Saturday, September 25, 2010

Deutsche Bank Warns Of Big Treasury Overshoot, Sees 10-Year Yields Going To 1.5%

At least for now, Deutsche Bank is in the bond uber-bull camp:

Our rate forecast of 2% in the 10Y Treasury yield by the end of the year continues to be our view after the Fed’s statement that it was “prepared to provide additional accommodation if needed”. Chiefly, our rate view is based on the fundamentals of the economy. But the possible announcement of QE2 in November creates the possibility of the market overshooting compared to our rate forecast, with 10Y yields moving substantially below 2%.

We think that low interest rates will persist for the next several years, establishing a new equilibrium. The lasting period of low rates is due primarily to the following 4 factors: (1) The continued weakness of household balance sheets, with households repairing their balance sheets by reducing their spending over the next several years, (2) The payments on underwater mortgages will dampen spending and boost savings — a paper from the New York Fed stated that the savings rate would have to rise 0.8 percentage points, (3) The stagnation of firms’ pricing power, thereby raising the possibility of deflation, and making job growth difficult, and (4) Low potential GDP growth, with the CBO estimation of 2.1-2.3%, owing to the secular reduction in capital spending during the crisis. Thus the markets will likely have to adjust to a new growth level that is lower than the business cycle averages in the last several decades.

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