Morgan Stanley Vindicated on Treasuries as Fed Rate Odds Decline

El-Erian Sees Sept. Fed Decision as Judgement Call
  • U.S. bank recommended five-year notes on view Fed to hold fire
  • Yield declines most since July this week as data fall short

Morgan Stanley’s bet on five-year Treasuries paid off as the notes head for their best weekly performance since July amid receding odds of a Federal Reserve interest-rate increase this month.

While Treasuries fell on Friday, they still are set to gain this week after U.S. August jobs growth trailed forecasts. The most recent figures have undercut hawkish comments by Chair Janet Yellen and her colleagues signaling possible policy-tightening. They include a report Thursday that showed manufacturing unexpectedly shrank in August. Bloomberg’s U.S. Surprise Index, which measures whether data beat or missed economists’ forecasts, dropped to an eight-week low.

Morgan Stanley strategist Matthew Hornbach this week affirmed his recommendation to buy five-year notes after their yield jumped to the highest in two months on Aug. 26, when Yellen said the case for higher rates had strengthened. The market-implied probability of policy tightening at the Fed’s Sept. 20-21 meeting has since receded to 26 percent from 42 percent. The Wall Street firm predicts no action this month.

“The Fed has kept open the possibility of raising rates in September, but it’s also said that it’s data dependent -- so the risk of something disappointing is high,” said Janu Chan, a senior economist at St. George Bank Ltd. in Sydney. “It’s about jobs and inflation. Payrolls is the most important piece of data that will guide the Fed.”

The five-year Treasury note yield rose two basis points, or 0.02 percentage point, to 1.20 percent as of 9:54 a.m. in New York, set for a five basis-point drop in the week, according to data compiled by Bloomberg. That would be the biggest decline since July 29. The 1.125 percent security due in August 2021 traded at 99 21/32.

Spread Widens

The yield, which is relatively more sensitive to changes in monetary policy than that on longer maturities, has slipped after climbing in August by the most since February last year. The spread between five- and 30-year yields has widened this week after shrinking on Aug. 30 to the narrowest in more than 18 months.

The Bloomberg Barclays US Treasury Index climbed 0.4 percent this week through Thursday, headed for its first increase in three weeks.

Fed Vice Chairman Stanley Fischer said this week that economic data will determine the trajectory of interest-rate increases.

U.S. Payrolls climbed by 151,000 last month following a 275,000 gain in July that was larger than previously estimated. The median forecast in a Bloomberg survey called for 180,000.

Cleveland Fed President Loretta Mester, who votes this year on the Federal Open Market Committee, said Thursday there’s a “compelling” case for gradually raising rates. She declined to say precisely when she believed increases would be necessary.

“We might end up in another ‘oops!’ moment, just as we did back in early June with the May jobs data,” Michael Every, Hong Kong-based head of financial markets research for Asia-Pacific at Rabobank Group, wrote in a report. “The importance of that U.S. employment print today can’t be overstated.”

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