“The Smoking Gun”: BofA Warns Fed Renormalization Could Send Equities 30% Lower
by Tyler Durden
ZeroHedge.com
May 30, 2017
With first the Fed, and then the ECB and BOJ, all expected to start normalizing their balance sheet over the next two years, a bevy of central bankers has been busy on the jawboning circuit, explaining why this would not have a major impact on either bond yields or stocks. They may be quite wrong, however, according to the latest analysis released overnight by Bank of America’s rates strategist Shyam Rajan, who calls the upcoming “trillion dollar mismath” between Treasury supply and demand over the next five years a “smoking gun” which will trigger an “equity-rate disconnect” due to the gradual phasing out of “price insensitive buyers” and calculates that “either rates need to be 120bp higher or stocks need to be 30% lower to trigger enough demand to match forward UST supply estimates.” Needless to say, both outcomes are negative for current record low volatility, and will have a substantial impact on risk-asset prices over the coming years, a vastly different forecast than the one the Fed has been scrambling to convey.
Here is the gist of Rajan’s argument:
The bond/equity disconnect vs. UST supply/demand
The trillion dollar mismatch in Treasury supply/demand dynamics over the next five years will likely trigger an equity-rate disconnect correction, in our view. Our analysis suggests either rates need to be 120bp higher or stocks need to be 30% lower to trigger enough demand to match forward UST supply estimates. In this report, we quantify the projected increase in supply, the decline in price insensitive demand and the triggers required for the two main price sensitive sources – pensions (higher rates), mutual funds (lower equities) to step up, to clear the supply-demand mismatch in USTs.
Supply is coming, irrespective of stimulus
There are few things more certain right now than increased Treasury supply, in our view. Whether one believes that tax reform gets done or not, Treasury supply is likely to go up substantially over the next five years. In essence, the US Treasury is underfinanced by anywhere between $2 – $4.5 trillion over the next five years, requiring substantial increase in auction sizes and/or new products. Of this, even conservatively speaking, there is likely to be a $1 trillion shortfall in demand using current trends.
The Rest…HERE
