The markets still have to work through the presidential election in the United States, but many economic teams and strategists are starting to issue their preliminary forecasts for stock indexes and for bond yields in 2017. Credit Suisse’s global equity strategy team has now forecast that the 10-year U.S. Treasury yield will rise to 2.15% by the end of 2017, versus roughly 1.80% this week.
What should really stand out for investors here is that Credit Suisse is joining the ranks of those who are bracing for even higher interest rates. The firm warned of a real risk that bond yields could rise more than expected. This may sound negative for stocks, but the Credit Suisse team feels that equities can accommodate higher rates and they prefer playing higher rates via financial stocks.
The formal call is for the 10-year yield to be 2.15% by the end of 2017. For an upper limit, Credit Suisse said it would not be surprised to see a the 10-year yield go over 2.25%.
Europe has been plagued by negative interest rates, and while Fitch showed this negative yield tally is shrinking, Credit Suisse said that it can see a 0.50% to 0.75% yield on the German 10-year yield in mid-2017. Bloomberg shows the German 10-year Bund yield at 0.16% now, up from −0.10% a month ago.
Credit Suisse also went on to show what factors generate upside risks for yields:
1) There is a general move of policy makers away from negative interest rate policies towards fiscal easing;
2) Growth proxies (cyclicals to defensives, global IP, commodity prices) imply yields should continue to rise;
3) China is no longer exporting deflation (for the first time in 2½ years) and US wage growth is in a modest uptrend, leaving long-term implied inflation rates too low;
4) The term premium and implied volatility are close to historic lows;
5) Populism tends to be bad for bonds;
6) Logistical and political challenges for quantitative easing in both Japan and the euro area are likely to arise;
7) Outside of Japan, government debt-to-GDP and unemployment in the G4 would stabilise on higher real yields.
As far as why Credit Suisse thinks that equities can accommodate a rise in interest rates, the firm sees stocks able to withstand bond yields rising to 2.50% in the 10-year Treasury and up to 1.0% in the 10-year Bund before the relative valuation case erodes. The report said:
The correlation between equities and inflation expectations is at new highs and thus supportive. Historically, equities re-rate until actual inflation rises above 2% (with 5 year/5 year forward inflation 1.8% in the US currently and 1.4% in the euro area). Regionally, Japan and Europe are the clear winners. While rising yields may pose a near-term challenge to GEM equities, the sharp improvement in the aggregate GEM current account deficit should allow greater resilience compared with the taper tantrum of 2013.
Credit Suisse even has a view of the U.S. sector by sector, although this was limited as it was more of a European and international strategy view. The report showed the following:
- US Telecoms: neutral – lots of bad news in the price
- US Utilities: underweight
- US life insurance: overweight