Bonds: Another bull trap in a secular bear market - BNPP

Eric Oynoyan, Research Analyst at BNP Paribas, suggests that over the past few days, 10y UST and Bund yields have squeezed by 10bp and they think this rally is another bull trap in a secular bear market for bonds.

Key Quotes

“Although a 10y Bund yield above 50bp implies a cheap valuation versus German macroeconomic environment and US 10y yields, the latter are set to rise over the coming quarters. This means that a cheap level for 10y Bund yields will rise from the 50/55bp area now to the low-70s and then to 90-100bp by late 2017. The repricing of the forward OIS curve has just started and there will be more to come if the ECB turns increasingly hawkish as we expect. We note that the Dutch election results have removed some of the support for Bunds that had been provided by the recent political uncertainty.”

“In the US, the Fed hiked as expected but we think the Fed funds curve is still too low for both 2017 and 2018. We expect more adjustment and that will push up yields. The negative net supply shock and higher GDP growth will warrant a higher term premium – the latter is still very low at +5bp - and higher real yields. A return of the term premium to its longterm average, and a more consistent level of US 10y real yields around 1.25% would see 10y Treasuries around our year-end target of 3.50%.”

“In addition to stronger growth, the US supply shock and expensive valuation on US 10y bonds, US and eurozone bonds are facing a further headwind. Net flows from Asia – initially China and then Japan since November – have turned sellers of US long-term securities (both charts opposite). These bearish dynamics from Asian investors have not been seen since H1 2013, when the US 10y sold off by 150bp after the Fed warned investors of an imminent Fed tapering.”

“We recommend investors keep short duration positions in the US, eurozone and are re-entering a short on 10y Gilt.”