Last week saw shifting positioning in US Treasury futures markets, as traders digested mixed macroeconomic data. Bearish steepening of the yield curve carried through to Wednesday after the July FOMC meeting brought little new information beyond a continued hawkish tone.
Stronger than expected GDP and PCE figures at last week's end drove a flattening of the curve, with two year US Treasury yields making a year-to date high just shy of 73bp.
But while many economists, strategist and pundits maintain that the Federal Reserve will commence tightening in September, some market signals contradict this view. A growing number of investors also anticipate that trouble in China and other economies may cause the FOMC to wait longer.
Societe Generale's cross asset research department's analysis of the OIS curve indicates that the market is back to concentrating the probability of lift-off in December, with only three hikes now priced up to the end of 2016. Implied volatility levels for options on US Treasury futures indicate repricing higher of one to five year tails ahead of expected hikes, according to the bank.
Other signals also support expectations for a later hike. Adam Grimes, chief investment officer for Waverly Advisors in Pittsford, New York, said that technical analysis of the futures markets suggested a rally is possible despite a looming hike. Although this view is unthinkable to many commentators and market participants, Grimes argued that "market moves are driven by dissension".
Waverly said it is monitoring 30 year futures for a possible entry but has no position at this time.
One possible explanation for this shifting stance on timing is that improvements in US economic fundamentals will become less sustainable amid factors such as a drag on foreign trade created by a strong dollar.
"This puts the Fed in a bit of a quandary," said David Rosenberg, chief market strategist at Gluskin Sheff. "We all know the policymakers want to move off zero but have pledged to be data dependent. And Janet Yellen has made it very clear that, for the Fed to move, its optimistic economic forecast with have to come to fruition."
For portfolio managers positioning risk in advance of a hike, with timing yet unknown, the current market structure is likely to provide opportunities. Societe Generale strategist Bruno Braizinha recommends positioning to capture a bearish flattening of the curve in the coming six to nine months, with a long volatility bias. According to Braizinha, "We expect the bear-flattening dynamic to dominate the curve as we approach the first hike, and these structures continue to show some pick up to the forwards.”
