The centuries-old bull market in US Treasuries has resumed its full boom again, probably driven by short hedges. Meanwhile, the risk markets are in disarray. The main question for the markets is to predict when these trends will be broken. Since I am not giving a market forecast, I will keep this article short, as I will simply describe what I think should be kept in mind.
I see here two main approaches to directional market strategies.
- Valuation: intervene once valuations reach what is considered extreme (cheap risk assets, expensive government bonds). No real attempt to time the trend change, but rather the hope of waiting for the flushing of positions, and hoping for a return to more reasonable levels.
- Events. Wait for certain events to provide a catalyst for a change in trend; in other words, market timing.
(Alternatively, one could look at relative value trades, which are focused on valuation. In the case of fixed income securities, this avoids duration trades and finds cheap / expensive corners of the market. This is probably the most judicious approach but you must have access to generally expensive transactions (market data to do this.)
Evaluation
I am in the “recovery” camp, and I would therefore seek outrageous prices. For the moment, I am not convinced that we are still at such levels (although I am extremely uncertain).
- If we look at the yields on treasury bills, they seem consistent with the move from the Fed to a negative interest rate regime. The New Keynesians of the central banks have a chain, and they will push it no matter what. Yes, almost everyone, with the exception of some diehard Ricardian fans, believes fiscal policy is the way out of a downturn, but central banks do not have the legal capacity to undertake a fiscal policy. Since the feeling is that they have to do something, they will push as many chains (quantitative easing, negative rates, forward-looking forecasts) as possible.
- I’m not the person to ask about risk asset assessments. Although the rate of change is high, we are not far below the all-time high values of the index. Meanwhile, from what I saw, the credit spreads weren’t spectacularly wide (but were widening).
Events?
Unless you feel that some sort of silver bullet is on the horizon, it still seems early to expect a big reversal in the flow of news. As has been discussed at length elsewhere, the United States faces particularly unpleasant challenges in stemming the pandemic – the service industries that do not provide low-paid workers sick leave, the cost of health care. A strategy of not testing to keep the numbers low will obviously not help matters if the intensive care units are overwhelmed.
The traditional management of overall demand (non-targeted tax cuts, rate cuts) should not do much (apart from lowering the risk-free curve). Realistically, we have to wait to see what is going on, and then policy makers can take targeted action to help the people and businesses hardest hit by the side effects of the virus. The news flow is not entirely negative: some of the Asian countries that were affected earlier by the virus have taken steps to appear to keep it under control. It remains to be seen whether the Anglo-Saxon countries have the capacity of the State to follow their example. This uncertainty explains why I expect that we will remain in a fog of uncertainty for a time that will seem like an eternity for investors in risky assets.
Final remarks
The perma-bears who have warned of central bank asset bubbles over the past decade are currently having market trends in their favor. However, it is not wise to indulge in doom-mongering. At some point things will change, the only question is the price level at which this happens.
(c) Brian Romanchuk 2020
