Thursday, January 8, 2015

Marginal Stability in Oil Could Prompt Outsized Risk Appetite

There is a little interest in a Hilsenrath note this morning and in particular a suggestion; ‘If, on the other hand, lower long-term rates are a reflection of investors pouring money into U.S. dollar assets, flows that could spark a U.S. asset price boom, it might prompt the Fed to push rates higher sooner or more aggressively than planned.’ 

Otherwise, I want to more strongly emphasize a notion touched on yesterday; that a small amount of stability in oil prices could have a VERY STRONG impact on risk appetite in general, in rates more specifically and the long end in particular.  One might recognize that oversized disinflationary concern accompanied falling oil prices.  Some of that concern was reflected in a very strong demand for developed nation sovereign bonds and more so at the long end. Because of yield curve differential and ‘flight’ interest, long-end U.S. Treasuries were likely an outsized beneficiary of this buying.  Add to this, a bullish projection by a new ‘King of Bonds’ in a Barron’s article over last weekend and you have a recipe for exaggerated and ‘at-risk’ U.S. Treasury gains.   

For U.S. Treasuries, this buying came as many traders had once again positioned for rising rates on the back of improving domestic labor and growth conditions.  Those conditions are largely unchanged, but the yield curve no longer reflects the Fed moving independently toward a firmer policy. 

Over an intermediate term of 5 years, the long end of the Treasury curve should be expected to be supported by the Fed’s portfolio impact.  However, there is room for a more immediate and significant spike in long rates as the consensus view for disinflationary implications for an oil shock shifts to lesser concerns.  Any near term economic data, including Friday’s employment report, that confirms limited growth impact from lower oil prices could have a stronger than usual influence on domestic rates.  

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