US yields capped as Fed takes note of limited market tolerance

In the January meeting the Fed not only put rate hikes on hold, but also signaled an earlier end to balance sheet unwinding, acknowledging financial market volatility and the risks to growth. We now expect the run-off to end already at the end of the year, leaving the Fed’s assets at around 3.7 US$ tn.

Highlights:

  • In the January meeting the Fed not only put rate hikes on hold, but also signaled an earlier end to balance sheet unwinding, acknowledging financial market volatility and the risks to growth. We now expect the run-off to end already at
    the end of the year, leaving the Fed’s assets at around 3.7 US$ tn.
  • The Fed will then likely tilt the portfolio composition toward shorter-dated Treasuries in order to enhance its power as a crisis-fighting tool. The Fed also announced its readiness to adjust the runoff process in case of a serious downturn.
  • While Quantitative Easing had a clear impact on asset prices, the effect of tightening appears at present more muted. A key reason is that the balance will shrink from a peak of 25% of GDP to 18%, still three times the pre-crisis level.
  • The remaining balance sheeting tightening is expected to contribute up to 15 bps to higher 10-year US yields. However, the dominant factors for US Treasury yields in the medium term are seen to be the slowing of the US economy and the expected end of the Fed hiking cycle.

Read the full publication below.

US JOB CREATION
BEATS EXPECTATIONS IN NOVEMBER. BUT OTHER INDICATORS POINT TO A WEAKENING LABOR MARKET

RELATED INSIGHTS

CHINA’S Q4 GDP GROWTH SURPRISED ON THE UPSIDE, BUT RISKS TO THE OUTLOOK HAVE INCREASED
This morning, China published its Q4 GDP growth alongside with December monthly activity data. Q4 growth accelerated to 6.5% yoy which lifted total 2020 GDP to 2.3%. December real activity data were more mixed. While exports came in strongly, important domestic demand components were a bit unsteady.
COVID-19 FACTS & FIGURES
US President-elect Joe Biden has unveiled a $1.9 trillion stimulus package proposal. Following the recent increase in cases, China has imposed new restrictions and lockdowns in the Hebei province. Canada has implemented new restrictions and a provincewide curfew in Quebec that will last until February 8. German Chancellor Angela Merkel warned that the recent rise in Covid-19 cases could force the country to prolong the nationwide lockdown until April.
EQUITIES: STAY POSITIVE WITH A VALUE-CYCLICAL TILT
Following a monster rally in stocks last autumn, multiples are well above historical averages, but equity investors can count on lingering low yields, tighter credit spreads and increasing central banks’ balance sheets which in turn maintain low the cost of equity and the discount rate of future cash flows.