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The benchmark 10-year Treasury note yield has peaked for 2018 as trade worries, weaker emerging markets and a strong dollar cap the prior move upward in rates, according to Morgan Stanley.
“We started to take note of a changing dynamic for global government bond markets in late April and early May,” the firm's global head of interest rate strategy, Matthew Hornbach, said in a note to clients Friday. “Not only do we think these factors will continue for a while longer, but we also think other factors will drive government bond yields lower.”
“That's right, 3.12 percent was it,” he added, referring to the 2018 peak in the 10-year Treasury yield hit in mid-May. The 10-year yield has fallen sharply since then, last seen under 2.9 percent as a renewed wave of trade tensions gripped markets and threatened to stall global economic growth. Yields fall as prices rise.
Persistent trade disagreements between President Donald Trump’s administration, the European Union and other economic allies have hampered market performance so far this year and kept pressure on borrowing costs.
“While trade tensions have yet to negatively impact U.S. economic data noticeably, the Fed has started to hear more concern from business contacts,” Horbach said. “We see risk that such tension will impact economic data more in the coming months, even if a benign outcome comes to pass eventually.”
A stronger dollar, too, would likely challenge emerging market economies across the globe, Hornbach said, with Morgan Stanley predicting downside for all markets under its coverage in Asia.
The dollar, which weakened throughout much of 2017, reversed direction early this year, with the ICE dollar index, which pits the greenback against a host of other currencies, back above 94.
The strategist’s bullish bet on Treasurys, however, isn’t universal across Wall Street. Evidence of a tight labor market and healthier gross domestic product have many market watchers wondering if the Federal Reserve will be forced to raise interest rates more aggressively to cool an overheating economy.
J.P. Morgan Chase Chief Executive Jamie Dimon, for example, said in his annual shareholder letter in April that it would be reasonable to expect a 10-year Treasury note yield of 4 percent with normal growth and inflation approaching 2 percent.
Still, this isn’t the first time this year Morgan Stanley has highlighted troubling trends in the markets. Mike Wilson, the firm's chief equity strategist, warned clients last month that the “end of easy” investing was over.
“After nine years of markets outperforming the real economy, we think the opposite now applies as policy tightens,” the team of Morgan Stanley strategists wrote at that time. “2018 is seeing multiple tailwinds of the last nine years abate — the end of easy.”
Like Hornbach’s, Wilson’s concerns included a return of inflation, uncertain political outlook and tightening monetary policy, the lack of which helped fuel the unprecedented run in the U.S. stock market over the past nine years.