U.S. Markets close in 2 hrs 44 mins

Bond World to Steepen in 2020 in Morgan Stanley’s Top Trade Call

Liz Capo McCormick

(Bloomberg) -- A multi-year trend of flattening sovereign debt curves will end in 2020 with the gap between German yields set for sharp steepening, according to Morgan Stanley’s top market bets.

A pattern of longer-dated bond yields climbing faster than short-term ones has already been underfoot in recent months. That comes as the Federal Reserve and European Central Bank are seen pausing on further policy easing after cutting interest rates, while threats to the global economy from the U.S.-China trade conflict and Brexit are also dimming to give a lift to long-end yields.

“Overall, for 2020, steepening is the trade,” Andrew Sheets, chief cross-asset market strategist at Morgan Stanley, said in an interview in London. “European yield curves will move a lot as the front-end is anchored by the fact that the European Central Bank is going to keep rates on hold. In the U.S, we don’t expect as much steepening but the curve will still move further away from inversion.”

The gap between Germany’s 2- and 10-year yields widened to as much as 39 basis points last week -- the most since July. The equivalent gap in Treasuries expanded to 27 basis points last week from as little as minus 7 basis points in August, its lowest since 2007. Inversion in Treasury yield curves is closely watched as it has preceded many of the past recessions in the U.S.

Morgan Stanley strategists advised in a note that among their top 2020 cross-asset trades was to wager that the gap between 5- and 30-year German government debt yields grows. The spread was at about 75 basis points Monday, and the firm recommends a target of 115 basis points.

A steepening trend in the euro area is an outcome the ECB will find favorable, Sheets said. That’s because it will improve the stability and financial health of banks as well as pension and insurance companies in the region. Earlier this year the ECB moved to a tiered policy rate system to ease the pain of negative rates on banks.

The move higher in euro-area yields overall has a lot of legs, according to Morgan Stanley. Bund yields have climbed to minus 34 basis points from minus 74 basis points in early September. Ten-year Treasury yields are at about 1.81% now after touching a three-month high of 1.97% on Nov. 7, and the U.S. bank expects them to continue to hover near 2%.

“Yields next year in the euro area will go up, as opposed to the false dawns we’ve seen in the past,” Sheets said. “The global growth picture has improved and euro-area growth is better, trade issues will stabilize and the effects of past monetary policy easing is finally hitting.”

To contact the reporter on this story: Liz Capo McCormick in london at emccormick7@bloomberg.net

To contact the editors responsible for this story: Paul Dobson at pdobson2@bloomberg.net, Neil Chatterjee

For more articles like this, please visit us at bloomberg.com

©2019 Bloomberg L.P.