Morgan Stanley Says Sell Bunds as Gap to U.S. Widest Since March

  • ECB could signal a tapering of stimulus for 2017: Hornbach
  • Bund yield near record low as Deutsche Bank spurs haven demand

Morgan Stanley recommends selling 10-year bunds against equivalent U.S. Treasury notes, even as the spread between their yields widens to the most since March.

The Wall Street firm is betting that yields will converge as the Federal Reserve refrains from raising interest rates this year, while suggesting the European Central Bank could signal a tapering of quantitative easing for next year. Treasury yields have been supported by signals from many Fed officials that policy tightening remains likely in 2016. Bund yields are approaching record lows after a rush for safety amid concerns over the financial health of Deutsche Bank AG saw euro area and Swiss bonds outperform global peers.

“It does create a potential catalyst for Bunds to sell off substantially given we don’t believe many investors believe the ECB will taper at all in 2017,” analysts led by Matthew Hornbach wrote in a note dated Sept. 30. “We also think there is potential for USTs to outperform on the back of the Fed having to be more accommodative than expected due to a weak growth and inflation outlook.”

The spread between 10-year Treasury and bund yields was 172 basis points at 7:21 a.m. in London, based on Friday’s close for the German security at minus 0.119 percent. It would be the biggest gap on a closing basis since March. Benchmark U.S. note yields were at 1.6 percent, little changed from the end of last week.

The record-low for the bund yield was minus 0.205 percent, reached on July 6. The Treasury yield dropped to an unprecedented 1.318 percent the same day.

“The squeeze in Bunds continues,” Danske Bank A/S analysts Arne Lohmann Rasmussen, Jens Peter Sorensen, and Anders Moller Lumholtz wrote in a client note dated Sept. 30. “Supply of German government bonds will as usual decline in Q4 relative to Q3. Coupled with a healthy budget outlook and QE purchases, that means Bunds are likely to remain expensive.”

German sovereign debt has returned 1.12 percent in the three weeks since Sept. 12, making it the fifth best performer globally among 26 developed markets tracked by Bloomberg and the European Federation of Financial Analysts Societies. Spanish bonds gained the most, returning 1.53 percent. Treasuries returned 0.87 percent.

The market-implied odds of a Fed rate increase this year were at 59 percent, according to Bloomberg calculations based on fed fund futures. The recent peak was 65 percent on Aug. 26, which was the highest since early June.

Morgan Stanley’s Hornbach sees the U.S. benchmark yield sliding to 1.25 percent at year-end on the view the Fed won’t raise rates in 2016, while demand for haven assets continues.

“That’s the beauty of government-bond markets,” he said in an interview with Bloomberg Television Friday. “Whenever there’s risk-off, that’s where investors go.”

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