Expecting "American stagflation" and limited room for the Federal Reserve to cut interest rates, Deutsche Bank recommends: shorting 10-year U.S. Treasuries

Deutsche Bank's strategist team believes that the U.S. economy is facing stagflation risks due to supply-side shocks and recommends shorting 10-year U.S. Treasuries.

On August 12, according to Wind Trading Platform news, Deutsche Bank pointed out in its latest research report that the increase in tariffs and tightening immigration policies will pose negative supply shocks to the U.S. economy, raising inflation while weakening economic growth, but will not lead to an economic recession.

The bank expects that core CPI inflation may rise by about 0.5 percentage points year-on-year in the coming months due to tariff impacts, significantly higher than market consensus and current pricing.

At the same time, Deutsche Bank emphasized that the market currently prices the terminal rate at around 3%, considering that the real interest rate with a 2% inflation target is only 1%, which is at the lower end of the range in recent years. The bank believes that from a purely economic perspective, the rationale for policy rates being significantly below neutral levels is relatively weak.

Deutsche Bank analysts, including Francis Yared, pointed out in the report that even if the Federal Reserve becomes more aggressive in cutting rates due to political pressure, it may lead to a distortion and steepening of the yield curve, pushing up long-term rates.

Supply Shock Dominates Economic Outlook

Deutsche Bank's analysis suggests that the impact of tariff policies on the U.S. economy is similar to a combination of VAT increases and negative supply shocks.

Although tariff revenues will be used for tax cuts, the tariffs will more significantly impact low-income households with high consumption tendencies, while tax cuts mainly benefit high-income groups with low consumption tendencies, leading to a moderate negative impact on overall demand.

Tightening immigration policies further exacerbates the supply shock in the labor market. Deutsche Bank economists believe that this will lower the equilibrium point for non-farm employment growth to the range of 50,000 to 100,000, but wage growth remains relatively resilient.

The report notes that despite recent weakness in employment market data, Deutsche Bank believes that its initial expectations have not undergone substantial changes.

In terms of the labor market, the latest employment report shows that the three-month moving average of non-farm employment growth is slightly below the aforementioned equilibrium range, but the bank's economists believe the data may be affected by seasonal factors, reflecting the reality of a low hiring/layoff environment and reduced immigration.

In this regard, Deutsche Bank points out that the Sam Rule, which adjusts for unemployment claims data, has not yet been triggered, the turnover rate has remained stable over the past year, and wage growth remains resilient, all of which align with the interpretation of negative supply shocks.

Therefore, Deutsche Bank expects that this structural change in supply and demand will push up inflation and weaken economic growth, but will not lead to an economic recession.

The bank notes that in the absence of fiscal consolidation and term premium buffers, 10-year U.S. Treasuries should not rebound due to an economic slowdown primarily driven by supply shocks.

Significant Upside Risks to Inflation

Deutsche Bank's bottom-up analysis of inflation strategies shows that tariffs may push core inflation up by about 0.5 percentage points year-on-year in the coming months. The bank expects that the month-on-month growth of core CPI in the next few months will be in the range of 0.3%-0.4%, with upside risks relative to market consensus and pricing It is worth noting that Deutsche Bank also pointed out that oil prices are currently absorbing OPEC+'s continuous production increases well, providing additional support for inflation expectations.

Deutsche Bank stated that in terms of neutral interest rate assessment, the market is currently pricing the terminal rate at around 3%, assuming a 2% inflation target with a real rate of about 1%, which is at the lower end of the range in recent years. In contrast, indicators such as bond-stock correlation show that the neutral real rate is close to 2%.

Considering the potential upward movement of inflation in the coming months, Deutsche Bank believes that when considering the current nominal neutral rate, underlying inflation should be viewed as closer to 2.5% rather than 2%. Overall, the terminal rate priced by the market may be more than 100 basis points below the neutral level.

Technical and Seasonal Factors Support Short Strategy

Deutsche Bank stated that from a purely economic perspective, short-end pricing has shown an asymmetry in rising yields.

The bank noted that while there is political pressure leading to a more dovish Federal Reserve risk, in the current macro environment, more aggressive rate cuts could easily lead to a distortion of the yield curve steepening and an increase in long-end rates.

The report pointed out that Deutsche Bank's term premium indicator has basically consolidated over the past two months, but seasonal factors and structural trends provide technical support for shorting 10-year U.S. Treasuries.

Based on the above analysis, Deutsche Bank has added a short position in 10-year U.S. Treasuries to its macro investment portfolio, targeting a yield of 4.60% with a stop-loss at 4.05%. For investors looking to hedge spread risk, the bank recommends going long on 10-year SOFR (Secured Overnight Financing Rate), targeting 4.10% with a stop-loss at 3.55%