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Bond market storm builds behind Wall Street's serene yield call
[NEW YORK] For all the talk about the end of the bull market in bonds, the consensus on Wall Street for the year ahead is for the smallest projected change in yields since 2008.
The benchmark 10-year Treasury yield will rise to 2.75 per cent at year-end, less than a third of a percentage point above where it began 2017, according to the median estimate of 62 strategists and economists surveyed by Bloomberg. Yields moved that much in just two days after the UK vote in June to leave the European Union.
The tepid forecast masks the tension that will define 2017 in the world's biggest bond market - between those who expect the reflation trade, spurred by the policies of President-elect Donald Trump, to take hold, and those who argue that the US economy has yet to escape its slow-growth stupor.
"The idea that the yield moves benignly from today's level to 30 basis points higher? Ain't gonna happen," said Steven Major, head of fixed-income research in London at HSBC Holdings Plc. His 10-year yield forecast of 1.35 per cent at year-end is the survey's lowest.
"The consensus view is reflecting a benign positive scenario and a continuation of the reflation trade. But when I look at markets and how they behave, it's more about events."
Major stood out in 2014 for correctly predicting that 10-year yields would drop to about 2.1 per cent, while the median at the start of the year said 3.4 per cent. His forecast of 1.5 per cent by year-end 2016 looked prescient in the aftermath of the Brexit vote, though it was overtaken by the events of last quarter.
Most strategists missed last year's whipsaw. Ten-year yields traded in a range of 1.32 percentage points, the widest since 2013, the year of the taper tantrum, data compiled by Bloomberg show. Yet they still wound up climbing just 17 basis points for the whole year, a potential explanation for the skimpy increase anticipated in 2017.
"No one wants to be a hero," Mr Major said.
"Last year, everybody was right for a few months at a time."
Mr Major says he's bullish for 2017 because of a long-held view that swelling sovereign debt has reduced the spending power in many countries. And the burden of mortgages, student loans and car payments has only risen along with yields.
In other words: financial conditions have tightened. The Goldman Sachs Financial Conditions index, which incorporates exchange rates and other variables, reached the highest since March after Mr Trump's victory.
That will give Fed officials reason to hike just once this year, said Dimitrios Delis, senior econometric strategist in Chicago at Piper Jaffray. His 10-year yield forecast of 1.95 per cent is third-lowest in the survey.
It reflects his view that the bond market reacted too swiftly to Mr Trump's proposals for fiscal spending, which the president-elect failed to elaborate on in his press conference last week. He sees GDP expanding 1.7 per cent this year, compared with the median forecast of 2.3 per cent.
"Trump got elected and the market priced everything to perfection - they're pricing in tax cuts, they're pricing in infrastructure spending," Mr Delis said.
"It's going to be a process. We're expecting growth to still remain low."
Joel Naroff, president of Naroff Economic Advisors Inc, embodies the opposing school of thought.
He expects wages, which grew the most since 2009 in December, will continue to climb, pushing inflation above the Federal Reserve's two per cent target and leading to 0.75 percentage point of rate hikes, more than the market expects.
,Mr Naroff sees the 10-year yield ending the year at 3.45 per cent, fourth-highest in the survey, and reaching four per cent by mid-2018.
"I don't think the Trump victory has been fully priced in by any means - rates were too low and where we are now is probably where we should have been in the first place," he said.
"If you're looking at valuing the potential outcomes, the risk is to stronger growth, higher inflation and higher interest rates."
That bearish sentiment has drawn two of the biggest bond investors into a debate over what level signals the demise of the three-decade bull run. Bill Gross at Janus Capital says it's when the 10-year yield eclipses 2.6 per cent. Jeffrey Gundlach, chief executive officer of DoubleLine Capital, says it's at three per cent.
There's another scenario that could drive up yields, one that most strategists give at most a passing mention: the potential for a Trump-inspired trade war, particularly with China, the world's second-largest economy and the owner of more than US$1 trillion of Treasuries.
The president-elect has pledged to declare China a currency manipulator when he takes office. He called out China for cyberattacks during last week's press conference.
The sparring will lead China to shun Treasuries, pushing 10-year yields to 3.71 per cent by year-end, even with the Fed raising rates just once, according to Rajeev Dhawan, director of the Economic Forecasting Center at Georgia State University.
"The global flows of capital will be disrupted, and that disruption will show up as a higher interest rate on the 10-year bond," Mr Dhawan said.
While yields could also rise as a result of stronger-than-expected growth, "my gut tells me a trade skirmish is coming". The range of opinions has even those in the consensus bracing for turbulence.
"You'll definitely see a more volatile trading environment this year," said Justin Lederer, an interest-rate strategist at Cantor Fitzgerald whose forecast for 10-year yields is right at the median, 2.75 per cent.
The prospect for losses means reactions will be swift, he said, because "we've been sitting at such low rates for such a long time."