Hedge Fund

Pervalle Global Blog - Bonds And Chill

November 2018

posted by Pervalle Global Macro Fund
3mos ago 344

Below is a piece we put together in November that was sent around to our network. Given recent market action and the thesis still largely playing out, we decided to share it, which we are likely to do more of in the future.

The probabilities of US rates falling materially over the next six to eight months are the highest of the cycle. While global equities and commodities have begun to price in slowing growth, US rates are marginally off the highs – with the 10-year trading at 3.06%. The disconnect is likely due to supply and demand worries surrounding the Fed’s balance sheet run off, expanding US fiscal deficits, and the lack of demand from European and Japanese investors as hedged yields turn negative.

We see these concerns being largely priced into the market; however, the following line items seem they are not:

China will continue to pressure the global economy, with no real signs of stimulus coming through the system until the back half of 2019 under the assumption they will be able to expand credit at similar historical rates

The US economy will slow materially due to crude oil pulling down industrial production, as well as higher interest rates weighing on the consumer and US housing

US and Global Excess liquidity will drag equities lower, resulting in a bid for bonds

The Federal Reserve will likely get cold feet and backtrack as they recognize the economy is slowing

CTA and momentum players should continue to cover their shorts, in turn flipping momentum positive

Technically, US bonds are bottoming and have very favorable risk reward profiles over the following months

Given the above, we assign an 84% probability to 10 year rates falling to 2.3% from 3.06% over the next 6-8 months, before pausing and ultimately moving lower if our thesis is correct. Below we outline this thesis and seek to disprove the current bear argument.

The entire post can be viewed here.