A perfect storm is brewing for interest rates to surge, says this bond expert

Scott Peng, the founder and chief investment officer of New York investment manager Advocate Capital Management, says a perfect storm is being unleashed. His model estimates the 10-year Treasury yield TMUBMUSD10Y, 1.123% will jump 162 basis points this year and another 160 basis points next year — which is well ahead of market estimates of roughly 17 basis points of gains in each of the next two years. The 10-year yielded 1.12% in early Wednesday action.

Peng, previously Citi’s chief interest-rate strategist and one of the first to spot pricing anomalies in Libor, says his model doesn’t even include any additional fiscal stimulus from the Biden administration, which has proposed a $1.9 trillion coronavirus relief plan as well as additional infrastructure spending.

Central to his view of a surge in interest rates is the historical correlation between nominal gross domestic product growth with both short- and long-term interest rates in the U.S., U.K., Germany and Japan. Long-term regression reflects a 50% ratio between GDP growth and the Treasury yield since 1960, though more recent history suggests the ratio may have declined to 27%.

Even that lower level of correlation would suggest the vaccine rollout, pent-up spending power, surge in government debt, and monetary stimulus would send yields higher.

Wouldn’t such a rise in rates raise alarm bells at the Federal Reserve? Peng calculates that the Fed would have to quadruple the size of its quantitative easing to offset the projected 2021 rise in rates. “A $300 billion per month QE pace would exceed the 2020 QE and is unlikely to be sustainable for any extended period, especially if the economy is recovering well,” he says.

Peng didn’t extend his analysis to stocks, but the implications would be straightforward. A spike in yields would make relative valuations far more unattractive — though it could create conditions for value stocks to thrive after a decade of underperformance.

The buzz

GameStop GME, -60.00% shares rose 2% in premarket trade after tumbling 60% to $90 on Tuesday. The short squeeze driven by users of the Reddit WallStreetBets forum had driven the stock to as high as $483 last week. Cinema operator AMC Entertainment AMC, -41.20%, which tumbled 41% on Tuesday, also rose 2%.

Online retail giant Amazon AMZN, +1.11% reported forecast-trouncing fourth-quarter earnings and revenue alongside the news that Jeff Bezos later in the year will step down as chief executive to become executive chairman, focusing on new products and early initiatives. Andy Jassy, the head of its fast-growing cloud division, will take over as CEO of the whole company.

Alphabet GOOGL, +1.38% GOOG, +1.38% jumped 7% in premarket trade as Google’s parent company easily beat fourth-quarter earnings estimates, getting a lift from both search revenue and its fast-growing cloud business.

There is a raft of earnings on deck, including payment service PayPal PYPL, +3.00% and online auction service eBay EBAY, -1.95% after the close of trade.

On the coronavirus front, pharmaceutical GlaxoSmithKline GSK, +0.67% will pay up to €150 million to CureVac CVAC, +4.39% to develop next-generation vaccines targeting multiple variants. Glaxo also will help produce up to 100 million doses of CureVac’s first-generation vaccine, a boost for Europe, which has been slow to roll out vaccines. Separately, preliminary research finds the AstraZeneca AZN, -0.67% –Oxford University vaccine provides protection up to three months before the second dose is administered. New coronavirus cases in the U.S. dropped to 115,619 on Tuesday, from a peak of 243,996 in mid January, according to the COVID-19 tracking project.

The economics calendar includes the ADP estimate of private-sector payrolls, and the Institute for Supply Management’s services index. A measure of China’s services sector came in below estimates.

The markets

The Nasdaq-100 NQ00, +0.67% contract led an advance in stock futures ES00, +0.35% after the Amazon and Alphabet results. The dollar DXY, +0.02% was steady.

Italian stocks I945, +2.55% surged on expectations former European Central Bank President Mario Draghi will become the country’s next prime minister.

The chart

In a letter to investors, hedge fund firm Crescat Capital said the stage is set for a massive investor shift out of overvalued megacap growth funds and fixed income securities, and into undervalued materials, energy and other commodities. It said if it could only focus on one chart for the next three to five years, it would be of the commodities-to-equities ratio. “The opportunity for buying gold stocks and selling overvalued large cap growth stocks appears like 1972. In just two years in 1973-74, the S&P 500 SPX, +1.39% declined 50% while gold stocks increased fivefold,” it said.

Random reads

Speaking of Reddit posts — a study finds language use on the platform could predict future relationship breakups.

Sounds like the beginnings of a script for a new Indiana Jones movie — mummies with golden tongues found in Egypt.

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