Morgan Stanley Ends Bearish Bet on Break-Even Rates After Yellen

  • Thirty-year inflation gauge holds near highest close since May
  • Company recommended in July investors short break-even rates

Are U.S. Treasury Yields Likely to Increase in December?

Morgan Stanley is abandoning a prediction that U.S. break-even rates will fall as the outlook for prices in the world’s biggest economy surge to the highest level in five months.

The yield difference between 30-year Treasury bonds and similar-maturity inflation-protected securities held near the highest closing level since May. The measure, an outlook for consumer prices known as the break-even rate, climbed Friday after Federal Reserve Chair Janet Yellen set out an argument for keeping policy accommodative.

The gauge has been climbing with oil after OPEC agreed to cut supply. In July, Morgan Stanley recommended investors take a short position in break-even rates, and pinpointed the 30-year sector a month ago.

“We move neutral break-evens as the bullish tone in oil prices and a focus on ‘reflation’ trades continues,” Morgan Stanley analysts led by Matthew Hornbach wrote in a note to clients on Friday. “The speech from Chair Yellen was also bullish for break-evens,” although “we do not think the speech showed any intent to follow such ideas,” the analysts wrote.

The 30-year break-even rate was at 1.82 percent as of 6:56 a.m. in New York after closing Friday at the highest since May 2. It was as low as 1.53 percent in June.

Yields Rise

Treasury 30-year bond yields were little changed at 2.55 percent. They climbed eight basis points, or 0.08 percentage point, on Friday, the biggest jump in five weeks. The price of the 2.25 percent security due in August 2046 was 93 22/32.

The benchmark 10-year note yield was 1.79 percent, having risen earlier to 1.81 percent, the highest since June 2.

National Australia Bank Ltd. is bullish on U.S. 10-year break-even rates, partly on the view crude oil may climb toward $60 per barrel from around $50 now. That would be consistent with a break-even rate of 1.8 percent versus the current 1.67 percent, according to Alex Stanley, an interest-rate strategist at the bank in Sydney.

“Yellen’s comments about letting the economy ‘run hot’ also points to a higher inflation risk premium,” he said. “It’s been clear for some time that, globally, central banks have a better idea of what to do about higher inflation than about inflation that gets too low.”

‘Plausible Ways’

Speaking at a Boston Fed conference Friday, Yellen said there were “plausible ways” that running “a high-pressure economy” may fix damage caused by the global financial crisis, providing an argument for maintaining a stimulative monetary policy without taking an interest-rate increase off the table for this year.

Futures indicate a 66 percent probability the Fed will raise rates by its December meeting, up from around 50 percent as recently as Sept. 27, according to calculations by Bloomberg. The calculations assume that the effective fed funds rate will average 0.625 percent after the next increase.

“The market is fairly priced for a rate hike in December,” the Morgan Stanley analysts wrote. “A lot of economic and market data remain to be seen. Given the asymmetry in the Fed’s reaction function, the odds that something happens before the December meeting that pushes the next hike back again seem right to us at one-in-three.”

— With assistance by Anooja Debnath

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