Now here’s a contrarian view if there ever has been one, particularly in light of recent market moves.
HSBC’s US fixed income team, comprising Steven Major and Lawrence Dyer, are forecasting that US treasury yields will be significantly lower, not higher, by the end of next year.
“President-elect Donald Trump made plenty of promises during the US election campaign but gave very little detail,” the pair wrote in a research note released on Monday.
“There are now widespread expectations of tax cuts and increased spending, particularly on infrastructure, but little clarity on how such programmes will be financed.”
While HSBC has upped it’s near-term forecast for benchmark 10-year treasury yields given the stonking move higher in recent days, suggesting that it will hit 2.5% by the March quarter next year, Major and Dyer remain sceptical as to whether the move can be sustained over the longer-term.
“We believe that if yields increase too much in the short-term then financial conditions will tighten, resulting in less growth and a constrained Fed,” the pair says.
“Our analysis shows that, historically, shifts in supply have not changed the relationship between longer-run economic growth and interest rates. Therefore, we expect yields to fall again on the basis that Trump’s policy proposals, which combine tax cuts and spending cuts, may not boost growth by enough to support higher yields.”
A slowdown in economic growth leading to a slower rate tightening schedule from the US Federal Reserve will largely offset any potential boost that may arrive from Trump’s proposed pro-growth fiscal policies, in other words.
As a result of this view, now incredibly contrarian compared to some recent forecast changes made by other strategists, Major and Dyer are forecasting that the 10-year note yield will sit at just 1.35% by the end of next year, some 90 basis points below its present level of 2.25%.
“Given the structural factors at play and the large number of unknowns, we are keeping our end-2017 forecast at 1.35%,” they say.
“Our view recognises the cyclical pressure pushing yields upwards but also that longer-term structural drivers, such as the debt overhang, will weigh on growth and yields.”
If HSBC’s call proves to be correct, it will have enormous ramifications for financial markets, seeing many of the moves in recent days reverse course in the back half of next year.
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