Monetary Policy

During and since the global financial crisis the Federal Open Market Committee (FOMC) has done a remarkable job in navigating the US financial system under extremely challenging circumstances, setting the standard for other central banks to follow.

After another week of yield curve flattening, we now have the 2s-10s curve in US Treasuries at just 43 basis points.

Having written recently about our thoughts on how the yield curve might flatten, we should also note that whilst this, our base case scenario, is happening at the moment, there are a number of other potential strong influences that we need to monitor as they have the ability to prolong this flattening.

Having discussed the shape of the yield curve as a recessionary indicator already last week, we would like to elaborate on what other indicators we look at as fixed income investors to determine where we are in the economic cycle, which in turn determines how we position ourselves on the yield curve and whether we look to credit risks or government bond risks.

The rapidly flattening US Treasury yield curve is prompting a lot of questions about the shape of the curve and it being a good predictor of upcoming recession.

"One day hot, one day cold, and the people on the other side of the message are left not really knowing where they stand."

As we now are well into the Q1 earnings season we have been debating how the current quarter could well be the best for risk in 2018.

A lot has been packed into a short week but, despite all the political posturing and rhetoric surrounding trade tariffs, it is still central bank policy that ultimately drives market sentiment and this week we have seen key inputs from leading players at the most important central bank of all, the US Federal Reserve, that have been somewhat overshadowed by more sensationalist news from the political arena.

Last Wednesday the Fed raised interest rates in the US for the sixth time since it began this hiking cycle at the end of 2015.

Last Friday saw the publication of the last electoral poll before the Italian elections that will be held on the 4th of March.

To understand this breakdown in correlation we need look no further than the source of the risk: the answer, just like in May 2013 when Bernanke gave us his taper tantrum, lies in rising rates.

Our forecasts for longer dated government bonds were for yields to gradually rise during 2018, but not in an uncontrolled manner.