Markets now know that the taper can be divorced from interest rate hikes. But for how long? What are your expectations on the timing of tapering?
Rate hikes are more determined by fundamentals of the economy. Tapering is more about managing liquidity in the short-term funding markets. So a taper can be divorced from interest rate hikes indefinitely. The Fed’s assessment on whether the current inflation rate is temporary or persistent will be key. They have reiterated that they need to see inflation above their long run target of 2% for a sustained period of time before raising interest rates. I believe the current inflation might not be as short lived as what the Fed is signaling to the markets and we might be seeing interest rate hikes sooner than what the market is pricing, which appears to be around one year from now.
Where do you see the 10-year Treasury yield at year-end?
Our traditional models have deviated from reality since the onset of the COVID pandemic. The start and stop nature of the global economy resulting from the lockdowns have caused traditionally reliable signals like global purchasing manager index (PMI), an index of the prevailing direction of economic trends in the manufacturing and service sectors, to be less useful. As such we’ve been watching inflation and inflation expectations; the size of stimulus package(s) that Congress will (or will not) pass; and the ongoing spread of the coronavirus and various mutations. Due to the uncertain nature of these factors, the variance around our forecast has also increased. Our estimate today is 1.5% to 2.0%.
What does the financial woes of one of China’s largest property developers, China Evergrande Group, say about leverage in the country’s real estate industry and financial system?
The financial disclosures show that the clock is ticking on Evergrande. While its problems caused some contagion in July, Chinese property bonds have stabilized and have largely decoupled from Evergrande in August. Investors are increasingly realizing that Evergrande issues fall in the idiosyncratic rather than the systematic risk bucket.