Debt markets brace to hold higher yields as stimulus sets in

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Debt markets brace to hold higher yields as stimulus sets in

(Bloomberg) – President Joe Biden’s $ 1.9 trillion relief plan, along with the prospect of further stimulus later this year, sets the stage for a drop in historically low Treasury yields, this which will likely lead to a resumption of volatility in the currency markets.

US yields rose even before the plan arrived, giving a hint of what might be in store. BlackRock Inc (NYSE :). sees up to $ 2.8 trillion in additional budget spending this year and the risk of another long-term rate hike. BNY Mellon’s John Velis says a 2% is possible by April as part of a “tantrum without the reduction” of Federal Reserve bond purchases. And currency volatility is so low it’s almost certain to increase, says Harley Bassman, creator of a widely watched treasury market movement gauge.

For weeks, the million dollar question for many investors was whether the $ 1.9 trillion relief plan would mostly go through the financial markets – as the first package did – or actually find its way. way into the US economy, where it could trigger changes. spending and investment greater than the initial size of the stimulus. The wave of reflation bets sweeping through global markets indicates that the latter narrative is taking a greater prominence, suggesting that such trades may have room.

“There’s a lot of stimulus going on that could total $ 2-3 trillion at the end of it,” Velis, FX and macro strategist at BNY Mellon (NYSE :), said over the phone. This includes another package later this year focused on infrastructure and growth, he said.

Yields began to gradually rise in January after Democrats appeared poised to take control of the Senate, sending the 10-year above the previously elusive 1% level. The rate, currently around 1.37%, is now at its highest level for almost a year.

But the increase in yields was not accompanied by corresponding reactions in the forex market, which remained largely stable. One indicator, for example, is the CBOE EuroCurrency Volatility Index, which tracks the projected short-term volatility of the euro-dollar exchange rate. It followed a predominantly downward trend in 2021, not far from the lowest levels of the past 12 years.

Rising rates are the first place where stronger growth and inflation prospects are reflected, and this should be followed by currency volatility. One place to watch is the yen, which has one of the lowest implied currency flights among major currencies, and has “more leeway to rise,” says Velis. Meanwhile, he sees the dollar’s next direction as “somewhat ambiguous.”

“Turbocharging the Restart”

At BlackRock Inc., the world‘s largest fund manager, new tax spending is seen as “speeding up the restart” of the pandemic-stricken US economy, with the additional spending only providing more support, according to a report. note from Jean Boivin, head of the company. research arm, and others. They see a major risk of a further increase in long-term yields “as markets grapple with an economic reboot that may exceed expectations” which could trigger episodes of volatility. They downgraded their view on government bonds, while broadening their pro-risk stance, notably by favoring equities.

The implied volatility of a wide range of financial instruments is currently “poorly valued and too low,” said Bassman, inventor of what is now known as the ICE (NYSE 🙂 BofA MOVE index. Wall Street’s most watched benchmark for interest rate volatility. . He says the combination of fiscal and monetary policy undertaken by the Biden administration and the Fed “can create volatility both ways.” While greater interest rate volatility should translate into currency volatility, he said, “the forecast is now much more difficult.”

“The bond and currency markets have factored in an initial $ 1.9 trillion stimulus that turns into transient inflation and a waning demand surge,” said Thomas Graff, a portfolio manager who helps oversee $ 100 billion at Brown Advisory in Baltimore. “What has not been taken into account is a sustainable and thriving economy. If the fiscal push is enough to put the United States on a higher growth plan, it will likely translate into a higher dollar and make currency markets more volatile.

© 2021 Bloomberg L.P.

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