Financial conditions in the US have deteriorated to levels seen in early May. Back then, when market stresses turn acute, 10Y yields marked an interim top at 3.20%. Events appear to be playing out similarly after the spike the volatility yesterday when 10Y US Treasury yields had a 30bps intraday swing, from a peak of 3.50% before closing at 3.20%. Respite from the FOMC meeting proved to be fleeting as an unexpected 50bps move from the SNB triggered sharp moves in the FX space. It probably does not help that the market had difficulty digesting the hawkish statements from the BOE. Focus is now turning to if the BOJ will eventually succumb to normalization pressures.
The upshot is that this market remains torn between factoring in central banks’ reaction to elevated inflation and the increasing likelihood of a downturn in 2023. We think that USD rates in the 5Y to 10Y tenors are probably within their respective ranges and probably will have a slight upward bias with the Fed still focused on inflation.10Y US yields at 3.20% looks a tad low in the current level and a push lower from here might entice payers. On balance, we still see the Fed to be less behind the curve compared to peers in the G10. For example, it might make more sense to pay EUR rates, anticipating a further catchup from the ECB (we expect 10Y Bund yields to hit 2.0% this year), which might feel greater pressure to hike rates. Unfortunately, a clear tool to curb peripheral spreads would almost certainly have to be announced before an outsized ECB move gets delivered.
Duration fears are at extreme levels. This is reflected with implied volatility in rates hovering near levels last seen during the Global Financial Crisis. We also see a large flight to safety that is keeping T-bills bid and overnight USD liquidity flush. Note that the SOFR has consistently traded below the floor of the Fed funds rate through the Fed hike cycle. For Singapore, we would note that the SORA fixings have been very low and SGD forwards finally capitulated lower as market participants finally recognize that SGD rates are not going to follow USD rates higher by the same magnitude. We remain in the receive SGD rates camp in general with a partial hedge in pay USD rates position.
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