Submitted by Tyler Durden on 12/18/2011 - 07:24 2s10s 2s10s Bond fixed Risk Premium
Buried deep in the 137 pages of Fixed Income 2012 Outlook, Deutsche's bond group looks at the implications of an extremely flat US Treasury Curve and implicitly low bond risk premium. Based on 5Y5Y rates relative to long-term growth and inflation expectations, tail inflation risks, and estimates of supply/demand shocks, the
current bond risk premium are at levels that were witnessed ahead of the bond market sell-off of 1994, at the peak of the bond market conundrum of 2004-2006 and around QE announcements. This 100bps or so of 2s10s 'flatness' relative to real short rates and expected deficits also corroborates this risk premium. So what does this tell us? The extremely low risk premium fully captures QE expectations. Empirically, they find USD19bn of new QE tends to reduce real rates by 1bps and based on this and a model of fundamentals and risk aversion parameters, they find that Twist was fully priced in last September and since then
the current dislocation suggests another full QE2-style package of about $800bn is already priced into the market (ex MBS reinvestment). We just hope the market is not disappointed
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