Tuesday, June 16, 2015

Return of the bond market vigilantes?

As we await the FOMC statement and the Janet Yellen press conference after the FOMC meeting, I thought that I would highlight the results of the latest BoAML Fund Manager Survey (FMS). A review of the FMS indicates that institutional managers are relatively bearish on the bond market outlook.

First, it isn't surprising that they expect higher short rates:

The expectation of a 3Q (read: September) rate hike is a fairly consensus call at 54% of the manager sample:

However, inflationary expectations are rising, which would put more upward pressure on yields at the long end and likely lead to a steepening yield curve.

When asked what the biggest tail-risk facing the market was, the Fed behind the curve was the second choice behind a geopolitical crisis.

When I put it all together, fund managers are expecting higher rates, higher inflation but they're afraid that the Fed might be behind the curve. This seems to be a recipe for the return of the bond market vigilantes (see my recent post Global risk off = More downside for stocks).

The chart below of the UST 10-year yield indicates that it has moved up through a downtrend (blue line) and may be in the middle of an up channel (dotted green lines).

When the FOMC releases its statement and Fed chair Yellen speaks in the press conference, I will be closely watching how the shape of the yield curve changes to see if my hypothesis about the bond market vigilantes is correct.

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