Guy Haselmann: Outlook for Treasuries

byGuy Haselmann

April 8, 2016

3 minute read

Outlook for Treasuries

by Guy Haselmann, Director, Capital Markets Strategy, Scotiabank GBM

I’ve been getting numerous questions since last Friday’s employment report as to whether my Treasury view has changed. I wrote the following to my sales team early this week that I now share with you.

The bottom line: I remain steadfast in my view that 10’s and 30’s will hit an all-time low yield in 2016, regardless of Fed action.

Below is what I wrote on January 4^th (“The Bond Awakens” note which is attached). Its explains the demand for long Treasuries. For the time being, I continue to stand by all of these factors.

• There still remain strong arguments for owning long-dated Treasuries. The reasons are fundamental, technical, Pension-related, relative, fiscal, regulatory, and due to the Fed’s balance sheet management.

• Fundamental – Economists frequently forecast 10-year Treasury yields by adding expectations for growth and inflation rates to a risk premium. This formula has been unreliable in recent years. Poor understanding of factors such as globalization, innovation, indebtedness, and demographics has led to chronic over-estimations. The business cycle might now be turning lower just as the Fed is hiking.

• Technical – The Fed owns around 40% of all Treasuries 10 years and longer. The ECB is buying 2X the amount of net issuance. The BoJ remains in full QE mode. There might be a shortage of long dated high-quality collateral.

• Pension Demand - Moreover, since 2008, the Pension Benefit Guarantee Corporation has doubled its ‘per participant premium’ and tripled its ‘per unfunded vested benefits (UVB) premium’. These premiums rise on January 1^st every year through 2019 and are scheduled to rise by another 25% and 30% respectively. The UVB motivation is to encourage Liability Driven Investment (LDI). The potential demand by the $3.2 trillion in corporate DB plans could be massive and have a profound impact on long Treasury securities.

• Relative – The US 10-year yields more than Germany (164 bps), France (128), Italy(67), Spain (50), Norway (85), and Japan (197). It yields 60 bps more than Slovenia and has the same yield as Bulgaria. In a highly globalized world, sovereign yield differentials among developed world economies may be more limited than in the past. A strengthening USD also increases its relative attraction.

• Fiscal – The US fiscal deficit has fallen dramatically. Net coupon issuance is expected to fall around 25% to the lowest level since 2008. Without any debt ceiling limits to worry about and due to money market reform needs, the Treasury will be funding a larger amount of its budget deficit with Bills (whose issuance as a percentage of outstanding debt is at the lowest level in almost 20 years).

• Regulatory – New capital rules (i.e., LCR) have incentivized banks to move toward more liquid securities with limited credit risk components.

• Balance Sheet – The Fed has approximately $215 billion of Treasury securities that mature in 2016 which it will be reinvesting across the coupon curve at auctions. This amount will be the equivalence of 10% to 15% of the entire gross new issuance of Treasuries in 2016.

Economist still want to predict long Treasuries by the formula: 10yr yield = growth + inflation (+/-) risk premium. This formula is dead for now.

TV anchors and their guests fail to understand the reasons driving long rates. They have less to do with inflation and more to do with demand. FOMC member also misinterpret what low rates mean and what are driving long Treasuries to higher prices (lower yields).

For the time being, the long end remains a commodity whereby demand is greater than supply.

Regards,

Guy

Guy Haselmann | Capital Markets Strategy
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Scotiabank | Global Banking and Markets
250 Vesey Street | New York, NY 10281
T-212.225.6686 | C-917-325-5816
guy.haselmann[at]scotiabank.com

Scotiabank is a business name used by The Bank of Nova Scotia

Read/Download the complete report below:

Global Macro Commentary Januray 4 - The Bond Awakens(1)

Author

Guy Haselmann

Mr. Haselmann has 30 years of diverse capital markets experience, including 14 years building and managing assets at 2 well-known macro hedge funds. During his career, Mr. Haselmann traded numerous capital market securities. He has developed risk management strategies and trading procedure guidelines.

Previously, Mr Haselmann was Director of Capital Markets strategy, at Scotiabank GBM, where he incorporated a global macro approach. Mr. Haselmann has been published in academic journals, newspapers, and has written countless strategy pieces. He has appeared on various TV and Radio programs, such as BNN Bloomberg and Bloomberg. Mr. Haselmann is a guest lecturer at several universities, including his alma mater the University of Delaware Lerner College of Business and Economics. He is a frequent panelist at industry conferences.

In addition, Mr. Haselmann was a gubernatorial appointee to the NJ State Investment Council and was appointed by the chair to the Investment Policy, Executive, and Nomination subcommittees. Mr. Haselmann is President, and a member of the Board of Governors, of the NY Money Marketeers.

Specialties: Analyzing global macroeconomic policies and capital market interconnections to strengthen investment and strategic decision-making in financial markets. Providing portfolio construction solutions to enhance risk-adjusted returns. Macro trading and strategy. Risk management. Alternatives advisory services. Hedge funds and other alternative investments. Funds of Hedge Funds. Analysis for optimizing position sizes. Capital market products. Options.