Look out below- Escalating U.S.-China trade tensions drove the stock market lower this week, with the Dow Jones Industrial Average seeing its longest losing streak since 2011. The U.S. 10-year Treasury yield also fell to its lowest level since 2017.
These developments led Bank of America strategists to cut their global rate outlook on Thursday. The note’s 13 writers said they expect the U.S. 10-year yield, which remained in the 2.3% range on Friday, to make up only about 0.3% of ground by year-end and finish 2019 at 2.60%.
But the worst-case scenario — one in which the U.S. and China can’t come to an agreement on trade and tariffs on Chinese goods rise to 25% across the board — looks especially grim, says Mark Cabana, Bank of America’s head of U.S. rates strategy and one of the note’s co-authors.
The main reason for the forecast cut, which is still cautiously bullish versus Wall Street consensus, was that the firm felt it was being overly optimistic in its previous outlook, Cabana told CNBC’s “Futures Now” on Thursday.
Even with that, it’s still fair to ask: “Are we being overly optimistic right now?” he said. “If we end up in this worst-case scenario, we certainly think that you could see the 10-year go through 2.25[%] and start breaking new lows that we haven’t seen for quite some time. So, that’s clearly a risk.”
Much of that risk is contingent on the outcome of the now yearlong trade dispute, Cabana said, adding that the bank doesn’t see the worst-case outcome as the most likely result of negotiations. While talks seem to have hit a roadblock, President Donald Trump and Chinese President Xi Jinping are expected to meet at the G-20 summit in June.
“Ultimately, we do believe that cooler heads will prevail. You’re going to get some type of resolution to trade tensions that won’t result in the worst-case outcome,” Cabana said. “I will say if we’re wrong on that, then we’re going to find that our interest rate forecasts are indeed a bit too high.”
And, as long as trade tensions of any kind persist, “we’re likely to see global growth suffer; inflation remains somewhat subdued and central banks could potentially adjust their tune even more than they already have to a more dovish stance of policy,” he said.
There’s also a “nuclear button” China can push in this fight, Cabana said: cutting its U.S. debt holdings. China cut its U.S. Treasury holdings to the lowest level in two years earlier this month.
“It’s certainly possible that China will continue to reduce their Treasury holdings over time, but we don’t necessarily think that they will be weaponized, so to speak,” he said. “We think that the Chinese may end up needing to hold less Treasurys as a result of their general currency management practices, but we don’t know that they would necessarily push the nuclear button.”
That’s because China, the largest overseas owner of U.S. Treasurys, could effectively hurt itself and the rest of the world by using this method to hurt the U.S., the strategist said.
“That could really roil financial markets and it could end up doing some pretty significant damage to the Chinese as well as to the U.S.,” he said. “So, we still think that that is something that [is] a risk, but we don’t see it materializing in the very near term.”
The major averages rose modestly on Friday after weeks of losses. The Dow has now seen five weeks of losses, while the S&P 500 and Nasdaq Composite have declined for three weeks.