Trump premium: How much is enough? - HSBC

Research Team at HSBC, suggests that the US is seeing a reflation trade based on expectations of a big fiscal boost following Donald Trump’s election victory and as a result HSBC has increased its forecast for the 10-year Treasury yield to 2.5% (up 100bp) for Q1 2017 but are keeping their end-2017 forecast unchanged at 1.35% because they think the economy will slow if yields rise.

Key Quotes

“President-elect Donald Trump made plenty of promises during the US election campaign but gave very little detail. There are now widespread expectations of tax cuts and increased spending, particularly on infrastructure, but little clarity on how such programmes will be financed. We cannot afford to wait for more detail before changing our bond yield forecasts. We are cautious about how many of Mr. Trump’s pledges can be delivered, including on trade and tariffs.

Approximately 100bp increase in term premium

We think the 10-year US Treasury yield could rise to 2.5% in Q1 17. This increase may hurt economic growth, and given the structural factors at play and the large number of unknowns, we are keeping our end-2017 forecast at 1.35%. Our view recognizes the cyclical pressure pushing yields upwards but also that longer-term structural drivers, such as the debt overhang, will weigh on growth and yields (Bonds in 2021).

Rationale for near-term increase in yield forecast

Normalization of term premium towards the average level of the last four years would represent an approximate increase of 100bp in yield from the low point. The term premium rise reflects the potential shift in the level of bond supply versus demand, in line with projections of an increased budget deficit. The 2.5% 10-year Treasury forecast for Q1 17 is 110bp above the low point for nominal yields reached in the summer.

Why is the end-2017 forecast not higher?

We believe that if yields increase too much in the short-term then financial conditions will tighten, resulting in less growth and a constrained Fed. Our analysis shows that, historically, shifts in supply have not changed the relationship between longer-run economic growth and interest rates. Therefore, we expect yields to fall again on the basis that Trump’s policy proposals, which combine tax cuts and spending cuts, may not boost growth by enough to support higher yields.”