Global Strategy Outlook 2022: Global Rates Quick View

Hello and thank you for joining us for a quick summary of our global rates outlook for 2022. My name is Priya Misra and I'm the Global Head of Rates Strategy at TD Securities.

2021 was a year of twists and turns. From a US fiscal stimulus led rise in rates in the first quarter to a global decline in rates in the second and third quarters, due to the surge of the Delta variant to a global higher rate move in the fourth quarter as inflation readings came in higher and more persistent.

We think 2022 will be a function, ultimately, of the unwind of central bank accommodation. Now I want to make three points in this regard.

First, the central bank unwind will be diverging across countries. The speed of the exit will be different across central banks and relative to what's priced in now. Just to summarize, we think the RBNZ should continue hiking while the Bank of England, the Bank of Canada and the RBA should begin hiking. The Fed will end tapering, but we don't think that the hurdle to hike will be met until 2023. As for the ECB, they remain far from hiking, but we expect them to scale up the asset purchase program, the APP program, even as they end the PEPP program. Now this divergence Is going to create cross market opportunities in rates. We think the CGBs and the NCGBs can outperform treasuries in the long end, and gilts can outperform bunds.

Second point, as for the central bank exit itself, the immediate form of the exit will relate to the end of QE, which can create supply demand dynamics in bond markets. We analyze our projections for global net supply to the private market and that duration supply is the largest in the US where we look for a bear steepening move as term premiums should rise as the market has to take down all this additional duration. Now this is the key reason behind our 2% goal for the US 10 year by the end of 2022. This dynamic can also drag some other country curves steeper, but their respective inflation and policy paths will be the dominant driver for curve moves globally.

As for hikes, given our economic outlook and the central bank reaction function, or rather our interpretation of the central bank reaction function, we think the market is much too aggressive in general in pricing in hikes, particularly in the US. Now the market is right now pricing in central banks that will be forced to hike right after tapering ends, but that will be a policy mistake according to the market. Now we disagree with the start as well as the pace of hikes that's priced in, which is why generally we're looking for higher long-term rates globally, but a more anchored front end. And therefore, we're looking for the curve to be steeper than forwards.

And finally, one of the biggest drivers of the central bank exit will be inflation. Now it is worth highlighting that inflation as well as linker breakevens have a high degree of co-movement across countries. This has been observed in the academic literature as well. There are a few reasons for it.

Commodity shocks tend to be global.
We have economic globalization.
Demographics are fairly similar.
We also have fairly similar central bank credibility of the inflation target.
And almost all central banks are dealing with monetary policy at the lower bound.

So, this is what creates this high co-movement across inflation numbers, as well as across linker breakevens. This time round I would say the energy price shock as well as the supply chain disruptions are also added global shocks, which is what's creating this high degree of co-movement across linker breakevens.

But I want to flag that not every market has reacted the same amount to the shock. US breakevens have risen the most, relative to the other linker breakevens and we like fading some of the divergences here. We like owning Canadian 10-year RRB breakevens over US breakevens.

Once the energy shock fades, the relationship across linker breakevens will be driven more by core inflation, which also have some co-movement. But given that core inflation is more a function of services rather than goods - they're less tradeable - they tend to be more domestic in nature, so there could be this potential for divergences across linker breakevens.

To summarize, 2022 is a year likely to be marked by volatility across the economic outlook globally. In a post-COVID world, as well as differing policy response to that.

Our outlook has a lot more details by country and if you have any questions feel free to reach me or anyone in the team and we would be happy to help.

All the very best for the year ahead and thank you for your time today.

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