Six months ago, Deutsche Bank’s Dominik Constam – who roughly one year ago was lamenting the trendy at the time “secular stagnation” theme as an example of “capitalism in crisis” and was blasting negative rates as the “failure of globalization” – turned from prominent bond bull to bond bear, predicting a sharp jump in Treasury yields as the Trump reflation trade picked up traction and as Fed tightening accelerated pace.
Fast forward to this weekend, when Konstam became only the latest bond bear to throw in the towel on his trade reco, and as he abruptly writes in the latest edition of DB’s Fixed Income Weekly, “We are revising our forecasts lower – the bear market we expected to continue through 2017 seems to be on hold mainly due to the lack of progress on structural tax reform and we do not expect that to change anytime soon.”
In short, the “bear market is on hold” with the stated reason Trump’s failure to enact his proposed fiscal stimulus. Now if only somebody had warned Wall Street’s brightest and best paid minds just one week after Trump’s election that the president’s plan to “make America great again” was not going to happen…
In any event, here is Konstam explaining why he threw in the towel.
We are shifting our forecast for yields “forward” in recognition of the failure of the new Administration to make any progress on structural tax reform let alone outright fiscal stimulus. We have been highlighting the evident concern around the lack of apparent progress but the Congress has become more explicit in its incapacity to legislate. This is obvious in the case of healthcare reform but still quite apparent in the context of tax reform. On top of this it is clear that President Trump remains reluctant to take on a more authoritative role with the Congress which we think bodes ill for any quick progress on legislation, be it healthcare or taxes.
While we embraced the logic of the Brady-Ryan tax plan in terms of offering the potential for investment led growth via temporarily raising inflation expectations and then raising productivity growth, it is clear that there remains substantial opposition to key components of that plan, especially the border tax adjustment.
It is hard to see how without revenue raising measures such as the border tax, structural tax reform can be as effective in terms of lifting investment spending without a substantial fiscal stimulus. And unless there is a new approach with bi partisan support, the risk is that tax reform turns out to be a half hearted gesture with little positive impact on potential growth let alone actual growth. The only difference between pre and post election would then be a Fed that was suckered into a faster pace of tightening on false hopes.
In this context we are modifying our forecasts. We are still hopeful that eventually something structural and reformed-minded will be delivered in the tax arena and interest rates can move closer to 3 percent however in recognizing the delay, our fair value models clearly indicate that 10s belong around 2 ¼ percent in near term. A move towards 2 ¾ percent is anticipated for year end, reflecting at least some tax progress. If we anyway assumed the Fed can eke out another hike and is willing to begin a taper process, yields should anyway rise at least in line with the forwards which is around 2 ½ percent.
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Near term we are also concerned that the market is underpricing the risk in French elections whereby Marine Le Pen polls sufficiently well in the first round that brings her closer to the margin of error in polling for outright victory in the second round – contrary to current second round polls. Those polls suggest a 60-40 split with second placed (first round) Macron winning in the second round. However it doesn’t take much for that to swing if for example Melenchon continues to improve and one assumes a large proportion of Melenchon voters eventually switch to Le Pen (both being populist candidates, a mirror image of Trump and Saunders).
While few investors necessarily want to state that a Le Pen victory in the second round is the most likely scenario, it is probably underpriced and there are attractive hedging possibilities in both rates and FX, especially after round 2. This suggests that even if fair value in rates is slightly below current levels, implying a mild break lower out of the range, there is scope for a deeper squeeze around Europe jitters.
Luckily for the market, it did not wait for DB to finally change its mind, and as noted last weekend, in March 10Y TSY Futs saw the sharpest covering of net shorts in history.
Incidentally, once net specs turn bullish over the next few days, that will be the time to turn bearish on the 10Y once again.
via http://ift.tt/2ofC51k Tyler Durden