Bond sell-off indicates new real rates regime
Since the start of the year US bonds have been under pressure as the ‘reflationary’ theme has gained momentum. Despite the concerning increase of new COVID-19infections, the Democratic win in the Georgia runoffs, the OPEC oil cuts and stronger-than-expected December data provided solid support for more rotation across and within assets. US 10y rates broke the 1% threshold with breakeven rates now above 2% and real rates moving higher.
Bond sentiment has turned more negative recently. The sensitivity of CTA funds performance to US 10y bonds has turned sharply negative over the last month and very positive to commodities and EM equity (Exhibit 1). US government bond funds saw marginal outflows, while US inflation linked bonds inflows stayed very positive (Exhibit 2). Option implied skew on long-term US bonds is also positive.
In the bond sell-off, the US rates curve repriced an earlier policy rates liftoff (Exhibit 3). With further stimulus looking more likely, our economists recently revised up their 2021GDP growth forecast to 6.4% in US and believe inflation might pick up earlier than expected. They expect hikes in 2H2024 and tapering to start in 2022.
Differently from most of 2020, when breakevens and real rate were movng in opposite directions, the current nominal rates increase was driven by both components moving up due to markets pricing higher inflation alongside higher policy rates (at least for >10y maturities bonds, Exhibit 4). The correlation switch between breakevens and real rates, which our rates team expects to continue for long-term rates, has important implications for cross-asset performance. Higher real rates and breakevens are likely to support more ‘reflationary assets’ such as short-duration value and cyclical equities as well as commodities, which we continue to favor inour asset allocation. Last 3m sensitivity shows that non-US equity, financials and US small caps tend to outperform with higher nominal and real rates while Nasdaq, high quality credit and Gold might suffer (Exhibit 5). While a gradual increase in real rates combined with higher growth expectations is likely to be digested well by equity, it could provide a headwind for further multiple expansion. Our US strategistse xpect most of the 2021 return to be driven by a strong EPS recovery and positive revisions. In rates, if 10y breakevens and real rates continue to move in the same direction, implied vol on 10y rates has some room to pick up, in particular vs 30yrates (Exhibit 6).
I can’t see why gold would suffer any more than any other commodity. There’s either a monetary and reflation tailwind for commodities or there isn’t.