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Wall Street breaks from groupthink on Treasuries

Like Christmas ornaments on Main Streets across America, Wall Street banks’ forecasts for the year ahead keep coming out earlier every year. At least this year analysts have something substantive to sink their intellectual teeth into: the impact of incoming president Donald Trump. The results are fascinating — especially for bonds.

The fixed income market has been one of the biggest victims in the “Trumpflation trade” that erupted after the election, with investors rushing to bet that fiscal stimulus will balloon the US budget deficit, boost growth, quicken inflation and force the Federal Reserve to raise rates more aggressively.

As a result, the sense of an era ending is the leitmotif that runs through the sellside’s 2017 outlook for fixed income.

“The party is over,” starts a typical piece by Vincent Chaigneau, Société Générale’s head of rates and currency strategy. “After years of easy money, inflation is finally bottoming out . . . The unwinding of this unprecedented exposure to rates will initially feed the sell-off and eventually stress the credit spread complex.”

But on the face of it, analysts seem to think most of the impact is largely priced into the bond market. The median forecast of 53 strategists polled by Bloomberg is that the 10-year Treasury yield will end 2017 at 2.45 per cent — up only modestly from the current 2.3 per cent yield, and the 2.18 per cent pre-election prediction.

Nonetheless, this median obscures a “bigly” dispersion in bond yield forecasts. In fact, Wall Street strategists — usually known for their herdlike consensus — are unusually polarised on how this new era will play out.

On one hand Jan Hatzius, Goldman Sachs’s widely respected chief economist, predicts that the 10-year Treasury yield will jump to 2.9 per cent early next year, and rise to 3.3 per cent by the end of 2017. This is one of the most aggressive forecasts, but more than a dozen strategists think the 3 per cent mark will be breached.

“For most of the last eight years, policymakers have been solely focused on shoring up the recovery; today they also must consider the risk of overdoing it,” Mr Hatzius wrote in his 2017 outlook.

Some bears are undeterred, however. HSBC’s Steven Major — one of the few strategists who has been consistently correct in predicting ever-lower bond yields in recent years — still thinks the 10-year Treasury yield will plummet to just 1.35 per cent by the end of 2017. That is the lowest of all the forecasts that have come in so far.

But it won’t fall in a straight line. Crucially, Mr Major thinks that US government debt will first suffer a further “Trump premium” sell-off, pushing the yield to 2.5 per cent, before higher interest rates and a stronger dollar choke off growth and batter the US economy back into a recession.

Basically, HSBC’s chief rates strategist argues that Mr Trump’s more aggressive government spending will not be able to boost growth sufficiently for a still-indebted economy to shrug off higher bond yields, causing the Trumpflation trade to eventually sabotage itself.

“Such a conclusion may run counter to the consensus economic view on the impact of fiscal stimulus. However, the consensus has been proved wrong before when it comes to interpreting the impact of unconventional policy,” he points out.

Mr Major is an outlier, but he is far from the only strategist who thinks the eventual outcome will be lower, not higher bond yields. Five analysts polled by Bloomberg think the 10-year Treasury will end 2017 at 2 per cent or less.

Who ends up in the right will be fascinating to see. It bears repeating how unusual this wide dispersion of forecasts is, in an industry that often falls prey to groupthink. More than a dozen analysts think Treasury yields will actually fall from the current level. This time last year, only two of 73 analysts thought yields would dip.

The variety of bond views stands in sharp contrast to the crushing consensus on the equity side. The S&P 500 will end next year at 2,313 points, another 5 per cent gain from today’s level, according to the median forecast of analysts submitting their forecasts to Bloomberg. The highest prediction is 2,350 points and the lowest is 2,200, a pretty slender difference.

Perhaps the most honest assessment of what president Trump means for the US economy and markets was made by Capital Economics’s Paul Ashworth, who simply entitled one of his notes with the millennial shorthand for bemused confusion: ¯_(ツ)_/¯

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