Well, we saw this coming last week.
Recall that exactly seven days ago, in “One Bank Warns: ‘The Market Is Vulnerable To A Risk-Off Trade,'” we highlighted a note from Deutsche Bank’s Dominic Konstam and co. who delivered the following assessment on rates:
We believe that despite considerable local stability, the market is vulnerable to a risk off trade. We see an asymmetric risk between rally and sell off. Specs remain significantly underweight duration and, in our view, a bull flattening rally below 2.25% 10y yields could cause substantial short covering activity, adding a tail wind to a rally below these levels.
That’s not entirely consistent with the message that particular team usually sends and it certainly suggested that with 10Y yields moving lower and fundamental tailwinds such as the Trump administration’s failure to rapidly advance their growth-friendly agenda and technical tailwinds such as (possible) renewed buying from Japanese investors (think a favorable FX environment and lower hedging costs) and the continuation of short-covering, adding fuel to the rally, Konstam was ready to throw in the proverbial towel.
Well fast forward one week and that’s exactly what happened. Although Deutsche doesn’t call it “throwing in the towel.” No, they call it “shifting the forecast forward.” How fun is that?
But who can blame them, right? Here’s an annotated chart and a 30,000 foot view:
Read below for a tutorial in how to transform two words (“f*ck it“) into 363 words.
Via Deutsche Bank
We are shifting our forecast for yields “forward” in recognition of the failure of the new Administration to make any progress on structural tax reform let alone outright fiscal stimulus. We have been highlighting the evident concern around the lack of apparent progress but the Congress has become more explicit in its incapacity to legislate. This is obvious in the case of healthcare reform but still quite apparent in the context of tax reform. On top of this it is clear that President Trump remains reluctant to take on a more authoritative role with the Congress which we think bodes ill for any quick progress on legislation, be it healthcare or taxes. While we embraced the logic of the Brady-Ryan tax plan in terms of offering the potential for investment led growth via temporarily raising inflation expectations and then raising productivity growth, it is clear that there remains substantial opposition to key components of that plan, especially the border tax adjustment. It is hard to see how without revenue raising measures such as the border tax, structural tax reform can be as effective in terms of lifting investment spending without a substantial fiscal stimulus. And unless there is a new approach with bi partisan support, the risk is that tax reform turns out to be a half hearted gesture with little positive impact on potential growth let alone actual growth.The only difference between pre and post election would then be a Fed that was suckered into a faster pace of tightening on false hopes.
In this context we are modifying our forecasts. We are still hopeful that eventually something structural and reformed-minded will be delivered in the tax arena and interest rates can move closer to 3 percent however in recognizing the delay, our fair value models clearly indicate that 10s belong around 2 ¼ percent in near term. A move towards 2 ¾ percent is anticipated for year end, reflecting at least some tax progress. If we anyway assumed the Fed can eke out another hike and is willing to begin a taper process, yields should anyway rise at least in line with the forwards which is around 2 ½ percent.