Hey there sports fans! If you’re like me, fall means maintaining hope for an Indian summer, thinking about the upcoming holiday season, and lamenting the inevitable collapse of your fantasy football team (this could have been the year!).
I have had a particularly poor start to the fantasy football year—so poor in fact, that while it is too early to give up, it is not too early to shift my attention elsewhere, like the fixed income market. Applying even more rigor than I put into fantasy football, I created what I consider the first "Fantasy Fixed Income Draft" in history. Here, we sift through the ever-expanding news cycle to “pick” the most impactful “players” (or in this case events) in the global fixed income markets.
What factors lead to a top pick status in the game of fantasy fixed income you ask? Well, it's part art and part science. Potential impact, as measured in absolute terms, is a key ingredient. So too is the probability of occurrence. Finally, we add a dash of the “Known Unknowns” (also known as the flex play or the intangibles), and voila!
Operating under the traditional 10-team league model, how is the league trending after the first mock draft? Let’s review below Q3 and front run Q4 below:
- North Korea Escalation: This was always the surefire first pick. Potential impact and intangibles are off the charts. It should cause a flight to safety, unless rhetoric devolves to action, and then we could see a rate spike in U.S., Japanese, and Korean yields.
- Fed Unwinding QE: I wrote previously that I thought this was a non-event given the anticipated speed of the unwind and strong demand globally for these security types. Will I be proven correct, or does this become a teachable moment? The only way to find out is to continue to monitor the slope of the curve, relative IG corporate spread levels, and trade volumes.
- Trump’s Legislative Agenda: Are tax reform and infrastructure realistic goals? What does this do for relative dollar strength and the cost to hedge currency risk in either success or failure? Hint: failure weakens the dollar even further and increases the cost to hedge, while success should increase rates a bit at the front end (adversely impacting EM hard currency bonds).
- Brexit: This is the first risky pick! Is Brexit priced in? What about the bounce in the pound given a deteriorating economic environment? What we have is an economy with inflationary pressures, a consumer base running on empty, and a central bank that is aching to raise rates. Early call for a recession in 2019.
- ECB Tapering: In terms of impact, this should be higher. The low probability of it occurring soon is what places it in the middle of the pack. What horizons make sense for a scenario, 18 months, 36 months? While we are through the big elections now, we are still a little peripheral discontent away from another potential crisis.
- The Debt Ceiling: Similar to our first pick, the impact and intangibles are high. This falls in the countdown because of the déjà vu associated with the argument. Even in a worst case, a “do-nothing” Congress finds a way to at least kick the can down the road (presumably past mid-term elections).
- China's Onshore Market: As I wrote previously, I think the onshore market is a baby bull that has some serious legs. Investors want yield, low duration, and predictable cash flows. This market delivers. A quality draft is all about doing your homework!
- The Subprime Auto Mess: Crisis sounds too severe for such a niche part of the market, however we know that there will be some fallout (just hopefully no contagion). This should bring the notion of sound underwriting back into the conversation at least. Even if losses are held to a minimum, an increase in standards will cause an uptick in spread. If it gets really bad, captive finance arms across industrials could see spreads blow out.
- Canadian Housing: Nothing lasts forever. With general affordability out of reach in much of Toronto and Vancouver, how do conditions ease without creating more disappointment than Maple Leafs hockey? See the note in #8 around sound underwriting and add in collateral level LTV, Debt Ratios, and delinquencies to further understand the downside risk at hand.
- Climate Change: The potential impact of climate change is cataclysmic and while the probability is virtually 100%, the intangibles prevent this from coming in higher on the list. Harvey, Irma, and Maria were horrible disasters, but what’s next? El Nino? Forest fires? Additional polar ice melt? Probably all of those things (and more). The impossible part is figuring out how this impacts the fixed income book today. Catastrophe bonds will remain in focus, municipal areas deemed at risk will probably see increased risk premia. ESG and green bonds probably continue to grow in importance. The magnitude and timing is the real unknown here.
So there you have it, the first mock fantasy fixed income draft in history (at least the first round). Could I have taken this further? Keeper league, auction style, trading picks? Absolutely. But I can see enough upside and downside in the immediate rearview mirror and across the short and intermediate horizon to keep busy well into 2018.
Feedback, opinions, interested in learning how to build this into your workflow? Shoot me a note at Insight@FactSet.com.