Strategist Addresses AFSA Conference on the ‘De-Anchoring’ of Rates and our Current “Goldilocks with Risks” Environment


Subadra Rajappa, Societe Generale’s head of US rates strategy, recently delivered the closing remarks at the AFSA Credit Summit 2018 in New York City where she discussed the gradual de-anchoring of rates and the current “Goldilocks with Risks” economic environment. We followed up with Subadra for a short recap.


 Can you explain what you mean by Goldilocks with Risk?

With economic fundamentals continuing to improve, we expect a pick-up in growth in the second quarter. Inflation is expected to head toward the Fed’s 2% inflation target as the job market continues to improve. Although tax cuts and fiscal spending are supportive of growth over the near-term, we are mindful of risks that could throw a wrench into this goldilocks scenario for the economy.

What are the key risks that you are concerned about?

The recent rise in rates and the strengthening of the dollar could gradually tighten financial conditions. With leverage on the rise and a low savings rate, consumers may be more vulnerable than we think. Mortgage rates are on the rise and so are rates on auto loans. Although other lending terms remain easy, auto delinquencies are on the rise. We are watching these and other metrics for stresses in the system.

What do you think is behind the recent sell off in the bond market and do you think it will continue?

The 10y Treasury yield broke through the key technical level of 3.03% and stayed above 3% for the first time since 2011. Strong retail sales and robust economic fundamentals support higher yields. Re-coupling of global monetary policy, reduced demand for Treasuries from foreign investors, and rising deficits could support a continued rise in yields over the near-term. But a sustained rise in yields is less likely unless there is a paradigm shift warranting a higher long-run interest rate.

What are the factors that could trigger a rally in bonds?

With the 10y Treasury yield around 3.10% we see risks to bonds as being symmetric; hence we suggest a neutral stance on duration. While we see catalysts to a further rise in yields over the near term, we also see risks that could trigger a rally in bonds. The strengthening of the dollar and further decline in risky assets, especially the recent weakness in emerging markets, could bring investors back to the safety of Treasuries.

What are the ramifications for other asset classes of a massive bond sell off?

The rise in yields and stronger dollar have strong implications for emerging markets and other risky assets such as corporate bonds. Our equity risk premium models show a further rise in yields having a negative impact on equities. A combination of these factors could tighten financial conditions which will make it harder for the Fed to continue to tighten monetary policy.


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