There’s a “new protocol” on how stocks, bonds, and currencies trade, writes analyst Aleksandar Kocic at Deutsche Bank.
In a note to clients this morning, Kocic points to the apparent dichotomy between reality (record low yields with the 10-year US Treasury below 1.5 per cent) and economists’ forecasts:
According to this month’s survey of economists’ forecasts hardly anyone expects 10s to be below 2.00% any time this or next year — the median forecast beyond Q3 2012 is above 2.50%. Even the short term projections for the end of Q2 show no signs of sub-2% rates. This is a puzzling disconnect between the market and the economy…The S&P forecasts provide another piece of the puzzle. Except for the two outliers, nobody is seeing S&P below 1400 by the end of 2012.
Those calls may seem a little odd, given where we are at with yields as mentioned pushing below 1.5 per cent and the S&P 500 hovering around 1285 at pixel time.
The note offers an explanation of what is driving the disconnect:
Our interpretation of this disagreement is that the market variables (currency, stocks, bonds…) have achieved their autonomy from the economic fundamentals. The insistence of low yields is rather a consequence of the current constellation of risks and the corresponding distortions in the rates market are producing dislocations across other market sectors.
Of course, the “current constellation of risks” is somewhat broad in an environment of slowing global growth and a political dynamic in Europe that is difficult to work into forecasts, and the “corresponding distortions in the rates market” stem from unprecedented policy decisions by world leaders and central bankers attempting to address these risks in recent years.
Deutsche Bank refers to this “new protocol” of “stocks, bonds, and currency trialectics” as “the maximal breakdown of historical correlations in just about every channel.“
Here are the “trialectics” (read: trades) Deutsche Bank expects will dominate this “new regime” that has emerged if it eventually turns out to be a favourable environment for equities:
- Rates push lower while USD remains firm
- Equities higher while USD remains strong
- Stocks remain supported while rates remain low
And here, according to Deutsche Bank, is what the new trading regime would look like in bearish scenarios:
- The crisis deepens with an overall risk-off trade across the board when gold emerges as practically the only safe asset, especially if we see additional stimulus coming in the form of QE3.
- Things in Europe normalize, while US economy muddles along with unimpressive payroll numbers. The flight to quality premium goes away with sell off in bonds, but stocks have to give up some ground eventually as investors go elsewhere now that things are normalized. USD also loses some of its premium as well, so either stocks trade flat or slightly lower, with USD weaker and rates higher.