Worst Week for Bonds Since 2013 Seen Overstating Trump Policies

  • Strategists warn expected economic gains aren’t proven yet
  • HSBC sees Treasury 10-year yields falling to 1.5% by year-end

After Treasuries plunged this week on expectations that President-elect Donald Trump will boost government spending and stoke inflation, some of the bond market’s biggest dealers and investors say the economic optimism may be short-lived.

Benchmark 10-year yields surged by the most in three years after Trump’s shock election victory on investor views that the Republican would pursue stimulative fiscal policies. A bond-market gauge of inflation expectations rose to highest since July 2015.

More than $1 trillion was wiped off the value of bonds worldwide this week as stocks surged on expectations that Trump, teamed with a Republican-led Congress, can accelerate economic expansion. While bond bears felt vindicated, strategists from Goldman Sachs Group Inc. to HSBC Bank Plc to Wells Fargo & Co. warned that financial markets may be overreacting. They said it’s premature to assume a pickup in U.S. growth and cautioned that rising yields may tighten financial conditions before the new administration even takes office.

"The market’s pricing in a rosy scenario that assumes everything works perfectly," said Lawrence Dyer, a New York-based interest-rate strategist at HSBC, one of 23 primary dealers that trade with the Federal Reserve. "Experience teaches us that it doesn’t always happen.”

The Treasury 10-year note yield rose 37 basis points this week, or 0.37 percentage point, to 2.15 percent as of 5 p.m. Friday in New York, according to Bloomberg Bond Trader data. That’s the biggest weekly climb since June 2013, the height of the episode known as the "taper tantrum."

After this week’s bond-market tumble, technical indicators such as the relative-strength index are signaling the move may have gone too far, too fast. The 10-year yield’s RSI rose to about 80 this week, the highest since June 2007. A number above 70 signals yields may be overbought -- or, in other words, that bonds may be oversold.

"The selloff is a bit overdone," Boris Rjavinski, an interest-rate strategist at Wells Fargo Securities LLC, a primary dealer. "It’s mainly driven by a bit of euphoria of expectations for a fiscal package." Rjavinski sees 10-year yields falling into a range of 1.9 percent to 1.95 percent by year-end.

Investors who have grown used to focusing on economic reports and central-bank policy statements are homing in on signals from Trump as he assembles his transition team.

"For the next few months, it’s not so much a data-independent model, but a Trump-speech-dependent model," said Thomas Roth, senior Treasury trader in New York at MUFG Securities Americas Inc. “His trade policy could have the opposite effect -- he can start a trade war.”

The real estate magnate has pledged to cut taxes and spend as much as $1 trillion on infrastructure. He’s also blamed China and Mexico for American job losses and threatened punitive tariffs on imports.

‘Convincing Signs’

"If we hear the anti-trade rhetoric in particular, then we are likely to see the equity market go lower, and the Treasury market would be torn between two different things -- the flight to quality versus the higher fiscal spending," Mohamed El-Erian, chief economic adviser to Allianz SE, said in a Nov. 9 interview on Bloomberg TV.

This week’s leap in U.S. yields in a world betting they’d stay lower for longer may spell trouble for growth prospects in the U.S. and abroad, according to Francesco Garzarelli, co-head of global macro and markets research in London at Goldman Sachs.

“The ongoing exuberance around even faster U.S. reflation post the U.S. election may prove ultimately self-defeating without much more convincing signs of a growth upswing,” Garzarelli wrote in a report Friday. “Until underlying inflation in Europe and Japan also increase, it is difficult to see a self-reinforcing bond selloff as the respective central banks will want to prevent a sharp tightening in financial conditions.”

Strategists at Morgan Stanley expect the selloff to stall when 10-year yields reach 2.3 percent, reflecting domestic demand from long-duration investors for fixed-rate assets. HSBC forecasts U.S. 10-year yields will fall to 1.5 percent by year-end and 1.35 percent by the end of 2017.

Treasury auctions this week showed waning investor appetite for U.S. debt. A $15 billion 30-year bond sale Thursday drew the weakest demand since February, a day after a 10-year note auction saw the smallest demand since 2009. The U.S. will sell $11 billion of 10-year Treasury Inflation-Protected Securities on Nov. 17.

"People at some point are going to start coming in," said John Bredemus, Minneapolis-based vice president at Allianz Investment Management, with more than $700 billion in assets under management. "The gut reaction is that we don’t want to own U.S., but people get over that pretty quickly."

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