US: Financial conditions will tighten - TDS

With the Fed expected to reach r* and potentially tighten beyond, analysts at TD Securities believe that financial conditions will tighten and realized vol is likely to increase across assets.

Key Quotes

“While front-end rates have priced in additional hikes, other markets are only just getting the message that real risk-free rates have risen significantly.”

“Higher frontend rates should alter cross-asset correlations. It will serve investors well to stay nimble in the year ahead.”

“Further Fed portfolio runoff will continue to drain reserves from the system, pressuring the effective Fed funds rate closer to the upper bound of the Fed's target range. This should bias FRA-OIS wider as bank funding and liquidity conditions gradually deteriorate.”

“We believe that signs of reserve scarcity should ultimately force the Fed to stop portfolio runoff by the end of 2019.”

“Even though we expect rates to rise in H1 2019, we remain tactically long duration amid near-term weakness in risk assets. Over the medium term, as economic data confirms that the growth momentum is still in place, the curve should flatten as the Fed should hike more than is priced in.”