Over the past 6 months, the Fed has caught up quickly from well-behind the-curve to ahead-of-the-curve on tightening. Fearing another inflation miscalculation, it may overtighten. Maybank Investment believes the US rates are rising and perhaps higher near term, but not necessarily staying high for longer.
In forming its rates view, US recession is not a question of if. BNM-Fed divergence should stay, but MGS can’t rally without better clarity on the peak US rate. Under bearish scenarios, a continued rise in UST yields could see 10y MGS-UST yield parity. The base case is 10y MGS yield will fall. Maybank thinks the recent rout has opened up a second window of buying opportunity for MGS.
The Fed is set to deliver the most forceful tightening since 1980s measured by a total rate change, causing unexpectedly sharp bear-flattening in UST curve which was made worse by UK’s mini-budget. FOMC forward guidance shows the Fed’s intent to tighten with the higher real rate for longer. UST volatility has risen to levels comparable with past crises, but the US composite HY spreads are still below the peak in June which doesn’t offer any comfort in our view. Fearing another inflation miscalculation, the Fed may end up overtightening. UST curve has steepened back slightly of late, but Maybank Investment expects it to flatten or invert further: 2y10y to -75bp, 10y30y to -20bp, and 3m10y may begin to invert as early as October from +55bp currently.
Balance sheet reduction is underway. We think selling MBS is more effective at tightening financial conditions, but Fed may hesitate for fear of crystalizing losses on its agency MBS holdings as most are low coupon. Maybank Investment is bullish UST duration.
