If you can get it…

Faithful readers will remember when I take them back to 2014. Then, numerous posts ended with the following notion: 3% may be the trade of the year, if you can get it… Reference had been made to the 10 year Treasury yield starting out the year at just above 3%, but in its ensuing bull run never looked back. It was the time when pundits argued over each other why yields should be going to 4 or 5 or even 6%. The rest is history.

Why is this relevant today? Well, we are not exactly in the same place, with an unpresidented scenario of Donald Trump moving into the White House. It may be correct that nothing will ever be the same, but if you compare the rhetoric, we are not that far off from the start of 2014, and the start of 2015 and 2016 for that matter. Mainstream is calling for yields to go to 5 or 6% in a year or two, and what does the market do?

It appears to be telling us that it has had it with this historic bond market correction. Enough is enough seems to be the message. Instead of breaking one second-tier bond fund manager’s 2.60% target and causing America’s financial markets to implode it looks like it wants to go the other way and rally for a change. As expected before the election, the 2.50% yield vicinity has been reached but served its purpose of resistance and held just fine.

10 year intraday yields retreated to 2.30% overnight, and 30 years plunged back below 3% and fell to 2.90% during the session, before retracing back up again into the close, to 2.36% and 2.96% respectively. Maybe this year’s theme in Monday’s 2017 forecast piece should have been a little more aggressive, such as 3% may be the trade of the year, if only you can get it… 😉 and this time for the 30 year bracket of the Treasury curve.

Let’s be a little more serious though. Confidence has served this bond bull well over the years, arrogance will not. I still feel there are plenty of reasons to remain constructive on the Treasury market, but there will be speed bumps. The 30 year auction overnight for example couldn’t repeat the success of the 10 year the day before. And Fed members starting to chat about unwinding the central bank’s balance sheet doesn’t help either.

Lots can and will still happen, particularly in the White House corner. At least we know it is a known unknown… and it gives us the chance to look into this year with caution. As pointed out on Monday however, I felt that 10 year Treasuries will remain volatile but end the year veering towards the 2% mark rather than the above-mentioned pundits’ targets of much much higher.

Humour me in looking at the rationale one more time. Firstly, nothing will happen overnight except for Donald’s rhetoric, which admittedly is not nothing. It hasn’t abated yet, and it looks like it will continue to be entertained after his inauguration. The real beef however, such as tax law changes and the start to fiscal spending, if ever Congress was to agree to the gargantuan numbers swirling around, may not materialise before 2018.

Secondly, as much as the bipartisan noise has been pointing at it, America’s recovery is far from structurally sound. Macro numbers are in fact still all over the place, and a labour market that is largely misinterpreted doesn’t make all the difference. Not that one cannot appreciate all the positive sentiment and an atmosphere of departure, but in the end rhetoric will be rhetoric, and Keynesianism will be short-lived.

Thirdly, is the Fed really going to hike 3 times or more this year? There is lots of talk about the monetary offset, as in more aggressive fiscal policy will need to be met with more aggressive monetary policy. When it comes to the hawks at the Fed, such as Jeffrey Lacker, rates couldn’t be raised fast enough against the current background. But Lacker is retiring this year, and will his colleagues take up the relay and carry his message?

One also has to wonder what Janet Yellen must be thinking. Traditionally adopting dovish views, combined with the open prospect of her being replaced early 2018, what motivation would she have to go steep now, after so much dithering throughout 2016? Fed chairs naturally think in terms of legacy, and doing nothing much for the rest of her mandate may well be the best way to preserve the little she still has.

Much like at the beginning of last year, when amid the noise of 4-6 projected hikes I ventured the forecast of zero moves – only to be proven wrong last minute – I am again inclined to believe that the Fed will at least under-deliver in 2017. Probabilities for those guaranteed 3 hikes this year have been fading. And by the way, strong dollar, higher rates including the all-important Libor for businesses is doing the tightening already.

Fourthly, may I bore you with another notion that has often been in this space: It isn’t cyclical, it is structural. For years now since the financial crisis the most renowned economists have been talking themselves into the fallacy of the cycle not being dead but late. The burst of the credit bubble in concert with unprecedented demographics has changed our lives for good, and no nostalgics of economic theory will bring the old world back.

Keynesians can create demand, for some time but at an even higher cost later. Real demand is still hard to come by, except for demographically prosperous areas such as Asia. So inflation will be hard to come by, whatever indicators are saying. And so materially higher long rates will also be hard to come by, as incredible as it may sound, particularly now.