Morgan Stanley is unconvinced US bonds are on the verge of a bear market

Getty: Mark Metcalfe

Analysts at Morgan Stanley aren’t buying into the narrative of a global bond bear market just yet.

Benchmark US 10-year bond yields — which move inversely to their price — have climbed by more than 20 basis points in 2018.

And there was more selling on Friday night amid lingering concerns around a US government shutdown.

That pushed US 10-year yields up to 2.66% — through the resistance level of 2.63% outlined by bond investor Jeff Gundlach as a key level of support for bond bulls.

But Morgan Stanley’s Matthew Hornbach and Sam Elprince aren’t phased.

In fact, they’re maintaining their year-end forecast for US 10-year bond yields to fall to just 1.95% — well below the market consensus of 2.88%.

Sure, a number of events have served to drive bond yields higher in January, the pair said.

But they argued that none of those catalysts will alter market fundamentals enough to cause a sustained shift in prices over the long-term.

A quick review of the January price action in bonds reveals a number of one-off catalysts that caused the market to react.

There was the decision by Japan to slightly taper its bond purchasing program, which caused US yields to rise by 5 basis points on January 9.

That was followed by a 5 basis-point rise the following day on news that Chinese officials were considering reducing their US Treasury purchases — based on a report which may have been incorrect.

Morgan Stanley also highlighted a potential $US38 billion tax bill payable by Apple as part of its plan to return off-shore cash to the US — which led to speculation the company may have to sell some its US Treasury holdings.

All of the above are one-off factors which have moved the market — but the underlying fundamentals haven’t changed, the analysts said.

They noted two key fundamental factors — synchronised global economic growth and the steady withdrawal of central bank stimulus — were evident last year, but drew little reaction from bond markets.

Instead, “two easily disputable stories pushed 10y Treasury yields back to the post-US presidential election highs”, the analysts said.

The pair conceded they would be forced to adjust their prediction “if the recent move to higher Treasury yields was driven by news we thought was meaningful and had the ability to move yields fundamentally and materially higher than our year-end forecasts”.

“However, the rise in Treasury yields so far this year has not been accompanied by news or economic data we deem worthy of the price action.”

They said a central argument for higher yields is increased bond supply as the US government seeks to fund higher deficits in the wake of the tax-cut legislation.

But according to Hornbach and Elprince, “Treasury yields and curve shape have already adjusted for additional supply”.

“Most of the upward adjustment in yields came in the wake of the US presidential election. The final push to complete the pricing of the additional supply began in September and ended in December 2017,” they said.

They added that the new tax laws will encourage US companies to contribute more money into pension funds to protect their tax-deductions. In such a scenario, pension funds “may be one such type of investor positioned to invest at current yield levels”.

Benchmark US 10-year treasuries traded flat today in the Asian session at 2.65%, slightly off their three-year high of 2.66% reached on Friday night.

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