The bond market has been quiet. Too quiet in fact.
That’s about to change, says Societe Generale’s fixed income team led by Vincent Chaigneau.
“Spring is likely to be more threatening for bond investors as US data improves, political risk in Europe ebbs and investors refocus on a slow central bank exits,” the team wrote in a note to clients on Thursday. The note is titled “The Sleeping Beast.”
In the wake of the U.S. Presidential election, traders priced in the prospect that Donald Trump’s agenda of a protectionist trade policy, cutting taxes, rolling back regulations, and massive infrastructure would bring back inflation to the United States. Reflecting this, the yield on 10-year Treasurys rallied more than 80 basis points, reaching a high of 2.64%, in the weeks following the election.
But for the last few months, the yield has been trapped in a tight 35 basis point range as traders take a wait-and-see approach in regards to Trump’s ability to execute his proposed agenda.
“We expect that to reverse in spring, especially if Trump proves a little more effective in pushing his agenda through Congress,” Societe Generale wrote. “Treasuries too present some seasonal patterns: the average of the past five years shows the 10yT reaching a low around mid-April before bearish forces start to take over.”
In Societe Generale’s view, this sideways movement will end when bond traders fixate on coming interest rates hikes — which the bank expects the Federal Reserve to continue.
“While the “Trumpflation” trade seems to be gradually deflating, recent Fed speakers continue to lean towards two or three more hikes this year, which is not currently priced in,” Societe Generale says.
In its statement accompanying the March rate hike, the Federal Open Market Committee reiterated its view for a total of three rate hikes for 2017. That has been followed up with additional hawkish chatter from Fed members in recent weeks. Several Fed members have reiterated the view of two more rate hikes in 2017, and San Francisco Fed President John Williams even took that a step further on Wednesday, suggesting the Fed could hike rates more than three times this year.
Currently, the market is pricing in a 60% chance the Fed’s next rate hike comes in June or sooner, according to World Interest Rate Probability data provided by Bloomberg. Additionally, it thinks there’s a 55.8% probability of at least two rate hikes by the end of 2017.
If everything plays out the way Societe Generale thinks it will, the 10-year should get to 3.10%, according to their model.
There is one caveat to the call — the looming threat of a government shutdown. The banks says that the odds of a shutdown have declined, but have not completely disappeared. If that happens the bank says the 10-year yield could fall below 2.25%.