U.S. Treasuries: decomposing the yield curve and predicting returns

May 25, 2019

A new paper proposes to decompose the U.S. government bond yield curve by applying a ‘bootstrapping method’ that resamples observed return differences across maturities. The advantage of this method over the classical principal components approach would be greater robustness to misspecification of the underlying factor model. Hence, the method should be suitable for bond return predictions under model uncertainty. Empirical findings based on this method suggest that equity tail risk (options skew) and economic growth surveys are significant predictors of returns of government bonds with shorter maturities.

(more…)

The dollar as barometer for credit market risk

March 9, 2019

The external value of the USD has become a key factor of U.S. and global credit conditions. This reflects the surge in global USD-denominated debt in conjunction with the growing importance of mutual funds as the ultimate source of loan financing. There is empirical evidence that USD strength has been correlated with credit tightening by U.S. banks. There is also evidence that this tightening arises from deteriorating secondary market conditions for U.S. corporate loans, which, in turn, are related to outflows of credit funds after USD appreciation. The outflows are a rational response to the negative balance sheet effect of a strong dollar on EM corporates in particular. One upshot is that the dollar exchange rate has become an important early indicator for credit market conditions.

(more…)

Equity values and credit spreads: the inflation effect

December 29, 2018

A theoretical paper shows that a downward shift in expected inflation increases equity valuations and credit default risk at the same time. The reason for this is “nominal stickiness”. A slowdown in consumer prices reduces short-term interest rates but does not immediately reduce earnings growth by the same rate, thus increasing the discounted present value of future earnings. At the same time, a downward shift in expected inflation increases future real debt service and leverage of firms and increases their probability of default. This theory is supported by the trends in U.S. markets since 1970. It would principally argue for strategic relative equity-CDS positions inversely to the broad trend in expected inflation.

(more…)

CDS term premia and exchange rates

November 24, 2018

The term structure of sovereign credit default swaps (CDS) is indicative of country-specific financial shocks because rising country risk affects short-dated maturities more than longer-dated ones. This feature allows disentangling global and local risk factors in sovereign CDS markets. The latter align with the performance of other local asset markets. In particular, recent empirical research supports the predictive value of CDS term premia for exchange rate changes. The finding is plausible, because both local-currency assets and CDS term premia have common pricing factors, while CDS curves are cleaner representations of country financial risks.

(more…)

A simple rule for exchange rate trends

June 2, 2018

Over the past decades developed market exchange rates have displayed two important regularities. First, real exchange rates (nominal exchange rates adjusted for domestic price trends) have been mean reverting. Second, the mean reversion has predominantly come in form of nominal exchange rate trends. Hence, a simple rule of thumb for exchange rate trends can be based on the expected re-alignment the real exchange rates with long-term averages over 2-5 years. According to a new paper, FX trend forecasting models based on this rule outperform both the random walk and more complex forecasting models.

(more…)

Overconfidence and inattention as asset return factors

January 20, 2018

Overconfidence in personal beliefs and inattention to new trends are widespread in financial markets. If specific behavioural biases become common across investors they constitute sources of mispricing and – hence – return factors. Indeed, overconfidence and inattention can be quantified as factors to an equity market pricing model and seem to capture a wide range of pricing anomalies. This suggests that detecting sources of behavioural biases, such as attachment to ideological views or laziness in the analysis of data, offers opportunities for systematic returns.

(more…)

Policy rates and equity volatility

January 13, 2018

Measures of monetary policy rate uncertainty significantly improve forecasting models for equity volatility and variance risk premia. Theoretically, there is a strong link between the variance of equity returns in present value models and the variance short-term rates. For example, there is natural connection between recent years’ near-zero forward-guided policy rates and low equity volatility. Empirically, the inclusion of derivatives-based measures of short-term rate volatility in regression forecast models for high-frequency realized equity volatility has added significant positive predictive power at weekly, monthly and quarterly horizons.

(more…)

Monetary policy stance in one indicator

November 25, 2017

New research proposes to condense policy rates and balance sheet actions into a single implied short-term interest rate. To this end the term premium component of the yield curve is estimated and its compression translated into an equivalent change in short-term interest rates. This implied short-term rate can be deeply negative and allows calculating long time series of the monetary policy stance including times before and after quantitative easing. It is only suitable for large currency areas, however. Indicators of smaller open economies should include the exchange rate as well, as part of an overall monetary conditions index.

(more…)

How to use financial conditions indices

October 14, 2017

There are two ways to use financial conditions indicators for macro trading. First, the tightening of aggregate financial conditions helps forecasting macroeconomic dynamics and policy responses. Second, financial vulnerability indicators, such as leverage and credit aggregates, help predicting the impact of an initial adverse shock to growth or financial markets on the subsequent macroeconomic and market dynamics. The latest IMF Global Financial Report has provided some clues as to how to combine these effects with existing economic-financial data.

(more…)

The latent factors behind commodity price indices

October 7, 2017

A 35-year empirical study suggests that about one third of the monthly changes in a broad commodity price index can be attributed to a single global factor that is related to the business cycle. In fact, for a non-fuel commodity basket almost 70% of price changes can be explained by this factor. By contrast, oil and energy price indices have been driven mainly by a fuels-specific factor that is conventionally associated with supply shocks. Short-term price changes of individual commodities depend more on contract-specific events, but also display a significant influence of global and sectoral factors. The latent global factor seems to help forecasting commodity index prices at shorter horizons.

(more…)

Tags

Tags
asset management Asset Purchase Program banks bond returns bond yields bubbles capital regulation carry China collateral commodities credit returns default ECB economic data EM equity returns euro area crisis Fed financial crisis FX FX interventions FX returns government debt government deficits herding inflation information insurances Japan leverage liquidity machine learning market turmoil price factors regulation risk management shadow banking statistical methods term structure trend following variance risk premium VIX volatility ZLB
ABOUT US

Macrosynergy is a London based macroeconomic research and technology company whose founders have developed and employed macro quantamental investment strategies in liquid, tradable asset classes, across many markets and for a variety of different factors to generate competitive, uncorrelated investment returns for institutional investors for two decades. Our quantitative-fundamental (quantamental) computing system tracks a broad range of real-time macroeconomic trends in developed and emerging countries, transforming them into macro systematic quantamental investment strategies. In June 2020 Macrosynergy and J.P. Morgan started a collaboration to scale the quantamental system and to popularize tradable economics across financial markets.

FOLLOW US
Linkedin
LEGAL
Research
Quantamental Academy
About Us