RBS Research today put out its 2010 Top Themes and Trades report.
Inside, there’s a great writeup about the bank’s outlook on the Federal Reserve, Treasuries, and private credit:
RBS: Most open to challenge is the idea that supply drives bond yields higher next year. The US budget deficit could perhaps hit USD1.6 trillion, in FY 2010, even worse than consensus expectations as tax receipts lag income growth in the early stages of a recovery, spending rises as more of the stimulus package kicks in, and the Fed is done buying (Treasuries at least).
The debt time bomb is indeed ticking and must be defused by fiscal restraint. But for calendar 2010, demand should comfortably keep pace with supply. Sovereign issuance fills the void of low private sector borrowing as private credit demand remains subdued. Foreign central banks have increased their Treasury purchases over the last two years and are important. But the biggest swing factor is likely to be commercial banks, sitting on vast amounts of vault cash and reserves at the Fed, and households where Treasuries are near historic lows in terms of share of household assets.
If private credit demands remain weak in the first half of next year, as we expect, banks will continue to be ‘investors’ rather than lenders. Their preferred habitat is likely to be the belly of the curve, centred on the 5 year zone. The Fed being on hold for much of 2010 is likely to cause a rolling flattening of the curve in which successively longer maturities fall toward the Fed Funds rate. 2s have just completed such a move and 5s are next in line to outperform. Unleveraged investors should overweight 5s and leveraged investors should be long the body of the 2s5s10s butterfly.
(Photo via Flickr user timlewisnm)