U.S. yields have risen in recent weeks with increased inflation expectations due to the proposed polices of President-elect Donald Trump, as well as the belief that the Federal Reserve will also raise interest rates again this month. The yield on the 10-year Treasury broke above 2.5 percent this week but Deutsche Bank economists believe that it could hit 3.6 percent at some point next year. This comes after years of record low rates across the globe due to aggressive monetary policy by central banks.
In other sectors, Deutsche Bank analysts ranked the Italian multinational Leonardo Finmeccanica and the insurance firm Prudential as "buy"-rated companies. However, the German bank believes that the food and beverage sector should underperform by about 8 percent – compared to other sectors in Europe - as those companies correlate less with a rise in yields.
Among sector pair trades, an investor should prefer being "long" banks versus food and beverage, it stated. They should also be "long" diversified financials and insurance versus food and beverage. The bank estimates that these trades should have between a 30 and 24 percent upside. The bank also added that diversified financials would likely outperform utilities by around 25 percent before the end of 2017, and autos would likely outperform real estate by around 15 percent.
The bank added that if high inflation expectations and the global growth environment continues, equities should hold up despite the rise in yields. If bond yields rise significantly then some analysts have highlighted that they could offer a better investment opportunity than equities.
The downside risks to this thesis are Chinese capital flight, concerns around European politics and high levels of "short" positions in U.S. Treasurys, according to Deutsche Bank. The analysts added that these scenarios could lead to major rallies in rates and thus lead to lower bond yields.
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