October Macro View

Factor: The US 10 year treasury bond yield gap between the non-US 10 years is currently much larger than it’s 35 year average.  The difference is 65 basis points (0.65%).

Prediction: Either non-US yields rise to close the gap or US yields fall.

Result: If they fall in 4Q17 utilities will beat financials and vice versa.  Rates falling would signal the US going into a deflationary period, and show that QE policies after the 2008 financial crisis did not work as hoped.  If rates rise we would be entering a reflationary period.  Industries that benefit from a rising 10Y yield may bottom in late September/early October.

Industries that benefit from rising 10Y: Banks, Insurance, Auto, Oil/Gas/Energy

Industries that get hurt from rising 10Y: Utilities, REITS, Telecoms

Banks benefit from rising long term yields because that is where they make their money from .  The banking industry makes a living off of the spread between short and long term interest rates.  The simple business model is that they pay the short term and receive the long term and capture the spread.  The industries that are hurt from rising yields are the ones that are very capital intensive.  Meaning they have a large amount of debt on their balance sheets and require a lot of capital expenditure.

What could drive reflation (recovery):

  1. Dollar weakness causes inflation
  2. QE tapering lifts yields (prices fall as Fed exits as buyer of bonds)
  3. Full year oil output cuts
  4. Trump fiscal policy


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