The Trillion Dollar Bash & The Second Leg Down?

by Michael J. Howell21. February 2018 11:47

The ‘big’ risks centre on US bonds. Bond markets essentially have two moving-parts – policy interest rate expectations and term premia. A strengthening economy and rising inflation pressures are already raising the trajectory of the Fed’s forward guidance. However, this is occurring against a backdrop of very low (negative) Treasury term premia that have been unusually depressed by the Fed’s LSAP and recent flight capital into US dollar assets from Europe and Asia. We are concerned that these benign influences on term premia are likely to unwind sharply as reverse QE engages, at a time when both the Trump fiscal deficit is swelling towards US$1 trillion and capital is exiting the US in search of economic acceleration elsewhere. US 10-year Treasuries will test 3.5% yields and the 10-2 curve will steepen. For equities, this could mean a second leg down. Bonds matter. And, China matters!


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