US Rates: Shifting global themes drive larger yield moves - HSBC

According to the analysts at HSBC, the large moves in the US 10-year Treasury yield were driven by shifts in broad global economic themes in 2016.

Key Quotes

“The 10-year note’s 2016 yield range – 1.36% to 2.60% – cannot be explained by shifting economic data or by shifts in expected growth or inflation, in our view. Instead, the hefty moves were driven by concerns of slower growth in China, Brexit, and Trump reflation.”

“Macro trends change slowly: A move to significantly higher yields, versus the recent 2.6% high for the 10-year note yield, would require longer-run expectations for growth and/or inflation shift to meaningfully higher levels. Alternatively, the FOMC could shift to a higher terminal funds rate. But, these variables tend to change slowly, over time. As in 2016, we expect only slow shifts in underlying fundamentals in 2017.”

“How to read the FOMC’s dots: The FOMC’s projections reflect each participant’s assessment of the “most likely” economic and rate path. A lesson from 2016 was that this single scenario is likely to have a rosier view of the economic outlook than the range of scenarios weighted by the market, and this can impact market trading levels.”

“Higher rates lead to lower rates: History does not repeat, but it does rhyme, as Mark Twain said. In this context, the recent uptick in US 10-year Treasury yields should be seen as an attractive longer term buying opportunity.”

“Look for an edge versus the Fed’s rate guidance: We particularly like buying on price dips in the 10-year sector. The recent 10-year yield peak, 2.6%, was consistent with a tightening pace of three rate hikes per year. A shift from three to four hikes a year implies only a +9bp increase in its yield, versus a +23bp increase for the two-year note. This risk versus reward is the opposite of that seen in September’s scenario analysis. The September two-year note cheapened +25bp since then, while the 10-year cheapened +80bp.”