US: Getting less fiscal - BNPP

Research Team at BNP Paribas suggests that the withdrawal of the AHCA – the Obamacare repeal and replace bill – has dampened expectations that the administration will push through its proposed tax reform, allowing USTs to rally.

Key Quotes

“Our economists still expect a boost to growth from fiscal policy (worth 0.7% in 2018), but less than previously expected. Structurally, we continue to expect higher rates in 2017, even with less fiscal stimulus, because: 

• Fundamentals: The synchronised global upswing in growth and inflation should see higher US rates, but not necessarily wider cross-market spreads as other regions catch up with US momentum and eventually policy dynamics. 
• Fed tightening: Multiple Fed speakers have mentioned the possibility of four Fed rate hikes in 2017 (Evans, Rosengren and Williams on 29 March alone). We continue to expect balance sheet normalisation in early 2018.” 

“Short-term market forces could be more mixed in their impact on rates, keeping 10y UST yields in their 2.31-2.62% range.

• Cleaner positioning may be less supportive of USTs: CTFC positioning report on 21 March confirms our suspicions of short-covering. Speculative shorts on TY (10y UST) futures have dropped to their lowest level since late November, helping to explain the recent rally in bonds.
• Overseas investment could be supportive of bonds: A new fiscal year and better yield differentials when USTs are hedged back into JPY should see inflows. Furthermore, risks of less fiscal stimulus could encourage other low yielding markets (EUR, GBP) to reconsider USTs.”

“With the 10y UST yield expected to stay in the range, we still favour positive carry positions, including forward starting steepeners (2y fwd, 2s5s), long 5y TIPS breakevens, and are focusing more on relative value.”