Rates Spark: Diamond hands - ING Think

Economic and Financial Analysis

                                                                                                                Rates

20 May 2021
              Rates Spark: Diamond hands
Article

              The technicalities from the FOMC minutes were more important than the
              taper reference. This Fed can take more control of the front end if they wish
              to. We think they will, and they should. Big players have a big stake, and
              rightly so.

                 Content
                 - FOMC minutes - some key nuances
                 - The Fed's diamand hands
                 - EUR rates are back to (supply) business after crypto gawking
                 - Today’s events and market view

              FOMC minutes - some key nuances
              There wasn't a whole lot in the April FOMC minutes to sway the macro debate. Some talk of
              tapering at some point was the feature picked up by the marketplace, but there was not a
              whole lot of substance to this. When there is a proper tapering discussion, it will happen when
              the economy is much closer to being healed in the labour market in particular; we are not there
              yet. The taper hint was enough to tempt both nominal and real yields higher though, which

pushes in the same direction as the ongoing macro recovery narrative.

    Some coaxing upwards of rates remains a viable policy possibility

The more interesting aspect to the minutes centres on more technical factors. It is clear that
the Fed has been monitoring the progress lower in ultra front end rates e.g. SOFR at 1bp. The
reverse repo facility at zero is effectively acting as a floor, preventing key rates from turning
negative. The Fed is keenly aware that there is a negative rates environment out there for repo
and front end bills. Some coaxing upwards of rates remains a viable policy possibility, through a
hike in the rate on excess reserves, and on the reverse repo facility.

Whether it likes it or not, the Fed has become a key player in the repo market

Source: Refinitiv, ING

Some permanence to the Fed's presence on the repo market was also a discussion point. In our
opinion this makes eminent sense. The Federal Reserve, by virtue of its very elevated holdings of
Treasuries, should be a key player in the repo market. By doing so the Fed has the capacity to
both add liquidity and drain it at will. It would mean a controlling influence, but let's face it,
that's the environment we live in these days. We're convinced that the Fed will want more
control of the front end, and to be ready the next time we have crisis conditions.

The Fed's diamand hands
A feeling of unease surrounding the froth in financial markets has been accompanying market
participants for some time as they eyed lofty valuations in risk assets. For lack of alternative,
and having the backing of the Fed’s steady guidance, that unease was often put aside, but
sometimes it resurfaces.

    A feeling of unease surrounding the froth in financial markets has
    been accompanying market participants

Yesterday markets took their cue from an unlikely corner in that regard. Crypto assets
experienced an eyewatering collapse that stirred concerns over wider financial market stability,
a more direct channel weighing on tech stocks. By the end of the day, the fall-out was

contained and even crypto prices have recovered somewhat from their lows. In rates markets
however the brief flight-to-safety has taken 10Y UST yields down 4bp from their peak
yesterday, and it ended the rise in 10Y Bund yields that initially soared beyond -0.08% early in
session.
In the end taking some of the froth out of financial markets might even play into the hands of
the Fed that wants to see evidence of progress first before even thinking of altering its course -
“diamond hands” that even Elon Musk will envy.

Financial stability concerns have reinforced the USD flattening bias

Source: Refinitiv, ING

EUR rates are back to (supply) business after crypto gawking
In EUR rates the focus should pretty quickly turn back to supply with France and Spain
auctioning bonds today. Usually a transitory technical factor for rates valuations, supply has
aggravated the upward dynamic in EUR rates of late.
As of now the increase in rates does not seem to have unnerved ECB officials who closely
monitor the financing conditions to assess whether intervention is necessary. ECB VP de
Guindos commented yesterday that the central bank would act if the rise in yields were
unwarranted, but he felt comfortable about the present level of yields. While disappointing to
those hoping to see a change of tune and very likely also not the end of the discussion, we
agree with the assessment as the fundamental backdrop in the Eurozone has been improving
amid the vaccine roll-out and the prospect of easing restrictions. We continue to see more
upside with a 10Y Bund yield at 0% still likely this quarter.

       Today’s events and market view
       In the absence of notable data releases the focus in Eurozone markets remains on bond
       supply and ECB speakers. With ECB president Christine Lagarde and chief economist
       Philip Lane both appearing in public today markets are on the look-out for any hint that
       yield dynamics might unnerve the central bank.
       In supply France is selling shorter dated bonds as well as a new inflation linked bond,
       overall for up to €13.5bn. Spain will sell up to €6bn. Overall the shorter maturity of
       today’s sales should lessen the pressure compared to the past day’s longer deals but

absent warm words from ECB officials, the rise in yields should resume.

Padhraic Garvey, CFA
Regional Head of Research, Americas
1 646 424 7837
padhraic.garvey@ing.com

Benjamin Schroeder
Senior Rates Strategist
+31 20 563 8955
benjamin.schroder@ing.com

Antoine Bouvet
Senior Rates Strategist
+44 20 7767 6279
antoine.bouvet@ing.com

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