A springtime for shorts?
Besieged Treasury bears may finally be set for a winning streak in the world’s largest bond market. Strategists are citing an under-pricing of inflation in the U.S. economy, waning foreign demand and a bid by the Federal Reserve to tighten its monetary stance at a faster pace than markets anticipate.
“The next two months will be more threatening for duration longs as data holds up well, political risk in Europe ebbs, and investors refocus on progressive central bank exits from easy money,” strategists at Societe Generale SA led by Ciaran O’Hagan wrote in a note. “And therein lies the potential for a surprise to upset the ‘sleeping beast,’ an overly complacent bond market.”
“Lower bond yields and stronger growth momentum give us a good entry point into a more aggressive short-duration position in developed markets,” strategists at JPMorgan Chase & Co. led by Jan Loeys wrote in a note. They project the 10-year Treasury will rise to 2.7 percent in June and finish the year at 3 percent.
Analysts at boutique research firm CrossBorder Capital Ltd. are more bearish, expecting the benchmark yield to test 4 percent within the next 12 to 18 months amid capital outflows from China and Europe.
Here’s four arguments in favor of the bears:
Fed’s Balance Sheet
Last week should have been a win for bond bears after Fed minutes suggested it would likely phase out of the practice of reinvesting proceeds of maturing securities held on its balance sheet at the end of this year, a move that will remove a big monetary backstop in debt markets.
Speculation the Fed may delay increasing short-term borrowing costs spurred a decline in 2018 interest-rate forwards, even as June rate-hike odds edged higher. Markets may have gotten the wrong message: there’s a high bar to clear before the Fed postpones raising rates, according to analysts at TD Securities.
“The market may be underpricing the pace of hikes in the near term, and rates will move higher as the Fed begins to communicate the case for more hikes,” fixed-income strategists led by Priya Misra wrote in a note. They suggest a delay in the tightening cycle would kick in only if financial conditions tightened quickly.