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Summary
- US fixed income has staged an impressive bull run since late April/early May, with yields plummeting across the curve.
- Yet several signals now warn of a short-term correction higher for US yields.
- We anticipate the correction will depend on the FOMC’s policy update next week and therefore avoid initiating countertrend tactical positioning as the timeframe is too short.
Market Implications
- We wait until after next week’s FOMC to make a more considered, medium-term play in the US rates space.
US Fixed Income on a Tear Since May
One of the more durable and impressive moves across asset classes in recent months has been the rally in the US rates market.
Across the curve, yields have plummeted.
The 2-year yield has collapsed, falling ~140bps from its YTD peak in late April/early May (just above 5% intraday).
The same is true of the 10-year, where the yield has fallen ~110bps since peaking near 4.75% in late April.
The 30-year yield is also down ~90bps over the period from its YTD peak at ~4.85%.
For Bulls, Though, Warning Signs Have Emerged
As durable and robust as this trend has become across the curve during the past few months, warning signs have emerged in the past week or so that make us more cautious.
This means that, rather than expecting immediate additional downside in yields, we anticipate a near-term countertrend, corrective reversal in the next week or two.
Tuesday’s US Rates Technical Report outlined how the outsized US rates rally in recent weeks has driven the Relative Strength Indicators (RSIs) for each of the contracts across the curve to levels that are either at, or very near, overbought.
RSIs are only one of the indicators that technical charting specialists use in their analysis of markets.
RSIs are a ubiquitous indicator in the technical analysis world, and we very much like them as a tool, not only because they are widely used, but also because of their simplicity.
By this, we mean the 30/70 rule for RSIs.
Simply put, when an RSI breaches 30 on the downside, the security being studied is oversold. And, conversely, when an RSI breaches 70 on the upside, the security being studied is overbought.
For example, in the case of the 2-year note (TU), the RSI was at 71.9 when we published our US Rates Technical Report on Tuesday. And, using the simple RSI rule, this reading meant that the indicator was falling overbought conditions in TU.
Our concern is that when RSIs get this high, the market becomes susceptible to a correction. In this case, the market’s overbought nature could lead to an RSI unwind and higher yields.
Stand Aside (at Least) Until the Fed Meeting, Await Clarity
Consequently, we avoid initiating risk in the US rates space until the overbought dynamics unwind.
The market has priced just under 30bps of easing for the September FOMC meeting. This roughly aligns with Dominique’s expectation.
Beyond next week’s decision, the Fed’s Summary of Economic Projections (SEP) will outline the forward path for rates. Dominique expects the SEPs to show three 2024 cuts (including the 25bps next week). That would mean 75bps of easing in aggregate for this year, which is also Dominique’s base case.
This compares with market pricing of ~105bps in cuts for 2024.
If Dominique is right and the Fed’s SEPs do outline a further 50bps of 2024 easing beyond the 25bps this month, the market could price out some of the current excess easing, lifting yields.
This would be consistent with an unwind of the RSIs we mentioned above.
In sum, all will be clearer when the Fed announces its updated policy on 18 September. We therefore wait (at least) until the Fed policy update next week before initiating risk in the US rates space.
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