Bearish Bond Narrative Has Gone Too Far, Deutsche Bank Says

The swing to deeply-negative sentiment on fixed-income assets this year has gone too far, with the market underpricing the risk of an artificial-intelligence blowup that triggers a rush into bonds, according to Deutsche Bank AG’s George Saravelos.

Client meetings in the US displayed concerns that AI is a “big driver of higher yields and the US Treasury has lost control of the long-end,” Saravelos, global head of FX research, said in a note Friday. These factors have fanned investor speculation of a coming suspension in 20-year Treasury issuance, while clients were “overwhelmingly bearish” on French debt after a turbulent selloff there, he added.

That’s a far cry from the market narrative last year, when AI was seen as potentially disinflationary and the US Treasury’s moves to stop yields from rising were viewed as credible. “The narrative pendulum has swung a little too much” in the other direction, Saravelos said.

“The biggest systemic risk in the market next year is not France but ‘something going wrong’ in the AI ecosystem: a safety event, a failed IPO, or disappointing revenues,” he said. “Concentration risk is immense, and it is this dollar negative (and very bond positive) event risk that is most under-priced in markets at the moment.”

US Treasury yields have risen to multi-decade highs as the surge in energy prices from the Iran war fanned inflation concerns, against a backdrop of a robust US economy. The latter is being boosted by spending on AI infrastructure, at the same time adding to the amount of debt investors are being asked to finance.

The battering of the bond market has increased speculation that the Treasury may further tilt the nation’s borrowing away from long-maturity bonds, and toward short-dated debt. Reducing or eliminating issuance of the 20-year bond, which demands a higher yield than nearby tenors, has emerged as a radical option, though some, including strategists at BNP Paribas SA, are skeptical that would be effective.

For Saravelos, the risk of a repricing of AI risk would benefit bonds. On French debt, meanwhile, he told clients some of investors’ concerns appear overblown.

“We explained why we disagreed with parallels of 2010-2015, but nonetheless it is clear it will take time for the market to regain confidence given the huge dislocations last week,” he said. “This is a fresh weight on the euro we were not expecting to materialize this year.”

Read More: France’s Bond Risk Is Outpacing Italy’s by Most in Euro History