pattern to that seen in the US. The four-week trailing series for the US have also fallen below zero (overall net outflows over the last four weeks) and have crossed the lower band of two standard deviations below the long-term average. In the case of investment grade (IG) credit funds in the US and Europe, the turnaround comes after a prolonged period of strong cumulative net inflows. The series therefore appears to be peaking at very high levels.
- source Société Générale

As we discussed on many occasions on this very blog, when it comes to US credit markets foreign flows matter, particularly flows coming from Japan. During the hiking period of the Fed in 2004-2006, Japanese Lifers and other investors gave up FX risk and took one more credit risks. Given the start of the new fiscal year in Japan, it is paramount to find out their intentions in relation to their foreign bond appetite. On this particular point we read another Bank of America Merrill Lynch note from their Credit Market Strategies series from the 27th of April entitled "Drinking from the firehose":
"Unhedged foreign bonds for life
Every six months Japanese life insurance companies update on their investment plans for the half of their fiscal years that just started. Hence we have now heard plans for the fiscal first half that began April 1st (Figure 10).

The color is very much consistent with last year and our discussion above – to reduce yen holdings in favor of foreign holdings and alternative investments (see our most recent updates: Foreign bonds for life 26 April 2017, Lifers on the hedge 24 October 2017).
Increasingly Japanese lifers plan to directly reduce currency-hedged foreign holdings, explicitly due to the rising cost, which should lead to more selling of shorter-maturity US corporate bonds (than have rolled down). That translates into increasing currency-unhedged holdings of foreign assets, which means an up-in-quality shift in Japanese
Reaching for investors
The recent spike in interest rates to 3% on the 10-year is the bond market reaching for investors (Figure 11).

While we have no real-time information on domestic insurance and pension buying – which we expect is increasing - we have detected a significant acceleration in foreign buying the past seven business days (Figure 12).

On April 17th our measure of foreign buying was down 59% year-to-date compared with the same period last year - but by now the decline is just 46%. In fact foreign buying over the past seven days is the strongest we have seen since February last year (Figure 13).

Of course, since a lot of this foreign money is likely currency unhedged (see: Unhedged foreign bonds for life 23 April 2018), which comes from a smaller budget, there is a limit to how long this pace can persist. However, increased yield-sensitive buying gives hope that the market is going to be better able to absorb the big seasonal increase in supply volumes we expect in May. This especially if inflows to bond funds/ETfs do not continue to deteriorate (Figure 14).
Defensive flows
US high grade fund and ETF flows weakened for risk assets such as stocks, high yield and EM bonds this past week ending on April 25. On the other hand inflows increased for safer asset classes such as high grade and government bonds. The overall impact on overall fixed income was a decline in inflows to $3.12bn from $4.36bn. For stocks flows turned negative with a $2.43bn outflow following two weeks of inflows, including a $6.23bn inflow in the prior week (Figure 15).

Inflows to high grade increased to $3.33bn from $0.86bn the week before. Inflows increased across the maturity curve, rising to $1.16bn from $0.26bn for short-term high grade and to $2.17bn from $0.60bn outside of short-term. Most of the increase was from ETFs that tend to be dominated by institutional investors. ETF inflows rose to $2.48bn from $0.38bn. Inflows to funds increased more modestly, rising to $0.85bn from $0.47bn (Figure 16).

Inflows to government bond funds were higher as well, coming in at $1.66bn this past week, up from a $0.85bn inflow in the prior week. High yield, on the other hand, had the largest outflow since February of $1.60bn, compared to a $2.67bn inflow the week before. Similarly inflows to leveraged loans weakened, decelerating to $0.16bn from $0.49bn, while global EM bond flows turned negative with a $0.72bn outflow following a $0.61bn inflow a week earlier. The net flow for munis was flat, up from a $0.68bn outflow in the prior week. Finally, money market funds had a $3.16bn inflow this past week after a $31.57bn outflow a week earlier." - source Bank of America Merrill Lynch
If the trend is "your friend" then it seems that it is becoming more defensive in credit markets, with rising dispersion on the back of investors becoming more discerning when it comes to their credit risk exposure. We might have seen a "Seventh-inning" stretch, but when it comes to earnings for Investment Grade credit, the results so far have pointed towards a notable acceleration in earnings growth, supported as well by a weaker US dollar benefiting the global players. 

The big question on our mind in continuation to what we posited last week is relating to the might overstretched short positioning in US 10year notes. We indicated in our previous musing "The Golden Rule" the following when it comes to our MDGA (Make Duration Great Again) stance:
"We don't think yet with have reached the "trigger point" making us bold enough to dip our investing toes into the long end of the US yield curve particularly as we are getting closer to the 3% level on the 10y Treasury yield" - source Macronomics, 22nd of April 2018
We continue to watch this space very closely, given the short-end of the US yield curve is becoming more and more enticing with the return of "Cash" being again an asset in a more volatile environment, we continue that the Fed's control of the long end is more difficult to ascertain. The most important question that will be coming in the next quarters as the Fed continues its hiking path will be about substituting credit risk for interest risk. Bank of America Merrill Lynch in their High Yield Strategy note from the 27th of April entitled "When Rates Arrive, Credit Risk Leaves":
"This week marks the second time in this credit cycle that the 10yr Treasury yield has touched on 3%. The previous instance was in Dec 2013, when the benchmark peaked at 3.02%, before turning the other way and rallying all the way to 1.36% by mid-2016. We continue to believe that the 10yr yield struggles to go higher from these levels and remain willing holders of some incremental duration risk.
One of the arguments around rates here with the 10/2yr yield curve at 50bps is that historically the Federal Reserve has refrained from intentionally inverting yield curve into deeply negative territory. We can observe such a behavior in Figure 1 on the left, where we plot the fed funds rate against the 10yr Trsy yield, or Figure 2 on the right where the former is plotted against the 10/2yr yield curve itself.

Regardless of the angle we take, the picture appears to be convincing in that over the past three policy tightening cycles, the Fed tried hiking once, or at most twice into a flat yield curve, and then it would cease further action. We think it is both natural and reasonable to expect this behavior to be repeated in the current policy tightening episode.
And if that is the line the Fed is unlikely to cross then our distance to that line could be only 3-4 hikes away from here, with the benefit of doubt that the curve does not flatten basis point for basis point of each hike. In this case, the Fed’s own longer-term median dot projection, at 2.75% or 4 hikes from here, may be closer to reality than it gets credit from consensus, which prices in 5-6 hikes.
A different aspect of the question on positioning between credit vs interest rate risk could be gleaned from Figure 3 and Figure 4 below.

These two graphs help us contrast the opposite extremes on the risk spectrum: the one on the left plots proportion of total BB yield contributed by its rates component, while the one on the right shows proportion of CCCs OAS coming from distressed credits. The two datasets are naturally inversely correlated (r = -30%), although they measure non-overlapping parts of the credit space.
Extreme observations on these graphs help us calibrate our risk allocation scale between heavily weighting rate duration risk or credit risk. Naturally, there is rarely a choice that includes both simultaneously, except for valuation deviations in smaller market segments. In the grand scheme of things, investors are mostly facing a choice of one over another.
So for example, between 2009 and 2016, rates represented only a modest part of overall BB yield, suggesting that their proportion could increase through either rising rates into stable spreads or tightening spreads into stable rates. In either case investors would be better off by overweighting credit over interest rate risk exposures.
Figure 4 further provides an additional layer of precision by highlighting extreme peaks of distressed contributions to CCCs spreads, which occurred in early 2009, late 2011, and early 2016. In all three cases, of course, an overweight in credit risk was the optimal strategy.
The opposite was true in early 2007 or late 2000, when both lines were at the other end of their historical range (i.e. an outsized contribution from rates to BB yields and modest contribution from distressed to CCC spreads). With the benefit of hindsight, both extremes provided clear signals to overweight the rate over credit risk.
Even when the lines were not at their extremes, in early 2011 or late 2014, they were leaning on the side of being long rates over credit. In other words, when rate risk dominates the picture, credit risk tends to fall into obscurity. Our preference is to lean against such consensus views, all else being equal, i.e. we would be inclined to take on relatively more risk that is on everyone’s mind, and take less risk that is out of scope and thus probably underpriced.
Today, both lines are tilted on the same side of distribution, i.e. rates contribute relatively more than their historical average and distressed contributes relatively little. While levels are far from supporting any extreme positioning tilts, they do point towards modest overweight in rates over credit risk. Our preference for excess returns in BBs with some element of total return exposure fits this description well. We continue to maintain a market weight in CCCs, although we are watching the deterioration in our default rate estimates closely. Any further increases in expected defaults could lead us to take a more defensive view on lower quality." - source Bank of America Merrill Lynch
Sure by all means, massive increase of US government supply represents a serious headache for a bold contrarian investor, yet we do think that we are getting very closer to the points where the US long end of the curve will start to be enticing from a carry and roll-down perspective, particularly when inflation expectations are surging and negative real US GDP growth might provide support the dreaded "stagflation" word. In our book, flat or inverted yield curves never last for a very long time, and often appear near the peaks of economic cycles. Sure we are marking a pause similar to a "Seventh-inning stretch" but, this is the direction the Fed is clearly taking. In this Fed hiking context, rising interest rates has favored a Barbell strategy because reinvestments are implemented at regular times, which allowed you to benefit from higher rates. Once the yield curve is almost flat, the Barbell strategy will become meaningless and the time will come to reconsider your asset allocation policy and to lean toward the median part of the yield curve (belly). As discussed in our conversation "Rician fading" from December the question is whether we are in a in a bull flattening case or in a bear flattening case: 
  • In a Bull Flattener case, the shape of the yield curve flattens as a result of long term interest rates falling faster than short term interest rates.  This can happen when there is a flight to safety trade and/or a lowering of inflation expectations.  It is called a bull flattener because this change in the yield curve often precedes the Fed lowering short term interest rates, which is bullish for both the economy and the stock market.
  • In a Bear Flattener case short term interest rates are rising faster than long term interest rates.  It is called a bear flattener because this change in the yield curve often precedes the Fed raising short term interest rates, which is  generally seen as bearish for both the economy and the stock market
In the case of bear flattening, Japanese lifers tend to gravitate towards foreign bond investment. Bull flattening encourages Japanese lifers to move away from foreign bonds and they are left with no choice but to park their money in yen bonds. To that extent, we think that the ongoing "Bear Flattener" is still supportive of US credit, but most likely towards quality, being Investment Grade that is. During the bear flattening in 2013-14 (as the taper tantrum subsided), Japanese lifers accelerated their UST investment. This could certainly push us in short order to put back our MDGA hat on and dip our toes into the US long end part of the curve but we ramble again...

Given ongoing volatility brewing in the US yield curve and the dreaded 3% level touched by the US 10 year Treasury Notes, the world is turning towards alternative “safe havens”…instruments that act as a store of value in volatile times, instruments that can be used as collateral to raise funding and post margin in derivatives transactions and instruments that lubricate the financial system. For years, the US Treasury bond has been seen as the safe haven - a high-quality asset that rally in times of market stress and offer diversification for investors’ risky portfolios. Obviously 2018 has shown growing pressure on the "safe haven status" coming from the Fed's balance sheet reduction, higher US Libor rates and the jump in the US budget deficit. The supply of Treasuries that the private sector will need to digest will be much greater than during the Fed’s QE mania. Could Japanese investors come to again to the rescue given they sold a record amount of U.S. dollar bonds in February as the soaring cost of currency-hedging undercut yields? We wonder as it seems their appetite seems to be more credit related eg non-government bonds related. For now cash in the US seems to have been emerging as a safe haven according to Bank of America Merrill Lynch European Credit Strategist note from the 26th of April entitled "What is the safest asset of them all?":
"Cash as an emerging asset class in the USRalf Preusser, our global rates strategist, makes an excellent point, namely that the typical haven characteristic of Treasury debt is being hindered by the appealing rates of return on cash in the US. As Ralf points out, historically during periods of market turbulence, money would flow from risky assets (such as stocks) into US Treasury bonds. But with $ Libor at 2.36%, support for Treasury debt is diminishing (consider that 5yr Treasury yields are 2.84%). In other words, the rise of “cash” as an asset class is altering the traditional allocation decisions of multi-asset investors in times of market stress.
Chart 5 highlights this point. We show the rolling 1yr correlation between total returns on 10yr Treasury bonds and the total returns on the Dow Jones stock index (daily returns). We overlay this with the evolution of 3m $LIBOR.

As can be seen, a decade ago the correlation between Treasury bond returns and stock returns was significantly negative (-60%). Treasuries performed their function as a place of safe harbor, and a store of value, around the time of the Global Financial Crisis. But since then the negative correlation has dwindled and is now just -28%.
Moreover, the chart shows that the changes in Treasury/stock correlation have closely followed the evolution of 3m $LIBOR, as Ralf has pointed out. Higher LIBOR rates have coincided with weaker Treasury/stock correlations. In other words, “cash” has started to become an attractive place to park money in times of market stress, and especially so since mid ’17 – when $LIBOR began to rise more vigorously.

In addition, Chart 8 above shows that the rolling 1y beta between Treasury bond returns and stock returns has also declined since the start of 2017, highlighting the reduced sensitivity of US rates to fluctuations in the stock market.
The competition from “cash”, therefore, seems to be challenging the traditional safe harbor characteristics of US Treasuries." - source Bank of America Merrill Lynch
Or put it simply when the king of the last decades, balanced funds are becoming "unbalanced" thanks to rising positive correlations we have been discussing many times. As we move towards the second part of 2018, it seems to us that clearly any tactical rally/relief should entice an investor in reducing his beta exposure and adopt overall a gradual more defensive stance credit wise. Safe havens it seems, and even the US dollar have so far been more elusive in 2018 apart from the "barbaric relic" aka gold's performance during the first quarter of this year.  Talking of "safe havens" as per our final chart below, even the defensive nature of the Swiss currency CHF has become questionable.

  • Final chart -  More and more holes in the safe haven status of the CHF cheese
Given the aggressive nature of central banking interventions in recent years, the SNB has also shown in its nature by becoming somewhat a very large hedge fund, particularly in the light of its large equities portfolio. It is therefore not really a surprise given the aggressive stance of the SNB to expect further intervention on its currency, preventing in effect its safe haven magnet status of the past. Our final chart comes from another Bank of America Merrill Lynch report World at a Glance entitled "After 3%" and displays how the CHF have lost its safe haven allure:
"CHF is certainly finding no friends at the SNB and during this latest bout of weakness, board members have shown little appetite to prevent further losses. Indeed, at the time of writing, SNB President Jordan has stated that a move above 1.20 in EUR/CHF “goes in the right direction”. The SNB’s motivations are clear – they still see CHF as highly valued and in our view want to see EUR/CHF trade meaningfully and sustainably above 1.20 before changing their characterization of the currency. Against the backdrop of the protectionism and trade wars, “vigilant” and “fragile” have been key buzzwords used by the SNB and they remain concerned that CHF may succumb to safe haven inflows on geopolitical tremors.
We would challenge the SNB assertion that the CHF is a safe haven currency. As the chart below highlights, CHF has meaningfully under-performed the two other major safe haven assets (gold and JPY) over the past 15 months.

We believe the existence of the SNB put will likely prevent sustained CHF appreciation during risk-off periods as the SNB continues to make it clear that it is prepared to use intervention as a tool in order to prevent sustained CHF appreciation." - source Bank of America Merrill Lynch
Whereas we have seem in credit recently a short term bounce, in this "Seventh-inning stretch", we think that gradually one should adopt a more cautious stance in regards to credit markets and be more discerning at the issuer level given rising dispersion. The change of narrative also means that "cash" in the US is back in the asset allocation toolbox after years of financial repression thanks to QE, ZIRP and NIRP. It remains to be seen if 2020 will mark the 9th inning or if it will be early 2019, as far as we are concerned, the jury is still out there.

"Switzerland is a country where very few things begin, but many things end." - F. Scott Fitzgerald
Stay tuned!

Sunday 22 April 2018

Macro and Credit - The Golden Rule

"After World War II, there were a lot of pension funds in Europe that were fully funded, but they were pressured to hold a lot of government debt. There was a lot of inflation, and the value of all those assets fell. Those pension funds couldn't honor their promises to the people." -  Edward C. Prescott, American economist and Nobel Prize in Economics.
Looking at the technical "relief rally" in all things "beta" including US High Yield thanks to the tone down in the geopolitical narrative but with the pickup of the trade war rhetoric between the United States and China, when it came to selecting our title post analogy, we reminded ourselves of the "Golden Rule". The Golden Rule (which can be considered a law of reciprocity in various religions) is the principle of treating others as one would wish to be treated. It is a maxim found in most religions and cultures:
  • One should treat others as one would like others to treat oneself (positive or directive form).
  • One should not treat others in ways that one would not like to be treated (negative or prohibitive form).
  • What you wish upon others, you wish upon yourself (empathic or responsive form).

The concept occurs in some form or another in nearly every religion and ethical tradition and is often considered as the central tenet of "Christian ethics".  It can also be explained from the perspectives of psychology, philosophy, sociology, human evolution, and of course economics hence our reference in relation to growing trade tensions. 

In this week's conversation, we would like to look again at where we are within the credit cycles, given as we pointed out in recent musings cracks have started to show in some parts and everyone is asking oneself when the downturn is given the relentless flattening of the US yield curve.

  • Macro and Credit - Have we reached the end of the credit cycle yet?
  • Final charts -  The return of Macro to the forefront thanks to higher interest rates

  • Macro and Credit - Have we reached the end of the credit cycle yet?
We have been discussing at length like many various pundits about the credit cycle and the fact that it was slowly but surely turning thanks to the Fed's change of narrative. We even posited that the Fed is the credit cycle in one of our musings. Back in October in our conversation "Who's Afraid of the Big Bad Wolf?", we indicated that for a "bear market" to materialize, you would indeed need a return of the Big Bad Wolf aka "inflation". With the continuing surge in oil prices in conjunction with commodities prices, we also pointed out as well in this prior conversation that credit cycles die because too much debt has been raised and therefore it remains to be seen if rising "inflation expectations" could indeed be the match that lights the ignite the explosion of the credit bubble hence the importance of gauging where we stand in this credit cycle. The increasing trade war narrative has proven in the first quarter to be "bullish" gold as we anticipated thanks to the "Golden Rule" being put forward between the United States and China. Following years of financial repression the house of straw of the short-vol pigs was blown off by the explosion of volatility following the Fed's decision to put a lower strike on its "put" for asset prices, which had been a deliberate part of their move in recent years. We have become increasingly wary of the situation of the US consumer hence us adopting more scrutiny on the rising price at the gas pump with an already strained US consumer balance sheet thanks to rising rents and healthcare and slowly rising wages with dwindling savings and rising usage of credit cards to maintain the lifestyle. 

So, one might rightly ask oneself, when does it all end given that as per the below recent Bloomberg chart, displaying US Economic Surprise indexes for both hard data and soft data trending lower:
- source Bloomberg

Many wonder if this time it will be different with the continuing flattening of the US yield curve. On this subject we read with interest Bank of America Merrill Lynch's Securitized Products Strategy Weekly note from the 20th of April,. First here is the summary of their findings:
"This time is different: late cycle mortgage lending, higher rates, and a flatter curve
This week’s yield curve flattening, to a post-crisis low of 43 bps on the 2yr-10yr spread, is raising concerns that the current cycle is coming to an end and recession is now on the not too distant horizon. It’s more than 9 years since the stock market low of March 2009, so it is clearly late in the cycle. However, we continue to believe that this cycle has at least a couple of more years before it ends and credit spreads, along with securitized products spreads (see “Bullish for Q2” for corporate-securitized products correlation discussion), widen materially.
In fact, although the path for spreads will be bumpier than what was seen in 2017, we think there is potential for spreads to tighten further in Q2 and beyond. As discussed last week, we think the 10yr breakeven inflation rate is likely to head higher in Q2, moving above 2.20% or even 2.30%, as oil experiences upward seasonal pressure. Given correlations, we see this as good news for securitized products spreads. (This week’s jump to an intraday high of 2.19% on the breakeven rate suggested that 2.20%-2.30% is not a particularly aggressive target.)
We acknowledge the tightness of spreads, but we caution against being too early to position for major spread widening in the near future. Although we see tightening potential for spreads, due to the tightness of spreads, we maintain our neutral view for securitized products.
We compare this cycle to the last cycle on two fronts:
First, and more broadly, we consider metrics such as the 2yr-10yr spread, the BofAML Global Financial Stress Indicator and the BofAML Liquidity Stress Indicator: all three indicators suggest little imminent stress. We see the current period as similar to May 2005. As a reminder, that was 2 years before credit spreads began to widen and over 3 years before full blown crisis and recession. Given the slow pace of monetary policy tightening in this cycle, we think the risk is that this cycle takes longer to end than the last one did when at a comparable point on the metrics just mentioned.
Second, and more specific to mortgages, we compare today’s mortgage lending environment to what was seen in the pre-crisis period and in the aftermath of the massive 2003 refi wave. The changes are dramatic. Non-bank lenders’ market presence is on the rise while banks are retreating; another refi wave has ended but primary secondary spreads are generous relative to 2005; most importantly, there is little to no evidence of a meaningful shift to the risky mortgage lending practices that precipitated the 2008 crisis. At a minimum, this cycle has a notable absence of the primary driver of what caused the crisis in the last cycle. If there is a trigger event for another broader downturn, it will have to come from a sector other than mortgages and housing. Perhaps it will be the corporate sector or the government sector but we would not dismiss the economic robustness derived from an exceptionally healthy mortgage market. Again, we think the risk is that years of healthy and disciplined mortgage lending prolongs this economic cycle."  -source Bank of America Merrill Lynch
We would have to agree, if indeed there is a trigger event for another broader downturn, then indeed, this time it will be different in the sense that it won't be coming from the housing sector and the mortgage markets. Many like ourselves are pointing out towards the excess leverage building up in the corporate sector thanks to a credit binge tied up to ZIRP and NIRP policies and credit markets. If US High Yield can be seen as being relatively expensive then European High Yield is a base case definition of what "expensive" can be defined as. We are closely monitoring fund flows given as of late there has been some rotation from credit funds towards government bonds funds as described by Bank of America Merrill Lynch in their Follow the Flow note from the 20th of April entitled "Trade wars flows":
"Rising geopolitical risk is pushing more money into govies
Over the past couple of months government bond funds in Europe have recorded sizable inflows. We think trade wars and rising geopolitical risk has been translated into deflationary pressures that feed primarily into a bid for “risk free” assets. IG fund flows in Europe have been slower to improve because of the trade uncertainties. However, inflows into Euro only IG funds over the last week were nonetheless positive.

Over the past week…
High grade fund flows were negative over last week after two weeks of inflows. While the breakdown by currency shows a marginally positive number for the eurofocussed funds, the dollar ones have driven the overall trend. Monthly data also were negative for a second month, March figures show.
High yield funds continued to record outflows (23rd consecutive week), and similarly the monthly data also displayed a fifth consecutive month of outflows. Looking into the domicile breakdown, US and Globally-focussed funds have recorded outflows, while the European-focussed funds flow was slightly positive. Note that this was the first week of inflows into euro-focused funds after 13 weeks of outflows.
Government bond funds recorded their 14th consecutive week of inflows just as the monthly data were rolling on to the fifth consecutive month of positive flows. All in all,
Fixed Income funds flows were on negative territory last week. Monthly data reveal that just like February, March was also characterised by outflows.
European equity funds continued to record outflows for a sixth consecutive week; driving the year-to-date cumulative flows below zero. The trend also transpired on the March number, which was the most negative since August ‘16." - source Bank of America Merrill Lynch
While it has been difficult to "Make Duration Great Again" given the recent rise in the 10 year yield in US Treasury Notes, from a contrarian perspective and given the significant short positioning in the long end, there will come a point when fundamentals might reverse the confidence in this overstretched positioning which would entail significant short covering. We are not there yet. 

Returning on Bank of America Merrill Lynch note on the relationship between a flattening yield curve and credit spreads, here is what they had to say on the subject:
"Yield curve flattening and credit spreads
The 2yr-10yr spread narrowed to a post-crisis low of 43 bps this week, raising concerns that the current cycle is coming to an end and recession is on the not too distant horizon. We see the recent flattening of the yield curve as consistent with expectations laid out in our 2018 Year Ahead outlook, published in November 2017. We expect the 2yr-10yr spread to reach zero and turn negative in the first half of 2019, and recession and material credit spread widening to occur 12-18 months later, in other words, mid to late 2020. Given the slow pace of monetary policy tightening in this cycle, we think the risk is that the process takes longer than we expect.
Chart 1 and Exhibit 1 provide some perspective on this view.
Chart 1 shows that today’s 2yr-10yr spread level of roughly 45 bps was observed in May 2005. We also see that today’s asset swap spread of roughly 300 bps on the ICE BofAML High Yield Index (H0A0) is comparable to the index spread in May 2005. (We use this high yield index for our securitized products discussion just because it allows us to make the longer term comparison.) The takeaway from this chart is that it took approximately two years for the curve to first fully flatten and then re-steepen. Similarly, it took approximately two years before credit spreads finished tightening, reaching a tight of 185 bps (over 100 bps tighter than the May 2005 level!), and began cyclical widening.
This is the primary basis for our view that material spread widening in the current cycle won’t occur until at least approximately mid-2020. In other words, we place a heavy weight on the yield curve as an indicator of where we are in the credit cycle. The first significant event that we would need to see for us to become more cautious on spreads is to have the curve fully flatten or invert. But even then, the 2005-2007 experience tells us that it could take over a year after flattening or inversion occurs before spreads materially widen.

Exhibit 1 shows a view of yield curve movements relative to the Fed Funds rate, along with rough projections. The primary observation for this cycle relative to the last cycle is that the Fed is tightening at about half the rate of the last cycle. Given this, we think the risk for this cycle is that the flattening and re-steepening/spread widening process takes longer than the last cycle.
Yield curve flattening and financial and liquidity stress indicators
Chart 2 and Chart 3 provide an additional view of today’s world relative to 2005, using the BofAML Global Financial Stress IndicatorTM and the BofAML Liquidity Stress IndicatorTM.

Both Global Financial Stress and Liquidity Stress are negative (indicating below average risk), have been trending lower since early 2016, and are currently comparable to the levels of May 2005. Both indicators moved up substantially only when the yield curve re-steepened in late 2007. Our takeaway here is that the low levels on the Stress Indicators are confirming our view that a 2yr-10yr spread of roughly 50 bps is  not necessarily indicating imminent stress. In other words, there is still ample monetary policy accommodation.
Mortgage lending in this cycle: low risk lending and the rise of non-bank lenders
While broad macro developments are currently similar to 2005, the mortgage market, arguably the trigger of the 2008 recession and crisis, is very different. In particular, mortgage market risk is far lower today than it was 13 years ago. To at least partly understand pre-crisis developments in mortgage lending, it’s useful to recall the role played by the massive 2003 refinancing wave.
Chart 4 shows the MBA refinancing index along with the primary-secondary spread back to 2000.

In some respects, the great refi wave of 2003 was the genesis of the mortgage crisis that followed. Lending capacity rapidly expanded to respond to the opportunity presented in 2003: refinancing volumes were unprecedented and margins, as measured by the primary-secondary spread (30yr mortgage rate-FNMA MBS current coupon yield) that peaked at 60 bps, were relatively attractive. When mortgage rates moved higher in 2004, refinancing volumes – and margins – collapsed. With massive capacity and minimal volume/margin in higher quality lending, the industry turned to higher margin, riskier lending as the alternative; we’ll come back to that in a moment.
But first, fast forward to 2018 in Chart 4 After years of low interest rates in the post crisis period, most that could refinance have refinanced: the MBA refi index is now at the lowest levels of the millennium. Chart 5 shows that purchase lending activity is on the rise, although it is still well below the levels of the pre-crisis era.

Going back to the primary-secondary spread in Chart 4, although it’s declined in recent years, we see a still relatively high margin on this low volume lending activity: currently about 75 bps, well above the levels of the pre-crisis period. The margin suggests no need to stretch on lending standards, but the volumes suggest that bankers have to work hard to get their share of the pie.
Next, consider some of the changes that have taken place or are underway.
Chart 6 and Chart 7 show the composition of lending in 2005 and 2017, respectively.

In 2005, 54% of production was ARMs, 36% was “expanded credit,” and 43% was government/conventional. In 2017, the composition shifted to 12% ARMs, 2% “expanded credit,” and 80% government/conventional lending. Clearly, the post-crisis regulatory changes and financial penalties associated with pre-crisis lending practices have changed lending behavior to higher credit quality.
Table 1 shows a lending and servicing snapshot for 2017, including YOY changes. Bank lenders experienced above average declines in lending volumes in 2017 while a number of the top 10 non-bank lenders actually experienced growth in originations.

On servicing, the shift away from the banks to the non-banks is even more pronounced. Bank servicing portfolios declined in aggregate while non-banks experienced double digit or even higher growth rates. Banks are conceding market share.
Overall, while the post-crisis refinancing lending opportunity has passed, and non-bank lenders are increasing their presence in the market, lending standards remain strong. The Urban Institute aggregate measure of the risk of loans closed shows that although credit risk has been rising in recent years, especially in the GSE segment, it remains well below pre-crisis levels (Chart 8).

If there is a trigger for the next crisis or even mild recession, we do not see it coming from the mortgage market. Similar to the indications from the Global Financial Stress and Liquidity Stress Indicators, there are no indications of current stress potential coming from the mortgage market." - source Bank of America Merrill Lynch
We would like to make a couple of remarks on the above. The shift to non-bank eg the "Shadow banking" has been significant. Banks have been less active in that space. Banks under higher regulatory pressure and oversight have reduced their activity and focused mainly on the higher quality segment of the mortgage market.  Also following the housing bust, US Homeownership Rates have come down significantly from a peak of 68% meaning US households could less afford buying a new home and have resorted to renting. Both Healthcare and rents now take a large chunk of the average American household income on a monthly basis. So, overall mortgage activity has become more muted for large banks. As always, there is risk you see and what you don't see to paraphrase Bastiat. It works as well for the US Mortgage market as indicated by the Brookings Institute in their article from the 8th of March entitled "The mortgage market risk no one’s talking about, plus a proposal to redesign the system":

"Nonbank mortgage originators and servicers—i.e.  independent  mortgage companies that are not subsidiaries of a bank or a bank holding company—are  subject to far greater liquidity risks  but  are  less  regulated than bank-lenders and servicers.  As of 2016, non-bank financial institutions originated close to  50 percent of  all  mortgages  and 75 percent of  mortgages with explicit government backing.
The research also  suggests that mortgages originated by nonbanks are of lower credit quality than those originated by banks, making nonbank lenders more vulnerable to  delinquencies triggered by a fall in house prices through  the  higher costs of servicing delinquent loans.  A  larger fraction  of  nonbank originations are insured by the Federal Housing Administration (FHA) or Department of Veterans Affairs (VA), which tend to be more likely to default than other types. Among  mortgages  in  Ginnie  Mae  pools, the data  indicate that mortgages originated  by nonbanks are twice as likely as bank-originated mortgages to be two  or  more  months  delinquent."  -source Brookings
Basically, as a reference to Nassim Taleb's latest book, banks have less skin in the game today in the mortgage market than they used to. So if housing is less the issue than in the prior cycle, then what is and what should we watch for when it comes to assessing the state of the credit cycles? 

On this matter we read with interest UBS Global Macro Note  "Credit Perspectives - Caution or Carry?" from the 19th of April in particular relating to the more advanced stage in the US of the credit cycle:
"Q: Where are we in the US credit cycle?
The US credit cycle is later-stage, but unlikely to end in 2018. Later-stage credit indicators are present. Corporate leverage is very high, covenant protections are very loose, lower-income consumer balance sheets are weak, and NYSE margin debt is elevated. But the market trades off changes in conditions, not levels. To this point, we do not see an inflection to suggest the credit cycle is turning. Our latest credit-recession model pegs the probability of a downturn at 5% through Q4'18. Corporate EBITDA growth is running at 5-8% Y/Y, enough to keep leverage and interest coverage from deteriorating. Lending standards and defaults are only tightening and rising, respectively, in select pockets, and the scale of tightening is not enough to engineer broad stress. Last, but not least, a quick shot to growth from significant fiscal stimulus in 2018 should keep the cycle supported.
Q: How will demand for US corporate credit evolve?
We expect overall US credit demand to slow, with an up-in-quality bias developing and continued demand for floating-rate product (leveraged loans, IG floaters). Rising USD funding costs are reducing the appeal of US credit to European and Asian investors. These funding costs are now 2.5% for Japanese investors and 2.8% for European investors (3 month FX swaps). With 3 more Fed hikes in 2018, these hedging costs will climb to 3-3.25% by year-end. We do not expect supportive unhedged foreign flows to materialize due to significant US policy uncertainty, higher capital charges on unhedged positions (especially Solvency II), and regulatory pressure (Taiwan). US IG is better positioned than US HY, as current yields of 3.8% should attract some additional domestic insurer and pension interest. Modestly rising credit risk in HY may also divert some flows back into IG. But US HY outflows are likely to continue, given Fed hikes, tight spreads, below average earnings growth, and declining equity valuations of HY-rated companies.
Q: How will Fed hikes impact the US credit cycle?
4 Fed hikes in 2018 will age the credit cycle and create pockets of volatility. The increase in LIBOR is resetting interest rates higher on $3.2tn of US business loans (1/3 of the total stock) and is reducing the appeal of US fixed-income to non-US investors. Higher interest rates are filtering through to US consumer loans; they are raising funding costs for non-bank lenders who utilize floating-rate bank credit to facilitate lower-quality auto and mortgage lending. But in the context of still strong US growth, the cycle has a buffer. Floating-rate leveraged loan issuers have interest coverage ratios still above 3x (EBITDA/Interest expense) and can withstand 3 additional Fed hikes in 2018. A strong job market will keep consumer delinquencies contained to the subprime space. And rising LIBOR is currently a benefit to large US banks, which can still access cheap funding via retail deposits, while receiving a higher interest rate on their loan portfolios.
We prefer US IG over US HY on a total and excess return basis. US HY spreads of 323bps are expensive vs. our blended model estimate of 429bps, while IG spreads are more aligned (105bps current vs. our blended model estimate of 116bps). We have a slight preference for BBB credit, given higher carry, and also that a declining non-US bid will hurt A-rated demand, while domestic demand could support BBBs. In US HY, we maintain our preference for B-rated credit. CCC's are vulnerable given declining equity valuations, while BB HY will struggle with higher duration fears. We prefer US leveraged loans over US high-yield given our call for 6 Fed hikes by 2019, and much stronger demand for loans and CLOs from US and non-US investors alike. By tenor, we prefer 5- 10yr IG, acknowledging slightly better valuations in the short-end than before. We still believe it is too early to position in 1-5yr IG credit, given lower carry, additional Fed hikes and negative repatriation technicals around large buyback/M&A announcements. We are also cautious on 10+ US IG credit, particularly in higher quality names, given very flat curves relative to expectations.
We understand the levels of conditions are weak, but the changes are critical to capturing inflection points. US earnings momentum, lending standards (C&I, consumer), and consumer defaults will be on our radar. The Fed and BOJ will be important. A Fed more tolerant on inflation will boost our view on risky credit; a change in the BOJ's yield target would be a negative for US credit. The resolution of the ATT/TWX antitrust case will also set the tone for future M&A supply.

A cyclical recovery won't be enough to tighten spreads. For US IG, spreads near current levels (105bps) are justified largely by "soft data", in particular strong ISMs. With a fading foreign bid, increasing duration fears and more M&A activity on the horizon, we think IG spreads will widen to 115bps in the near-term. The one positive is that US IG has already cheapened YTD, which will attract domestic investor interest and reduce material downside.
US HY now screens expensive, as spreads at 323bps are inconsistent with both structural credit risks and increased equity volatility. In addition, we believe significant outflows YTD have whittled down cash balances for fund managers. Aggregate fundamentals remain stable, but tenuous at lower ratings, with leverage elevated and interest coverage weak. We expect HY spreads to shift wider to 400bps.
The credit cycle isn't turning yet. Our credit-based recession gauge highlights a 5% chance of recession through Q4'18, far from the 40-50% that signals a red flag. Earnings growth, lending standards, and bank NPL trends are "good enough" to sustain the cycle. However, interest coverage will likely become less favourable as 3 more Fed hikes in '18 and '19 will flow through to $3tn in floating-rate business debt.
Fixed-rate US HY coupons are stable as firms are not yet refinancing into higher rates. For floating rate leveraged-loans, coupon payments have been range bound, as re-pricings and tighter spreads have offset higher LIBOR. But we expect higher interest payments for loan issuers later in 2018, as the Fed hikes 3 more times, and spreads can't tighten as much to offset higher LIBOR.
Despite rising interest costs, floating-rate US loans have resilient enough interest coverage to sustain 3 more Fed hikes in 2018. This dynamic, plus growing demand for floating-rate credit, underlies our preference for US Loans over US HY. 3 additional Fed hikes in 2019 will prove more problematic. This will push loan coverage ratios to low levels (inferior to 3x) for B-rated firms and pressure free cash flow. Earnings growth will need to rise to reduce this future risk.
US leveraged loan supply hit $500bn in 2017, over 50% for M&A and LBOs, and reported 1st lien leverage is 3.9x – the highest on record. EBITDA add-backs averaged 20-21% in 2017, and are averaging 26% for large PE sponsor deals YTD – suggesting leverage is underreported and rising. A conservative view would push average 1st lien leverage closer to 5x on M&A deals.

The non-US bid into US IG credit will slow in 2018. Non-US investors are paying 2.5% (Japan) & 2.8% (Europe) to hedge their US fixed-income allocations. We do not believe foreign investors will remove FX hedges, given broad uncertainty on the trajectory of the US dollar. As the Fed keeps hiking, these costs will rise further and US IG will become less attractive than long-duration sovereign alternatives and even EU IG credit by year-end.
Slower demand is one part of the equation, but we still expect IG supply to be robust in 2018 (+2.5% Y/Y). The M&A pipeline is large, and we expect more issuance could hit the market, conditional on favourable antitrust outcomes which have lowered closing rates. High multiples and still low rates suggest firms will finance with debt. Offshore repatriation may reduce issuance on the margin, but most IG firms do not have significant cash, either overseas or on balance sheets, to utilize.
The savings from corporate tax reform will only modestly delever capital structures, even assuming firms utilize 25% of their tax windfall to pay down debt. More importantly, credit spreads have already priced this; spreads per unit of net leverage are at all-time tights. Bottom-line, earnings growth needs to be much stronger to de-lever capital structures.
HY spreads have remained very resilient. Despite significant outflows in Q1, HY spreads were effectively unchanged. We believe Dec'17 coupon reinvestments and low issuance YTD (-22%) had replenished cash buffers. But given the outflows of Q1'18, cash buffers are low once again. We expect HY spreads to widen more aggressively if volatility picks up anew." - source UBS
As we pointed out recently, rising dispersion means that at the current stage of the credit cycle in the US, credit investors are becoming more discerning in their issuer process selection, meaning overall that active credit manager should continue to outperform as the credit cycle is gradually turning on the back of the Fed continuing its hiking trajectory. Sure, "beta" has rallied hard recently, but, one should think about gradually adopting a more defensive stance by starting to reduce high beta exposure towards safer places. While we pointed out in our conversation "Fandango" that some positioning appears to be stretched such as short the long end of the US yield curve, we don't think yet with have reached the "trigger point" making us bold enough to dip our investing toes into the long end of the US yield curve particularly as we are getting closer to the 3% level on the 10y Treasury yield. We are certainly watching any signs that would point out that the recent weaknesses seen in hard and soft US data has been temporary or not. 

While the "Golden Rule" is being vindicated by the Trump administration for the growing use of trade war measures, boosting gold price in the process, 2018 seems to be marking the return of "Macro" as a strategy following the unfortunate demise of many Hedge Fund players after years of financial repression thanks to lack of cross-asset volatility. As per our last charts below, Global Macro is making a come back thanks to rising volatility and dispersion across asset classes it seems.

  • Final charts -  The return of Macro to the forefront thanks to higher interest rates
The final removal of the lid on volatility which has prevailed thanks to the strong central banking narrative has been fading and marked earlier on this year by the explosion of the short-vol pig house of straw that built up during many years. Our final charts come from Bank of America Merrill Lynch from their Global Liquid Markets Weekly note entitled "The gold big bang theory" from the 16th of April 2018 with one of the charts displaying the spike in vix which can be linked to the rising rate environment:
"Tighter Fed policy is helping lift OIS and LIBOR
We first argued in September 2017 (see Mind the unwind) that risk assets could suffer as a Fed balance sheet compression added on top of an already steady pace of US interest rate hikes. Six months later, the effects of tighter US monetary policy are starting to become visible in a number of markets and returns across major asset classes are negative for the year. The Fed has already been hiking rates at a steady pace for 9 quarters now (Chart 1).

Looking forward, with a tight labor market backdrop and rising commodity prices, our economics team believes that the Fed will likely complete three more hikes this year. In addition, we believe that Fed balance sheet tapering (see Missing the BEAT) has been an important contributor to the rapid widening in the 3m LIBOR-OIS spread (Chart 2).
In turn, higher interest rates are pushing up vol...
Just like ultra loose monetary policy was a balm for asset markets, this combination of rising rates and balance sheet tightening could well be having the opposite effect on bond and equity markets. As we have previously explained, rising interest rates tend to put upward pressure on macro volatility (Table 1).
This effect is often lagged but quite persistent, and macro volatility has been on the rise for some time now. In our view (see Forward vol looks cheap to carry as long as you believe markets are late cycle), the spike in the VIX can be partly traced to the rising interest rate environment (Chart 3).

But higher interest rates are not the only source of uncertainty at the moment for global markets. US fiscal policy is entering a slippery slopeIn fact, just as monetary policy has tightened, the US Federal budget deficit is poised to balloon (Table 2) over the coming 24 months.

Our economists have previously argued (see Fiscal injection: round 2), that the US Federal government could face the worst cyclically adjusted fiscal deficit as a 5.1% of GDP in 2019 because of the continuous fiscal stimulus: tax reform, increase in budget caps, and greater infrastructure spending. Less bond demand from the Fed and a tightening interest rate path is meeting looser fiscal policy. And as the Fed stops reinvesting its bond proceeds, the market will have to absorb more US Treasuries (Chart 4).

Recent tax changes have also reduced the demand for dollar commercial paper from US corporates abroad.
Inflation is trending higher helped by oil prices
Of course, the tighter monetary policy path in the US and the normalization of interest rates is informed by the rising inflation pressures across the economy. On the one hand, the decline in the unemployment rate will likely support a steady increase in core inflation (Chart 5).

On the other hand, rising oil prices are already feeding into an increase in headline inflation (Chart 6).

Because we now expect Brent crude oil prices to hit $80/bbl over the coming months (see The ruble drop is bullish for oil) and US job growth is poised to remain steady, the Fed will likely continue to tighten policy.
Naturally, cross-asset info ratios have fallen
Tighter money policy will continue to impact macro volatility. With volatility on the rise, info ratios across major asset classes could well continue to roll over (Chart 7) in the coming months.

In our view, equities and bonds are unlikely to see the stellar rolling Sharpe ratios of the past few years as the Fed continues to drain liquidity. Moreover, we would argue that a tighter US monetary policy outlook is already acting as a drag on asset values. Year to date, cash returns of 0.4% compare favorably to S&P returns of -1.2%, Eurostoxx returns of -2.0%, or 10 year treasury returns of -2.1% (Chart 8).
So is the Fed ready to switch course? Not yet
True, leading indicators such as PMIs remain in positive territory across all major economies and inflation is on the rise. So the Fed is unlikely to change Yellen’s preset course for now under the new leadership of Powell. Yet, as money supply around the world continues to roll over on the back of tighter policy, asset returns could struggle (Chart 9).

The market is perhaps right to expect the Fed to hike interest rates roughly as scheduled (Exhibit 1).
But we still believe that escaping zero interest rate policy (ZIRP) will not result in a smooth path for asset markets." - source Bank of America Merrill Lynch
Back in November 2012, in our conversation "Why have Global Macro Hedge Funds underperformed?" we posited that when volatility across all asset classes crashes, global macro strategies tend to suffer on both an absolute and relative basis. If indeed we are moving from a cooperative world to a noncooperative world based on the Golden Rule in conjunction with a return of volatility then one should be wise to dust up the Global Macro playbook we think... 
"Monetary policy causes booms and busts." - Edward C. Prescott, American economist and Nobel Prize in Economics.
Stay tuned !
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