How Bad Could It Get For Bonds?

Tyler Durden's picture

With stocks pushing to new multi-year highs - seemingly all-in on the Fed's newfound transmission mechanism - the bond market is beginning to quake just a little. 10Y rates shifted quickly through 2.00% today - hovering around 10-month highs - but the question is, just how bad could it get for bondholders if the Fed were to lift their repressing foot of the yield-seeker's throat. While we believe they are missing the circular nature of any Fed implied tightening on stocks (and therefore bonds reflexively), Goldman sees 10Y yields 120-240bps under 'fair' currently thanks to Fed QE efforts - and believes 4.0% yields are on the cards by 2016. Our question - what exactly would HY spreads look like under this 'bullish' scenario? And for the stock bulls - is this just catch-up by bonds or the great rotation so many hope for? And if Goldman believes this - why is their (and their primary dealer friends) holdings of Treasuries so extremely high?

Goldman sees a one-way street to 4% yields by 2017...

 

as the Fed's footprint knocks 120-240bps off Treasury yields...

 

Of course, as we noted, this unilateral analysis misses the one big point - that a (belief in the) removal of the punchbowl by the Fed (which is realistically the only way yields will rise this far this fast) would have a liquidity-crushing impact on the difference between equity valuations and fundamentals - and while Treasuries may see volatility rise (from record lows)...

 

...we suspect safe haven flows (to explicitly more attractive bond yields) will temper the real explosion (and rotation) so many expect.

 

As we will not go gracefully back to an old normal market any time soon...

 

We suspect - just as oil will eventually self-regulate the expansion hopes of local economies via energy price margin compression - that treasury weakness will not be seen as hope-for-recovery-driven but an opportunity for better yields as the boomers remain far more risk-averse (especially at almost all-time highs in stocks).