It’s important to be consistent, and a reader on Friday was kind enough to bring it to my attention that when it comes to the outlook for bond yields in 2020, SocGen’s Subadra Rajappa is keeping her 10-year forecast entirely consistent with the bank’s relatively downbeat outlook for the US economy.
SocGen, you might recall, is “resolutely pessimistic” on growth in the new year. That’s a quote from the bank’s economic team, which is sticking with a call for a shallow US recession in Q2 and Q3 (albeit followed by an upturn in 2021).
Their outlook for US growth next year is just 0.7%. Compare that to Goldman’s above-consensus forecast of 2.3%.
Given that, it makes sense that Rajappa (who has the house call) is looking for 10-year US yields to end 2020 at just 1.2%.
“In the context of a recession in mid-2020, we expect the Fed to deliver 100bp of cuts in 1H20 in response to a meaningful slowdown in growth and amid subdued inflation”, she recently wrote, explaining the call, and adding that “the US presidential election is also likely to contribute to volatility”.
It’s worth noting that were the Fed to deliver 100bps of cuts in the first half of 2020, that wouldn’t be out of the ordinary, at least in terms of rate moves in election years. The Fed traditionally hasn’t shied away from taking action in the lead-up to a vote.
That said, 2020 is different for a number of reasons, not the least of which is that Jerome Powell is damned if he does and damned if he doesn’t.
If the Fed cuts rates at any point next year outside of a serious deceleration in the economy, Democrats will charge that the central bank is bowing to Trump. If, on the other hand, the economy overheats (as the November jobs report suggests it might, the still-coolish wage inflation numbers notwithstanding) and the Fed hikes, Republicans and the White House will insist that the Fed is conspiring against the president.
In any event, Rajappa doubts whether the analogy between now and previous “mid-cycle adjustments” holds.
“While three cuts and a pause resembles the insurance cut episodes of 1995 and 1998, beyond that there is little in common between now and the 1990s, when rate cuts helped re-stimulate the economy, eventually enabling the Fed to hike again following the LTCM crisis in 1998”, she goes on to say, before delivering the bad news as follows:
In contrast to the 1990s, we are now ten years into the current business cycle, with growth around 2-2.5% for most of the cycle (see Graph 6). Insurance cuts will unlikely be insufficient to re-stimulate the economy and pre-empt a recession. Granted, interest-rate-sensitive sectors of the US economy (for instance housing) are responding positively to rate cuts but compressing corporate profit margins and declining business investment and capex spending will likely lead to a further decline in the pace of job creation as we progress through the cycle.
So, if you’re thinking about abandoning your duration exposure or otherwise tempted to get on board with the bearish bond trade on the assumption that a serious, sustainable pro-cyclical rotation is just around the corner, Rajappa thinks that might be a bit premature (and that’s probably understating her case).
At the least, she says, investors should “remain on high alert and retain long duration positions in bonds outright and as a hedge against risk-asset exposure”.