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 * What are AT1 bonds, and how do they work?
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STEADY FED MAKES SHORT END LOOK ATTRACTIVE

Gary Kirk

Partner, Portfolio Management

Meet Gary

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TwentyFour Blog
| Read | 2 min
21 Feb 2022

Escalating geopolitical tensions have contributed to a volatile past week for
investors, but uncertainty regarding central bank action continues to dominate
the bond markets, with one investment bank now predicting nine straight hikes
from the Fed beginning at its March meeting.  

This uncertainty is most obvious in the disparity between market expectations
and the current guidance from the Fed’s Federal Open Market Committee (FOMC).
The market is currently pricing in six full hikes for 2022, putting the implied
year-end Fed Funds rate at around 1.6%. By contrast, the FOMC’s dot plot chart
currently points to just three hikes this year, with the Fed Funds mid-rate at
0.875% by year-end. A three-hike divergence between the market and the Fed is
considerable, and indicates just how much the former perceives the latter to be
behind the curve. The faster pace of rate hikes being priced in by the market is
reflected at the short end of the US Treasury curve, with the yield on two-year
Treasuries having doubled since the start of the year to around 1.5%.

We do believe the Fed will raise rates at its March 15-16 FOMC meeting, and we
also expect the dot plot chart to be revised at that time. However, it would be
a surprise to see the guidance moved far enough to be in line with market
expectations. January’s consumer price inflation (CPI)I print of 7.5% was of
course a shockingly high number, but the immediate market reaction of increasing
rate hike expectations from five to seven for 2022 did seem overdone, and thus
we were not surprised to see this projection subsequently fall back to six. The
aforementioned geopolitical risk is also impacting the curve, with Treasuries
seeing increased demand as fears of a Russian incursion into Ukraine increase.

The Fed will obviously look to tackle inflation, but in our view it is probably
correct in being more gradual than the market is calling for. Firstly, some of
the inflation is clearly due to disruptions in the supply chain, which are
gradually being addressed. More importantly though the Fed will be very wary of
tightening too much too soon, into an economy that is expected to slow over the
coming quarters. The US Q4 2021 GDP print of 6.9% was inflated by inventories,
which accounted for 4.9%, and when we look back at the pre-COVID data it is
clear to us that the economy may not be as buoyant as currently considered. In
2019 the economy grew 2.3%, well below the 1947-2021 average of 3.2%. The Fed
will of course be mindful of this when it assesses the appropriate scale and
pace of its future monetary policy action. 

We join the rest of the market in eagerly awaiting next month’s FOMC meeting,
but in our opinion short end credit is looking relatively attractive here given
US rate hikes are more than fully priced in and we are expecting a more gradual
tightening schedule from the Fed, rather than the ‘hard landing’ some
commentators are predicting.
 

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What are AT1 bonds, and how do they work?Investors are overreacting to banks’
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TAKING THE TEMPERATURE OF CREDIT MARKETS

TwentyFour Blog | Read | 2 min 17 Feb 2022 by Pierre Beniguel
TwentyFour Blog | Read | 2 min 17 Feb 2022 by Pierre Beniguel


TAKING THE TEMPERATURE OF CREDIT MARKETS

So far this year, the spread between two-year and 10-year US Treasury yields has
declined from 77bp to 51bp.

Read more

TwentyFour Blog | Read | 3 min 14 Feb 2022 by Mark Holman


WHAT ARE GOVERNMENT BONDS SAYING?

Yield curve shape and yield curve change are often good predictors of the state
of the economy and its outlook.

Read more

TwentyFour Blog | Read | 3 min 11 Feb 2022 by Gary Kirk


MANAGING THE DOWNTURN

As 2021 wore on we became increasingly concerned that the disconnect between
asset prices, economic fundamentals and monetary policy was becoming more acute.

Read more


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