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Warning: the following note from the normally mild-mannered European Rates Strategy team at RBS is seriously bearish.
They think the yield on 10-year US Treasuries can trade at 2.0-2.5 per cent.
Eat your heart out, Bob Janjuah.
First the context, emphasis ours throughout:
We have always been believers, from one year before the crunch when we went bullish govt bonds (5yr US specificially at 5-5.25%), in Great Depression II. Patience has been required; it now has potential to speed toward its conclusion; a European $1trn package which does little & political panic tells you we are about to reach the end of the road, with lower safe haven yields. The world should be discussing deflation, not inflation. The world should be dicussing buying 30-yr govts, not continually wondering like a stuck record where the first rate hike will appear. The battelines are drawn, the govts on the other side have used up their ammunition (apart from QME next which is bond bullish/fx bearish). Game on, as my pal/colleague Andy Chaytor would like to say.
We have been suggesting in meetings that financing of deficits is in part a confidence issue. Rather like going into a bank with a big hall to give you confidence, since the bank knows if you all withdraw your money they dont have the cash in the vault (think ‘Its a Wonderful Life’ opening scene). If you, the investor, think that there will be others to continue to finance the ongoing deficit, you will be (more) willing to buy.
But this is now in jeopardy in some jurisdictions. Why? because the world of end investors who are expected to finance deficits with their central bank/insurance/pension/retail investor capital (ie this is not about speculators, this is about deficits) no longer have this confidence. ‘Yes i could buy these bonds now, but even with the very strict 5% budget deficit cut, you still need to borrow a NET 7% of GDP from someone else, as well as refinance all your redemptions, and I no longer have confidence you can do that because your debt/deficit is too high. And in the euro you cannot print your way out or devalue. If i think no-one else will buy, I certainly will not’. The end game.
The only way that Europe does not break up (have members leave) is by accelerating the deflation that was always potentially coming (or at least should be in active discussion) in our deleveraging theme. This deflation is eminently possible – this is not a note about EMU break-up. Rather, if austerity measures continue for some time – and Harvinder thinks that they could feasibly continue for 7 years in Greece because the metrics are so bad they will still need help after the package’s timeline – deflation has to be a risk.
And now the conclusion:
1) So the confidence notion for deficits is in jeopardy
2 ) deleveraging still has to take place, especially EMU
3 ) the level of lending by northern EMU to southern EMU makes this a full EMU bank contagion risk
4 ) risk assets can move far faster than everyone always thinks, once the wolfpack (as Swedish finance minister terms financial markets) smells blood
5 ) various asset metrics say this is possible soon (VIX popped from complacency at 16 to 34, highest in a 1 year, in two weeks, gold +16% in 1 month, 3mth LIBOR/OIS 12-months forward up to 35bp)
6 ) there is nothing anyone can do about this. This is key. All through the crunch we have said somone had to take the hit of debt deflation (hence why my investor presentation was called ‘debt deflation’ for 3 years). Governments chose to nationalise the problem and make the taxpayer liable, hence why govt austerity is necessary and also supports why govts underperform supracorps.
7 ) We are in the middle of what I call the ‘Harry Potter scar’ in meetings. 2007-2009 was the sharp down-wave, Q209-Q210 the rebound driven by massive fiscal + monetary shock and awe, and we have been waiting for government intervention to wane and realisation of appaling private sector demand to come through (the 3rd part of the scar, the next downwave or at best anaemic growth). See this chart from the Bank of England about the very poor levels of domestic demand across Europe, and imagine what the numbers will look like once you remove fiscal largesse. Eg, German domestic demand has risen a net 0% in the past 10 years.
8 ) market discussion could easily turn to next moves being rate cuts (which we have been discussing for some time from a FI strategy bull perspective). And QME.
9 ) as with the (possible) end of any regime, expect extremes. Even if EMU is not changing, disinflation/risks of deflation is coming quicker. Watch for politicians/bureaucrats making emergency announcements (eg Germany short selling ban last night is a symptom, irrelevant in itself, but a symptom this is reaching its end game).
10 ) So: why should LIBOR/OIS not trade at 100bp if banks are seen as riskier propositions? why should 3mth futures curves not be inverted? Why should govts not trade cheap to swaps (and certainly to bond-like supracorporates)? why should gold not trade at US$2000 eventually (notwithstanding the fact that our commodity experts favour platinum and palladium right now, see Nick Moore’s weekly here)? buy the tail risk.
Somebody pass the tin hat.
More in the usual place.
Related link: Germany's plan to deal with budget transgressors – FT Alphaville How the Wolf Pack is (already) playing the BaFin ban "“ FT Alphaville
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