US Fixed Income: How much Fed in response to fiscal stimulus? – Deutsche Bank

Research Team at Deutsche Bank, suggests that the first order impact of the Trump electoral surprise was a partial normalization of the term premium via a lower ratio of G3 QE asset purchases to G3 net supply.

Key Quotes

“The Trump campaign budget plan, as scored by the CRFB, would add $5.3 trillion to the stock of federal debt over 10y, implying an average monthly increase in net supply of $44 billion. This lowered the QE/net supply percentage from 160% to 120% and implied an upward move in 10y yields of 40 bp relative to the status quo.”

“The latest leg of the selloff has been driven almost in equal parts by a higher term premium and higher Fed expectations. Our model attribution suggests that higher 2sfunds has contributed 17 bp to the sell-off since November 7th, while higher term premium has contributed 18 bp.”

“We see the Fed response to fiscal stimulus as a key risk to the rate outlook. We examine two stylized paths for funds and model their implications for the trajectory of 10y yields. The more dovish path suggests that the selloff has moved into overshoot territory. The more hawkish Fed path results in 10s peaking at 2.60% in H2 2017.”

“Other risks include the forthcoming Italian referendum, French elections, and of course the possibility that the Trump stimulus will be whittled down substantially, and anyway might have less impact on growth than hoped given the tendency of the private sector to save what the public sector spends in so called "Ricardian equivalence".”