One of the biggest stories of the past two months has been the sharp repricing of yields on the heels of Donald Trump’s stunning electoral victory in November.
The pace of the move would probably have caused considerable market discomfort had the baseline not been so low. That is, although the move higher was remarkable, rates were so low to begin with that the selloff barely got yields back to some semblance of fair value.
As we start the new year, there are all kinds of divergent theories about how things will play out. Will we get panic selling mid-year causing yields to overshoot and triggering a selloff in other DM debt? Will the Fed hike more aggressively than anyone thinks as the FOMC gets more concerned about inflation and an economy that’s “running hot”? Or will the 10Y remain anchored thanks to the dovish impulse sent by the Bundesbank and the BoJ? Or perhaps the rising tide of populism in Europe will translate into a stronger ballot box showing than anyone expects for far-right candidates across the EU, triggering a flight safety.
No one knows. What we do know, thanks to the benefit of hindsight (which I’m told is always 20/20), is how yields have acted in the past around “disruptive” market events. Have a look:
(Chart: Wells Fargo)
Here’s some color from Wells Fargo:
Political Events are Likely to Cause Occasional Bursts of Volatility, Rather than Huge Shifts in G10 Sovereign Debt Yields. Government bond markets equilibrated reasonably quickly after the U.K. Brexit vote and the U.S. election. Exhibit 2 shows that this behavior is not new; the 10-year Treasury consistently has found its footing about two weeks after major market disruptions. The chart also shows that yields generally do not return quickly to their pre-shock levels. The calendar is loaded with elections this year. Among the G10 plebiscites are the Netherlands (March), France (April/ May), and Germany (August-October).
So that should give you a range in terms of what to expect one way or another as we all prepare for what’s sure to be an interesting year.