'We were wrong': Morgan Stanley says it was too bullish about the US bond market

(Ralph Orlowski / Getty Images)
  • Last week’s bond selloff saw US 10-year treasury yields “break out of the ranges we expected to hold”, Morgan Stanley said.
  • Rates strategist Matthew Hornback attributed the shift to a sharp turnaround in US data since August.
  • Morgan Stanley expects US 10-year bond yields to end the year at 2.75%, up from its January forecast of 1.95%.

The surge in US bond yields last week caught markets off guard.

And the reverberations were felt across different asset classes, as US stocks had two sharp falls to end the week while the Aussie dollar fell to its lowest level since February 2016.

Also caught off guard were the global bond strategists at Morgan Stanley, who have consistently maintained a bullish view towards the US bond market in 2018.

“We were wrong to expect treasury yields to be capped at previous year-to-date highs,” said MS strategist Matthew Hornbach.

The catalyst for last week’s move was unexpectedly strong data on Wednesday night, as operating conditions in the US services sector rose to the highest level on record.

That was backed up by steady employment data on Friday night, which saw benchmark US 10-year yields consolidate above 3.2% — the highest level since 2011.

The increase saw US 10-year yields “break out of the ranges we expected to hold”, Hornbach said. And Morgan Stanley’s preference to buy longer-term bonds “ended the moment yields broke those levels”.

Since late-August, US bond yields have climbed more than 40 basis points. And Hornbach attributed that move to a noticeable turnaround in US data:

Morgan Stanley

“The second consecutive month of strong economic data has caused investors to reevaluate the prospects for both Fed policy and future economic growth,” Hornbach said.

He added that bond yields have risen significantly faster than the rate of inflation over that time, with a more pronounced shift higher in longer-dated debt such as 10-year and 30-year yields.

Such a move indicates that investors have shifted their expectations for economic growth and inflation over the long-term, rather than just the next couple of years.

And Hornbach said if the positive data surprises continue, the selloff in the US bond market “may not abate like it did earlier in the year”.

Morgan Stanley now expects US 10-year bond yields to finish 2018 at 2.75% — still lower than their current level, but a fairly sharp rise from its January prediction of 1.95%.

Morgan Stanley

NOW WATCH: Money & Markets videos

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.