A tug-of-war is developing between two competing narratives on US Treasurys.
On one side are those who, like Bloomberg’s Mark Cudmore, believe that the Fed’s messaging on Wednesday conveyed a cautious outlook on the economy thus telegraphing “much more to come” in terms of falling yields and USD weakness.
On the other side are those who are sticking with the reflation story and hanging on to the idea that dissipating political risk following an assumed loss for Marine Le Pen in the French elections combined with a more benign outlook on global growth and inflation will ultimately mean long-end rates are likely to move higher.
We’ll reserve judgement on our end, but we would note (again) that this is three rate hikes in a row that have been followed immediately by falling yields…
…and any capitulation on the still massive Treasury short could well lead to something of a short squeeze although the impact of that on such a massive market is debatable.
Well with that in mind, consider the following from SocGen who pretty clearly falls into the latter camp (while maintaining a bullish view on equities apparently on the assumption that yields won’t reprice too far, too fast).
Gear to a steeper US yield curve until June. The Fed may exert 25bp of flattening pressure on the curve over the next three months, but the move is likely to be back-loaded, leaving the front-end somewhat anchored and favouring a bear-steepening/bull flattening dynamic in the near-term. We think the bear-steepening dynamic may find further support from a scenario whereby Trump starts to pivot decisively toward a pro-growth agenda, the outcome of the French elections proves positive for risk sentiment and the March ECB meeting keeps the door open to our economists’ 2H tapering scenario.
Prefer equities to bonds in a rising yield environment. We find that equities show some resilience to moderately bearish bond scenarios, although this resilience slightly decays as shocks intensify. For now, still-attractive equity risk premium (ERP) levels indicate some scope for equities to absorb some rise in bond yields. A moderately bearish bond scenario, particularly if accompanied by a change in the policy mix with more emphasis on fiscal easing, could well prove supportive for equities.
We continue to like US equities. The FOMC committee pushed its 2018 real GDP forecast up by one-tenth to 2.1%, highlighting its confidence in sustained economic growth over the next two years. We think there could be more upside in US equities from current levels despite the rising yield environment if long term growth – or the little “g” – starts to rise.