Morgan Stanley Capitulates, Sees No Rate Hike Until 2011, Pushes Back Call For 4.5% On 10 Year By Two Quarters
The one biggest bond bear since December 2009, Morgan Stanley, has just thrown in the towel, and instead of expecting 4.50% on the 10 Year by June 30, the firm has now pushed back its target by 2 quarters. Which means that its longer 5.50% Target on 10 Years has been scrapped. The firm's strategists have also adjusted their call on Fed hikes (now expected to occur no sooner than 2011 instead of September 2010). Lastly, the firm's most vocal call, one for a substantial 2s10s steepening to 325 bps has also been moderated from Q2 to Q4. We also include the latest Rates Strategy slide deck from MS.
From Jim Caron:
Our rates call has been adjusted lower to reflect sovereign risk and we have pushed back our UST 2s10s curve steepening call of 325bps from 2Q-end to end of year. The carry trade still reigns supreme. We expect the UST 2s10s curve to be ~280bps for most of the remainder of the year, and then steepening toward 330bps in 4Q.
FROM A STRATEGY PERSPECTIVE this does not materially change our view since the core of our strategy was to play for a curve steepener. Given our new Fed call, we are even more emboldened to buy front-end forward rates and earn roll-down and carry and hedging that view with shorts in the back-end. In other words, we still like owning forward curve steepners. We also still believe that longer-tail volatility will outperform the shorter tails. Net net, we maintain our core view to be long the curve and long volatility.
Not a bad way to soak up over a trillion in Treasury supply at laughable rates, and keep funding the biggest black hole this side of the Andromeda galaxy: the US deficit.
Some other perspectives from MS' Economics Team:
Sovereign Credit Risk Means a Lower Path for US Rates
Fed on hold through year-end, lower path for yields. We now expect that the Fed will be on hold until early in 2011; previously we thought that they would begin to raise rates in September. We also now see a lower path for 10-year US Treasury yields through 2011; we expect
yields will rise from today’s 3½% to 4½% by the end of 2010, 100 bp lower than our previous forecast.
Contagion risk is the driving force for rates… The European sovereign credit crisis has capped inflation expectations, and it could reverse some of the significant improvement in financial conditions that has revived US growth. Although aggressive action by European officials to stem the crisis likely will reduce the tail risks of contagion, uncertainty remains high.
…but only a limited brake on US growth. Credit contagion won’t materially slow US growth, in our view, as US domestic fundamentals are now taking over from global support. Combined with lower US rates, changes in foreclosure mitigation policy, and extended tax cuts, domestic strength is prompting us to revise our forecasts for US real growth somewhat higher: from 3.2% to 3½% over the four quarters of 2010, and from 2½% to 3% for 2011.
Delaying tightening now gives the Fed more work to do. We think the Fed will raise the funds rate to 2½% by the end of next year, yet even that increase seems likely to put real short-term rates barely in positive territory. And while the yield curve likely will flatten after 2010, we expect another 50 bp rise in 10-year yields to 5% in 2011.
The Fed's thinking here is obvious: the hope is that the 2:45 crash is sufficient to continue issuing 10 Year at sub 4% rates. We find this laughable, and are convinced that Liberty 33 will need to orchestrate at least three more 10%+ crashes in the next 3-6 months to be assured of a glitchless soaking up of $1.5 trillion in UST supply.
Below is Morgan Stanley's Strategy Forum Slidepack for the "visual" learners.
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