DM Rates: Still no respite
There was no respite from the selloff in DM govvies when markets returned yesterday. The aggregate fear of duration risks (as measured by implied vol in rates) are now approaching levels seen in June (which preceded a snap lower in yields as recession fears take hold). This has spillover impact unto other markets, resulting in a sharp deterioration in financial conditions since the Jackson Hole Symposium. The most recent bout of volatility can be attributed to worries about the UK's fiscal conditions. The combination of planned tax cuts and an incomplete set of economic projections have prompted bond vigilantes to push 10Y Gilt yields above 4%. Within the G10 space (and the EMs we track), 10Y Gilts are the worst performers, with yields rising by 240bps since early August. While the GBP calmed towards the end of the trading day, GBP rates are still factoring in a terminal rate of 6%, higher than the US. Without a clear response from the BOE, jitters will likely linger ahead of 23 November, where the Chancellor of the Exchequer Kwasi Kwarteng is expected to unveil the medium-term fiscal plan. Unsurprisingly, JGBs are the best performers as the BOJ kept to a dovish note. However, it is clear that the JPY’s pace and level of depreciation have caused some concern amongst authorities. Speculation of band widening in YCC is likely to persist. Some of our key forecasts have been hit as the market quickly prices in what looks to be a regime shift into an era of positive real yields. 10Y UST yields have already hit our target of 3.90%. Meanwhile, 2Y UST yields are still rapidly rising, but are not quite at our forecast of 4.70%. We would continue monitoring financial conditions, noting that these levels of stress have heralded a short-term turnaround.
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