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After this week's violent moves in yields the market is begging the Fed for a closer guidance. March FOMC will provide such an occasion, unless they "need" to explain stuff earlier, this coming week already.
Fed is facing a delicate balance here; they want markets to respond to an improving economy (higher yields), but they do not want too violent moves in yields as it can delay the recovery.
As Bofa points out there are 2 primary channels;
1, higher borrowing costs could dampen rate sensitive sectors of the economy too agressively
2, a big fall in equities and credit spread widening would lead to a negative feedback loop (note we are writing this with SPX down 3.2% from ATH...)
March will definitely be interesting, and we could potentially get Fed headlines hitting the tape this week already. As Bofa concludes;
1, Qualitative guidance over quantitative
2. “Buzz” words - expectations
3. Waning slowly about policy changes - 6 mth window to set expectations could be appropriate
As a gentle reminder, equities do not like violent rate rises. Second chart shows SPX performance vs st dev moves in rates.
JPM's Kolanovic strikes again;
1, low rates leads to institutions rotating out of bonds into equities
2, creates downward pressure on volatility
3, which in turn creates a positive feedback loop where systematic and disc hedge fund strategies increase allocations to equities (this could play put for most of 2021)
4, if current below average exposure goes to historic percentile would result in $550 bn inflow from systemic and hedge fund strategies
5, add forgotten buybacks to the mix and Kolanovic argues for their 4400 SPX px target.
Below chart shows that average VIX levels closely follow levels of interest rates with a ~18-month lag. Conclusion is basically;
"Given the significant increase of monetary accommodation 9 months ago, we expect it to pressure volatility for most of 2021"