JP Morgan’s Andrew Norelli, who is a member of the bank’s Global Fixed Income, Currency & Commodities (GFICC) group, sees quantitative tightening affecting the fixed income market in three phases. By recognizing these phases on a high level, it’s easier for investors to understand how they might react on a more granular level when specific events occur.
First, Norelli believes monetary tightening removed cash and increased the supply of non-cash assets, causing financial asset prices to move lower beginning in January. He favors short-duration bonds during this phase, which have been strong performers in recent months.
Second, Norelli predicts that tighter financial conditions will eventually affect the underlying economy. While this weighs on risk asset prices, government bond prices will rise as markets anticipate a dovish course correction from the Federal Reserve. He favors high-quality duration during this phase to capitalize on these dynamics.
And third, Norelli predicts that the Fed will acknowledge the impact of its tightening and make a dovish course correction. During this period, there could be a continued negative correlation between risk assets and duration. However, risk assets will recover while government bond prices fall. He favors shorting Treasury duration in this phase.