Goldman, Morgan Stanley forecast divergent paths for Treasuries

New York

TWO of Wall Street's biggest banks are forecasting divergent paths for Treasuries in the last three months of 2016 as strategists weigh the effects of improving US economic data and stimulative central-bank policy abroad.

Economists at Goldman Sachs Group Inc see benchmark 10-year yields climbing to 2 per cent by year end, fuelled by an improving outlook for inflation and economic growth. By contrast, Morgan Stanley is forecasting yields will fall to 1.25 per cent amid accommodative global monetary policy and continued demand for haven assets.

"Central banks are going to remain broadly supportive of bond markets," Matthew Hornbach, head of global interest rate strategy at Morgan Stanley, said on Friday.

"That's the beauty of government-bond markets. Whenever there's risk-off, that's where investors go."

Treasuries have gained more than 5 per cent in 2016, defying consensus forecasts that yields would rise, as investors have sought havens over concerns ranging from stagnant global growth to fallout from the UK's Brexit vote. US 10-year yields ended September little changed after being whipsawed by central banks during the month, rising after the European Central Bank didn't expand its stimulus programme only to fall after the Federal Reserve and Bank of Japan maintained accommodative policies.

Benchmark 10-year yields rose three basis points, or 0.03 percentage point, to 1.59 per cent as at 5pm in New York, according to Bloomberg Bond Trader data. The price of the 1.5 per cent security due in August 2026 was 991/8.

Treasuries fell on Friday and equities climbed as Deutsche Bank AG shares rallied after a media report that the lender is nearing a US$5.4 billion settlement with the US Department of Justice, less than half the amount initially requested.

Strategists see yields on the benchmark note ending the year at 1.76 per cent, going by the weighted average forecast in data compiled by Bloomberg.

Jan Hatzius, chief economist at Goldman Sachs in New York, said on Sept 27 that inflation pressures are beginning to build. Inflation is one of the main gauges the central bank tracks when deciding monetary policy, and rising inflation hurts the value of bonds' fixed payments.

"All of the signals are suggesting that we are now pretty close to full employment, and we're starting to exert some upward pressure on inflation," Mr Hatzius said. "The Fed is going to respond to that. Gradually, but I think they will respond."

Mr Hatzius said that he sees a 65 per cent chance the Fed will raise interest rates in December. Futures traders assign about a 59 per cent chance for a hike by then, going by futures data compiled by Bloomberg. The calculation is based on the assumption the Fed's target trades at the middle of the new band after the central bank's next boost.

Goldman's forecast aligns with that of Jeffrey Gundlach, chief investment officer at DoubleLine Capital LP, who earlier this month said that he sees the 10-year yield rising above 2 per cent in 2016. BLOOMBERG