11.20.2024
UST Getting there
Same winner, different market reactions. Although 10Y rates surged following both Trump’s landslide victories in 2016 and 2024, the market seems to have factored in a different Fed reaction function compared to 2016, which was incorporated into our baseline.
Since we first flagged upside risks to UST yields in the case of Republican sweep1, 10Y rates surged 65bp. However, the market appears to have adopted a different view of the Fed’s likely response compared to the stance taken in 2016, which was incorporated into our baseline.
Instead of assuming that the Fed would maintain a passive approach until President-elect Trump’s policies eventually flare up inflation, the increase in real rates alongside stable breakeven rates suggests the market discounts a pre-emptive response from the Central Bank that will keep medium-term price pressures at bay, effectively capping the term premium.
Cumulative rate cuts priced in through 2025 declined from 115bp to 55bp since the end of August. A resilient macro-outlook has certainly contributed to this shift; however, our qualitative analysis shows the “Trump effect” contributed to a larger extent.
We don’t expect the market to change narrative remarkably before President-elect Trump is sworn in. This will keep a lid on the UST sell-off that started in mid-September.
Against this backdrop, we remain of the view that UST yields have more room to increase from current levels (around 4.45%) – especially if the market were to take the view that Trump’s policies warrant a higher neutral rate – though not as much as we expected in August. Accordingly, we now believe that 4.60%-4.70% is the appropriate entry-level to turn gradually LONG under a Republican sweep (4.80%-4.90%, previously).
The new entry-level should also hold even if the market realigns with the Fed’s dot plot and our Fed forecast, both envisaging further cumulative easing of 125bp by the end of 2025. In that scenario, we would expect real rates to decline and breakeven rates to increase.
A word of caution. Although no longer our tactical baseline, UST yields at 4.80%-4.90% cannot be entirely ruled out at this stage. For that to happen, either growth would need to exceed our current projections and/or President-elect Trump’s policies would need to create near-term inflation, which neither our baseline nor the 2017 trade war experience suggest. This is yet another reason to keep our strategic OVERWEIGHT stance outlook under review (with a negative outlook).
Chiara Cremonesi
Senior Rates Strategist
Investment Research
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