HALISTER1: RESEARCH ROUNDUP: UST Outlook Hinges on Tax Reform, Fed Holdings

RESEARCH ROUNDUP: UST Outlook Hinges on Tax Reform, Fed Holdings

(Bloomberg) -- Positioning views on USTs are focused on the potential impact on yield curve of tax reform and wider deficits and of Fed reinvestment tapering.
  • Citi (Jabaz Mathai and Jason Williams)
    • “Fiscal fatigue is likely to continue weighing on the curve”
    • Fed appears likely to raise rates in June, yet “we would not want to assign more than a 65%-70% probability to that outcome at this point”
    • Investors are increasingly skeptical Congress will pass any tax reform; if it doesn’t, March 13 highs for 10Y yield “may very well represent the peak” for 2017, and curve should flatten as deficits become less of a concern
    • Fair value for 10Y yield based on global framework is 2.65%, suggesting “rates can move higher in the next couple of months if Washington gets its act together”
    • In Treasury futures, new longs in FV and TY probably “played a bigger part in the rally during April than short covering”; shorts have not capitulated materially, thus “cleaner short positioning” is needed “before a strong short conviction trade can be entered”
  • BofA (Shyam Rajan and Carol Zhang)
    • Impact of deficit expansionary stimulus on shape of UST curve will be a key trade if temporary tax cuts gain traction
    • BofA’s long-term curve model suggests forward deficit projections matter more than spot deficits, and that a 50bp increase in 2Y rates “offsets the steepening impact of 1% deterioration in forward deficits/GDP”
    • Model offers these rules of thumb:
      • $200b increase in 5yr forward deficit projections steepens 5s30s by 15bp
      • 25bp increase in 2Y yields flattens 5s30s by 7.5bp
      • Thus, “structural bear steepeners only make sense if coupled with out-of-the-money payers on the front end”
  • SocGen (strategists led by Subadra Rajappa)
    • UST 10Y yield may rise 40bp-60bp over three years as Fed pares SOMA reinvestment; MORE
  • BMO (Margaret Kerins and Dan Belton)
    • UST 10Y yield has scope to 3.5% by end-2019 as Fed ends balance sheet reinvestment and raises rates; MORE
  • Nomura (strategists led by George Goncalves)
    • UST 10Y yields are 20bp-30bp too low based on outlook for Fed rate hikes and balance-sheet unwind, yet are likely to be contained in short term by headline risks
    • 10Y yields may carve out bottom between 2.1%-2.4% in next two weeks
    • 10Y and 30Y supply needs to clear at higher coupons to confirm resumption of selloff
    • Favor curve steepeners based on Fed balance sheet action, but respect short-term flattening bias tied to Fed rate hikes and reach for duration
    • Opportunities are increasing in cross-rates; in particular, U.S.-German 10Y spread has room to narrow based on cyclical recovery and possibility of “a more straightforward taper” by ECB in coming months
  • TD (Priya Misra and Gennadiy Goldberg)
    • 5y swap spread tightener recommended based on expectation that deficits will widen over 10-year period; MORE
  • Barclays (strategists led by Rajiv Setia)
    • Maintain 3s10s flatteners given benign hiking cycle priced in; also maintain U.S.-U.K. 10Y convergence trade
    • Expect Fed to reiterate strengthening labor market conditions but not strongly signal hike in June
    • In RV, maintain short OTR 30s vs double old 30s, given current pricing of liquidity premium should be lower
    • In vol, recommend 3m*5y 1x2 receiver spreads to take advantage of low realized vol, rich receivers and low probability of large rally ahead

Alert: HALISTER1
Source: BFW (Bloomberg First Word)

People
Jabaz Mathai (Citigroup Inc)
Jason Williams (Citigroup Inc)
Carol Zhang (Bank of America Corp)
Daniel Belton (Bank of Montreal)
Gennadiy Goldberg (TD Securities USA LLC)

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