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Morgan Stanley Says Bet on Bond Yield `Steepeners' as Recovery Takes Hold

Investors should bet that longer-term interest rates will rise faster than short-dated ones as central banks maintain low interest rates as the recovery takes hold, according to Morgan Stanley.

Five-year notes will perform best, making the most profitable trades to buy them against 10-year and 30-year bonds, fixed-income strategists led by Jim Caron in New York wrote in a research report dated yesterday. Five-year rates will fall relative to two-year ones, they said.

“Economic stability is an underpriced risk that we believe will be the surprise for the market in the second half of the year as it ignites an asset reflation trade,” the strategists said. “Much of the double dip and deflation fears are already priced. European sovereigns muddle along and the risk premium assigned to them declines. This will allow the forces associated with global growth to reassert themselves, producing higher yields and steeper curves.”

The premium that investors demand to hold 10-year U.S. Treasuries over five-year notes narrowed one basis point to 115 basis points as of 9:37 a.m. in London. The so-called yield spread was at 137 basis points on March 9.

To contact the reporter on this story: Matthew Brown in London at mbrown42@bloomberg.net

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