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 levels in five months.
The difference between yields on regular Treasuries and inflation-protected debt, a measure of the outlook for consumer prices known as the break-even rate, closed at the highest since May on 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 6:50 a.m. in London on Monday after climbing as high to 1.84 percent on Oct. 11, the most since May 3. It was as low as 1.53 percent in June.
The yield on the nominal 30-year Treasury bond was little changed at 2.55 percent after jumping eight basis points on Friday, the biggest increase in five weeks. The 10-year yield was at 1.79 percent after climbing to 1.80 percent last week, the highest since June 3.
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 from 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.”
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 increase rates by its December meeting, up from around odds of below 50 percent as recently as Sept. 27, according to calculations by Bloomberg.
“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.”