SocGen's Chaigneau: Get Ready For A 'Serious Hangover' in Fixed Income

Nov 29 2016 | 6:11pm ET

The worldwide “easy money” party is over, according to Société Générale CIB’s global head of rates and FX strategy, and financial repression is set to recede for the foreseeable future. The result, Chaigneau writes, will be a serious global debt hangover as an unprecedented exposure to interest rates is unwound. 

Chaigneau’s thoughts laid out in Société Générale’s CIB’s 2017 Outlook for Fixed Income Report, released Tuesday and seen by FINalternatives. 

“After years of easy money, inflation is finally bottoming out,” Chaigneau says in the report’s executive summary. “Global growth is also picking up a bit, if too late to stop populists from stealing the show. Fiscal policy is back in favor and will provide another near-term kick to growth - enough to reduce the need for super easy monetary policy. "All in all, financial repression is receding; expect a further normalization of bond yields over 2017." 

Investors should prepare for a serious hangover, Chaigneau continues. “There is more debt in the non-financial sector than ever before. Bond funds under management have tripled over the past decade, and duration has surged. The unwinding of this unprecedented exposure to rates will initially feed the sell-off and eventually stress the credit spread complex. 

Other key highlights of SocGen CIB’s 2017 FI Outlook:

  • USD scarcity. As non-U.S. borrowers struggle to roll a gigantic stock of U.S. debt, the cross-currency complex will be a channel of stress. Uncontrolled USD strength is the main risk to the firm's bearish bond views.
  • Expect curve steepening in EUR, GBP and JPY as term premia normalize while forward guidance protects the front ends.
  • 2017 is a busy year for European politics. Idiosyncratic risks, ECB tapering and rising yields will prove challenging for sovereign spreads, though there will be selected opportunities as political risk gets overpriced, e.g. in OATs.
  • The inflation rally has legs. 
  • Expect the 10y Treasury bond to reach 2.90% by end-2017. 
  • There is a not-so-trivial feedback loop at work in global debt markets. The surge in global debt over the past ten years will naturally make any bond sell-off more dangerous, as default risks rise, but the unprecedented build-up of both debt and duration exposure may also aggravate the sell-off initially, as the now much-bigger bond funds suffer losses and withdrawals. This challenge is exacerbated for non-U.S. borrowers dealing with dollar strength.

Société Générale CIB is SocGen’s corporate and investment banking unit. The company provides specialist M&A advisory, structured finance, equity capital markets, cross-asset research, and execution and prime brokerage services. Founded in 1864 and headquartered in Paris, Société Générale itself is one of the largest financial institutions in the world, with €1.33 trillion in assets. 

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