BofA Warns A Complete Bear Flattening In Treasuries Would Be Devastating

Tyler Durden's picture

Authored by BofAML's Hans Mikkelsen,

Fear the bear flattening

What if this was the year where the Treasury curve bear flattened completely as happened in 1994? While this is not what we are looking for, we have highlighted this outcome as the biggest and most relevant risk to credit this year, and with a probability that we believe appears uncomfortably high. While the total return performance of the high grade market in a Treasury complete flattening scenario would be extremely adverse (losses of at least 10%), the pension "reverse rotation" story that we subscribe to serves to significantly limit losses for excess return investors to just 80bps, as the long end of the spread curve outperforms.

Still, as the majority of high grade investors nowadays have total return - as opposed to excess return – objectives (Figure 8), a complete bear flattening of the Treasury curve would be quite devastating.


To show the potential impact on credit returns we run three scenarios as described in Figure 11.

First our “Baseline” scenario is simply the most likely outcome this year for reference – i.e. higher interest rates and tighter credit spreads, without the big flattening move. As shown in Figure 9 we expect total returns of -105bps under this baseline scenario between now and year-end and, as highlighted in Figure 10, excess returns of +198bps. Furthermore total returns should be positive in the front end, while excess returns are especially attractive toward the back end.


In the “Treasury flattening” scenario (see Figure 11 for the details) we show the impact of a complete bear flattening Treasury curve to 5% yields at all maturities, while credit spreads tighten as in the baseline scenario. Clearly the impact on total returns (Figure 9) is devastating, as our index stands to lose 10%, led by the long end (-14%) – but even the front end 3-5-year maturity bucket stands to lose 9%.


Finally we show a more realistic “Flattening, widening” scenario where the bear flattening of the Treasury curve leads to a rotation out of credit and much wider credit spreads (Figure 11). Obviously this scenario compounds the total return losses in Figure 9. However, we assume that the 50bps spread widening from current levels is led by the front end and 10-year sectors, as the pension/insurance bid for long paper keeps the back end in check. Thus excess returns under this scenario in Figure 10 range from -210bps in the 7-10-year sector to just -3bps and -8bps in the 1-3-year and 15+-year maturity buckets, respectively.



The bottom line is a more dramatic bear flattening in the Treasury curve has very significant implications for credit spreads and pension fund returns (and allocations) all of which are negative for stocks - no matter what your friendly local asset-getherer tries to tell you about Forward P/Es or higher rates mean strong economy... you can't fund buybacks or dvivdends at anything but shareholder-wealth-destroying levels once rates and spreads start to rise... and if spreads are rising then SMEs are not going to be getting the credit that everyone assumes will fuel the next leg of Capex (or whatever dream there is)...

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The Vineyard's picture

How are the treasuries going to flatten in a deflationary environment?  I don't get the logic.  Bitches.

Bunga Bunga's picture

How are the treasuries going to flatten when the fed manipulates the curve. I don't get the logic.

fonzannoon's picture

The fed spent a good part of last year kicking everyone and Pimco out of the long end of the curve. It would not surprise me if they now kick everyone out of the shorter dated stuff as well. Belgium has an insatiatble appetite for our stuff and we need to kick grandma into SPY and hand the ECB some UST's to let the games continue I guess.

NoDebt's picture

Larry Kudlow has been screaming about how bullish an "upward sloping yield curve" is for years.  Or maybe that was just his upward-sloping stupidity curve.  Maybe that's why he's gone now.  Or maybe not.  I don't recall having seen anyone fired for stupidity in the MSM yet.

Did a black hole swallow that 777?  Yeah, probably.  Maybe.  Who cares?  Let's go with that.

scuttlebutt's picture

Listening to Kudlow on my sirus radio yesterday, Tuesday, (for about five minutes, time I'll never get back) the shit coming out of his and his experts mouths was behond scary. They were going on about- putting some fear into friends and foe alike...

Anyways for me, more disturbing, is how many more people think, and believe the diarhea the likes of him expunge.

Good Riddens Kudlow

zhandax's picture

"how bullish an "upward sloping yield curve" is for years" 

Probably just extrapolated 'enemy of my enemy' analogy.  An inverted (or downward sloping) yield curve is highly correlated with a downturn in business activity.  In less centrally-planned days, this also correlated with a drop in stock prices.  Not sure how much correlation it has to casino winnings today, though.

ebworthen's picture

Poor Larry is caught in the 1980's Vornado.

He doesn't quite understand we have been completely sold out.

"Free market capitalism is the best path to prosperity" is his catch phrase.

Sure Larry, if the rule-of-law was extant and the markets were not a rigged Ponzi backed by the FED.

100 years too late.

f16hoser's picture

9-11 was a Treasury Flattening Event:

If Treasuries are coming due, expect another "False Flag" event. Obama said he fears a Nuke in Manhattan. Coincidence? If I lived in NYC, I would go on a long vacation. NOW!


yogibear's picture

You'll want to be somewhere warm, but not as warm as NYC will be if Obama's warning is right.

In 2009 he said buy the market.

Now he's touting about a nuke. He looked like he saw a ghost while saying it. I would get out the city as fast as I could. 

The anniversary of  Osama bin Laden's death is coming up (May 2, 2011). The radicals want to make a big bang?

OldPhart's picture

Sadly, I have NEVER seen an excess of returns.  (I'm assuming it means earnings of a sort?).

DoChenRollingBearing's picture

Would anyone feel better about 0.05 free BTC?  See photos from Peru and try to solve the question:

fonestar?  Bueller?  Anyone?



"El Capo" has just won the contest.  But the photos are still there.

seek's picture

I got beat out by El Capo by 30 minutes. I thought the QR code would be interesting besides its color coordination, but alas, it's McDonalds!

DoChenRollingBearing's picture

But, what if his name had been "El Chapo"?  Oh, man would I be in trouble sending crypto-currency to (OK, now captured) Public Enemy No 1!


Yes, McDonalds.  On Av. Benavides close to here.  I saw the QR Code on that paper they put on trays.

stant's picture

its not for the widows and orphans, which there are many more of, they have no savings

drinkin koolaid's picture

Another frickin Wall Street PHD economist that has no fuckin clue. 

fonzannoon's picture

if we get a (further) rotation out of credit, where will that money end up? Seems to me it only goes one place.

NoDebt's picture


Just kidding.

It's equities.


I Write Code's picture

If there's no yield curve the banks can't make their riskless billions, poor boobies.

But I suppose that means therefore the Fed, who now rule all of creation, will keep the curve, presumably positive, say short 2% and long 5%, roughly the same spread as now.

techstrategy's picture

Rising yield to get people out of gold.  That is the real goal.

daveO's picture

They have a long way to go. Just look at the Shadow Stats rate of Inflation. Positive 'real' rates would kill all the banks.

shutdown's picture

Could someone please translate this gibberish into plain English?

hobopants's picture

Very much not an expert, but what I got from it was

flat yield curve would mean the yield for short and long term treasuries would be roughly the same.

Credit spread tightening would mean treasury rates would begin to rival rates on private sector debt.

This guys take is that active investors would lose less than passive in such a situation.

Only thing I can see is it would suck royal balls for anyone holding long term debt of any kind.

I could be completely off base, and would love to hear one of the more savvy gurus take on it myself.

elwind45's picture

You can look at IPE or TBT and see your assumptions are wrong and having royal balls isn't a requirement? The belly of the curve is going further out and not in the market like this turd hopes? His book is dumping stocks on you and buying long credit behind your back! Money is flowing north into price and south into yield and this guy needs you afraid of being no fool and buying his dump? Long rates will collapse just on whispers of dollar strength

hobopants's picture

Merely trying to interpret what the article is trying to say, not assuming anything one way or the other as I don't have the background in finance. My gut tells me the situation isn't likely in a market with this much manipulation, rates will likely stay wherever they want them.

Babaloo's picture

What bunga said. How is the curve gonna flatten if the Fed keeps the fed finds rate at zero?

I think this guy's got too much time on his hands.

El Hosel's picture

Go ahead, make my day, any day. Punish already.

fattail's picture

Yes..  let's raise short term rates four Percent and watch five years of misallocated capital burn to the ground.   All of the broken business models held together by bubblegum and duct tape are going to be exposed.  

Nope...  sorry ain't going to happen.   We will print until we can't, because we can't stop.  

The equity market crash will give the Fed the reason it needs to crank up the printing press.  Or Ukraine.   Or Syria.  Or China.  Or WWIII.  


It will never stop.

yogibear's picture

End game for the US fiat.

dogismycopilot's picture

"Seventeen *days?* Hey man, I don't wanna rain on your parade, but we're not gonna last seventeen *hours!* Those things are gonna come in here just like they did before. And they're gonna come in here..."

MisterMousePotato's picture

Hudson! This little girl ... .

Why *don't* we put her in charge?

elwind45's picture

How is it you need 4 5 6% short rates to do damage? The long end is telegraphing this articles worst case and now you know! IPE or TBT and this turd isnt timely just wondering what is happening?

Ban KKiller's picture

Bank of America has an honest accountant that can count more than his balls? 

Fucking bank stooge!