Summit, yen-tervention, & US rates

Global Market Context (May 15)

• Global rates are experiencing "bear steepening" with notable movements at the long end in Japan (+15 bps) and the UK (+20 bps).
• Equities and AI-related tech stocks continue to hit new all-time highs, largely ignoring geopolitical risks like the "Not a Chance Hormuz Opens" (NACCHO) scenario.
• The U.S.-China summit resulted in a maintained detente with no major de-risking; no new tariffs were imposed, but export controls on chips and rare earths remain unresolved.
• President Xi was offered a U.S. visit for September 24th, though specific details on trade deals and geopolitical issues (Iran, Taiwan) lacked resolution.

Fixed Income & U.S. Rates Strategy

• Inflation data beats to the upside are acting as "kryptonite" for bonds, driving investor demand back to alternative asset classes due to concerns over fiscal sustainability and central bank tightening.
• Megan Swiber (U.S. Rate Strategy) forecasts increased upside risk for rate hikes, with a recommendation to remain underweight the front end of the curve.
• Market positioning is currently "short" regarding U.S. rates, with fixed income funds underweight Treasuries and allocated to spread products, creating inertia in the 2-year yield (~4%) and 30-year yield (~5%).
• Japanese intervention is estimated to have required $40–$50 billion in Treasury selling to fund the outflow, though official Fed data shows only a $23 billion decline in foreign official holdings week-over-week, suggesting the full impact has not yet materialized in the data.
• Significant Treasury selling flows would likely manifest as a decline in 2-year swap spreads; currently, front-end Treasuries are richening, indicating limited immediate pressure.

FX Strategy & Dollar View

• Bank of America holds a tactical bullish view on the U.S. dollar, citing a widening, unsustainable gap between current U.S. rate differentials and U.S. data surprises relative to the rest of the world.
• The Renminbi (USD/CNY) rallied above 6.8 post-summit, suggesting limited downside for the dollar near-term despite the low diplomatic expectations.
• Japanese Ministry of Finance (MoF) intervention has exceeded 10 trillion yen ($65 billion), marking the largest intervention period of the decade, yet bearish Yen consensus remains intact without coordinated intervention from the U.S. Treasury.
• Adarsh Singh (FX Strategy) notes that effective intervention requires the Bank of Japan to move ahead of the curve with rate hikes, expected to begin from the June policy meeting onward.

Federal Reserve & Chair Warsh

• Client inquiries regarding new Fed Chair Warsh focus on the timing of his policy views, with the earliest potential communications expected at the June FOMC meeting or congressional testimony, rather than the swearing-in ceremony.
• Market pricing has been tempered by the assumption that Warsh may adopt a more dovish reaction function regarding the dual mandate, specifically balancing inflation risks against stagflation risks in the labor market.
• Regarding balance sheet management, Warsh is expected to prioritize "shortening the WAM" (weighted average maturity) of Treasury holdings rather than reducing the overall size of the balance sheet immediately.
• A reduction in balance sheet size is contingent on liquidity rule changes, which are expected to have limited impact as bank chief investment officers (CIOs) are anticipated to be slow to respond to such changes.