Just when it looked like the bond rally might be set to take a pause amid fiscal stimulus rumors out of Germany and tepid demand for Berlin’s history-making zero coupon 30-year offering, Donald Trump upended markets with a series of aggressive Friday tweets that sent investors scurrying for safety.
Havens surged, and US yields tumbled, as US equities sold off hard into the weekend.
The new week will began with 10-year yields back near the lows hit mid-month.
Clearly, the latest escalation and the prospect of more to come, suggests US yields could fall further still. The August rally was turbocharged by a variety of factors including convexity flows, as the forced duration grab gathered steam the further yields dropped. Additionally, term premium spillovers from abroad played a role, as did foreign investor flows despite punitive hedging costs.
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Of course, the accelerants were just that – gasoline on a fire that would have been raging anyway, thanks to acute concerns about global growth, plunging inflation expectations and the assumption that central banks are set to embark on a prolonged stimulus effort.
All of those factors are still squarely in play. “After brief consolidation in ranges, escalation of the trade war could extend the bond rally further, with increased probability that US 10s revisit all-time yield lows set in 2016”, Goldman wrote, in a Sunday note.
Goldman goes on to suggest that “an extension of the recent range-break in yields should further fuel the recent gamma-led vol spike, with demand for US vol likely higher in a rally”.
On top of that, the bank says “cross-border flows into USD fixed income driven by [the] surge in negative yielding debt may not moderate without broad improvement in data”.
With the Fed still seemingly reluctant to acquiesce to its fate (even as Jerome Powell’s speech arguably set the stage for an eventual march back to the effective lower bound), another furious long-end rally could mean more bull flattening. But, for Goldman, the increasingly risky outlook (which includes a likely no-deal Brexit in October) should prompt traders to bet on aggressive rate cuts. “We think markets will press front end cut pricing even more, which reinforces our (bull) steepening bias in US yield curves”, the bank writes.
As far as breakevens go, just forget about it. “We could also see medium and longer term breakevens compress further, pushing them in the direction of the 2015/16 lows”, Goldman says.
Deutsche Bank on Friday suggested 10-year yields in the US could reach 1.35% if the Fed is indeed forced to cut rates to near zero in order to avoid importing disinflation on a resilient greenback.
“Tactically we expect 10s to trade well through 1.50% in the short run”, the bank’s Stuart Sparks said.
