US Rates Strategy US Rates Outlook: Insurance or More? - Ian Lyngen, CFA Head of US Rates Strategy 212-702-1703 - Oregon.gov

US Rates Strategy
    US Rates Outlook: Insurance or More?

    Ian Lyngen, CFA
    Head of US Rates Strategy
    Ian.Lyngen@bmo.com
    212-702-1703

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Our Call: Late-Cycle Inflection
                                  Q3 '19 Q4 '19 Q1 '20
                         2s         1.65 1.55 1.15
                       2s/10s       0.10 0.45 0.45
                         5s         1.45 1.40 1.20
                        10s         1.75 2.00 1.60
                        30s         1.95 2.15 1.80
                       5s/30s       0.50 0.75 0.60
                     2s/10s/30s    -0.10 0.30 0.25
                     2s/5s/10s     -0.50 -0.75 -0.35

1   Source: BMO CM

Fed’s Dimming Economic Outlook
    FOMC          2019 2020 2021 Long-Run
    GDP           2.10   2.00   1.80     1.90
       Mar Est.   2.10   1.90   1.80     1.90
    Core-PCE      1.80   1.90   2.00
       Mar Est.   2.00   2.00   2.00
    UNR           3.60   3.70   3.80     4.30
       Mar Est.   3.70   3.80   3.90     4.30
    Fed Funds     2.40   2.10   2.40     2.50
       Mar Est.   2.40   2.60   2.60     2.80
                                   Source: FOMC, BMO CM

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Third Quarter 2019:
     Monetary policy uncertainty will be particularly high during the
      third-quarter following the Fed’s preemptive easing plan. The
      debate is how far (no longer ‘if’) Powell will need to go –
      particularly if any additional correction in risk assets has
      occurred.
     The trade war continues to drag out with no end in sight. The
      prospects for further escalation linger as hopes for a near-term
      deal with China dim.
     Traditional economic theory holds that the 12- to 18-month
      lagged impact of monetary policy will begin to flow through to the
      real economy in H2 2019.

      Source: BMO CM
3

Fourth Quarter 2019:
     As the year winds down and the combination of mixed economic
      optimism and an even more cautious Fed becomes a reality,
      questions about what will cause the next recession will dominate
      the market discussion.
     A lower forward path of policy rates will be priced in as investors
      begin to more convincingly look beyond the ‘insurance cut’
      narrative to whatever may be lurking on the horizon.
     Solidifying concerns about a global slowdown will serve to
      contain rates and the shift in monetary policy will lead the belly to
      outperform. Any steepening of the curve will be offset by
      investors’ belief that the Fed will employ the balance sheet (i.e. a
      fresh round of QE) if the next economic downturn becomes
      severe enough. This is a new dynamic in the Treasury market
      based on the experience of the Fed’s response to the crisis.

      Source: BMO CM
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Seasonals are a Key Factor in Our Near-term Bias

5

Rolling Fed Expectations Will Imply Deeper Cuts

6

Financial Conditions Much Easier in 2019

7

Neutral: We’ve Passed It (Funds vs. Core-PCE)

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Volatility Drives Financial Conditions

9

Front-end Inversion is Very Typical

10

Fed’s Curve Preference

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Cleveland Fed’s Recession Odds Climbing

12

Under-Confidence Risk

13

Falling Confidence Lowers Spending

14

5s/30s Cyclical Flattening Completed

15

Above Average Growth Sustainable?

16

Trade Remains a Wildcard due to Tariffs

17

Is the CapEx Boom Over?

18

Inventory Drag – Big Bet on Consumption

19

Inventories Building Faster than New Orders

20

Housing Continues Weighs on Domestic Growth

21

Global Business Sentiment Declining

22

Europe Still Leading Race Lower

23

European External Export Growth Stalls

24

Global Manufacturing PMIs Dismal

25

Global Trade Declining Sharply

26

Disappointing 2019 for US and World Economies

27

European Economy Turning? Trade Concerns Linger

28

Italy’s Recession Triggers European Banking Concerns

29

Every Significant Recession Preceded by an Energy Spike

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Different This Time? US Oil Production Soars

31

Different This Time? Concentration in Lower-end IG

32

Non-Mortgage Interest Payments Spike Ahead of Recessions

33

Savings Rate Falls as Interest Payments Increase

34

Importance of Student Debt and Auto Loans

35

Student Debt Delinquencies Remain Elevated

36

Education Loans Undermining Household Formation

38

Real Wage Gains

39

AHE Don’t Guarantee Accelerating Core-CPI

40

Home Buying Conditions Lowest Since 2009

41

Consumer Confidence and Housing Diverge

42

Home Buying Conditions more than just Mortgage Rates

43

Downward Pressure on Prices in 2018

44

Real Net Worth Negative (YoY)

45

Risk to Corporate Profit

46

Corporate Receipts Drop on Tax Reforms

47

Year-over-Year Core Peaked

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Rent and OER Remain Strong

49

Downward Pressure on OER

50

Shelter a Key Positive Contributor to Inflation

51

Ex-Shelter CPI Under Pressure

52

Tariffs, Soy (11.2%), and Commodity Pressure

53

Autos: Driving Modest CPI Volatility

54

Apparel: Transitory or Just Volatile?

55

SMRA Shows Investors No Longer Short

56

Sentiment Remains Overbought

57

Overseas Interest in TIPS Plummets

58

TIPS Ownership High in China and UK

59

Hedge Adjusted 10-year Yields Range-Bound

60

Japanese Investors Back in Treasuries?

61

When does China Return to Treasuries?

62

Foreign Official Flows Show Significant Selling

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