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Rates market share center stage as volatility of risky assets picks up

On Top of the Radar

The inversion of the 2yr/10yr portion of the US yield curve (in other words, the yield on the 10-yr UST fell below of the yield on the 2yr UST) added to investors’ concerns that the U.S.-China trade war was taking a toll on global economic growth; plus, weaker economic data from Germany and China helped fuel the “risk-off” attitude. As global equities (MXWD) started to decline during last week, “risk-off” sentiment engulfed the markets; as such, defensive and interest-rate sensitive “bond proxy” performed better.

Interestingly, the US options markets appears to be focusing more on rates than tariffs, as the divergence between the implied volatility of the ratio of US Treasuries to S&P500 and Chinese LC EQ to S&P500 suggests more uncertainty on the future path of US rates than the trade war impact on China. We think there is an opportunity to own volatility ahead of the upcoming annual Fed conference in Jackson Hole, Wyoming from August 22-24.


Under the Radar

US-China Trade War, Continued

The White House’s decision to delay proposed tariffs on roughly half of the targeted incremental China imports provides positive information on how the Administration is approaching trade policy. But a 10% tariff is still going into effect on some China goods on Sep 1st.

The decision to delay implementation of tariffs on some goods was driven by concerns over the political risks associated with imposing tariffs on consumer goods before the holiday season as well as the recent deterioration in the US equity market; this suggests that there is a limit to how far, or at least how quickly, the White House might escalate trade restrictions. However, the announcement nevertheless finalizes tariffs on nearly all remaining imports from China that have not yet been affected by additional tariffs. The formal release of the notice substantially reduces the probability that the planned tariffs due to be implemented September 1 will be called off before then.

Global Capital Markets Conditions
Global market MTD performance

Until the last two weeks, the summer season in the US was fairly typical: lower volume and subdue volatility. But August arrived to shake things up! During the first two weeks of the month, the broad US market already had two days with close to 3% declines (most of the losses were recovered on the following days, but that could be due to short coverage rallies).

Furthermore, last week, the 2yr-10yr portion of the US yield curve, which gets a lot of attention from Wall Street, finally inverted (the 3mo-10yr portion, which has been inverted for over 5 months, is closely watched by the Fed). This event triggered an upgrade to "Defcon 3" by TV talking heads…, even President Trump got to his preferred method of communication to "Tweet out" his opinion.

We continue to expect a steepening of the US yield curve beyond the 2-year maturities.


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