Treasury Yields May Fall to 2% as Gundlach, Banks Eye Recession

(Bloomberg) — The rally in US Treasuries is set to accelerate as the world’s biggest economy slides toward a recession, strategists say.

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Benchmark 10-year yields may fall to as low as 2% by early next year if the US suffers a bigger downturn than currently envisaged, according to Mizuho Bank Ltd. Yields may slide to 2% if a severe recession is triggered by, for example, a few more regional banks coming under pressure, JPMorgan Asset Management says.

“I do attach quite a very high probability of a recession over the next six-to-12 months,” said Tai Hui, chief Asia market strategist at JPMorgan Asset Management in Hong Kong. “If you are facing a much more a severe recession, the Fed may have to move a bit more aggressively” to cut rates and that will push down Treasury yields, he said.

Investors are snapping up sovereign bonds amid warnings the US economy is spiraling into a downturn. DoubleLine Capital’s Jeffrey Gundlach said this week the odds are “pretty darn high” right now of a recession. Worsening turmoil at US banks is just another factor spurring traders to add to bets the Fed will cut rates later this year to rescue the ailing economy.

US 10-year yields have already tumbled about 75 basis points from their March highs to trade at about 3.34% on Friday as fears of a recession boost demand for the safest assets.

History suggests they may have more room to fall, according to Prashant Newnaha, a strategist at TD Securities in Singapore.

“The market is sending a clear message that the Fed tackling inflation is fighting yesterday’s battle,” he said. “The US is very close or probably in recession right now,” said Newnaha, adding that the 10-year yield may drop to 2.5% and lower by year-end.

Beating Stocks

An investor who bought Treasury 10-year notes at Wednesday’s closing yield of 3.35% would make a pretax profit of about 13% if the yield dropped to 2% in December, according to data compiled by Bloomberg. By comparison, equity strategists surveyed by Bloomberg predict the S&P 500 Index will fall 1.6% by year-end, a figure that doesn’t include any dividend payouts.

Read More: Morgan Stanley, UBS Pick Bonds Over Stocks on Recession Risk

Any selloff in Treasuries should be seen as a buying opportunity, said Amy Xie Patrick, who helps manage the Pendal Dynamic Income Trust that’s beaten 96% of peers in the past year.

“That soft-landing strip was narrow before, and it’s probably a dot now,” she said, referring to policymakers’ ability to engineer a gentle slowdown. “Pops in yield” make longer-maturity bonds attractive, Sydney-based Xie Patrick said.

Not everyone is leaping on-board the Treasury bandwagon.

US bond bulls risk being disappointed if inflation proves sticker than expected, forcing the Fed to keep its hawkish stance, according to Stephen Miller, an investment strategist at GSFM in Sydney.

“We’re pretty close to the bottom of the range at about 3.34% right now, because the bond market is anticipating a too-rapid decline in inflation,” he said. Even if a deterioration in the regional-bank situation occurs, “the Fed even then would be stretching it to match the policy rate reductions currently priced by the market,” he said.

But most in the market appear firmly bullish on bonds.

Westpac Banking Corp. is among those lowering its forecasts for Treasury yields. “US 10-year yields are already very low in my book, but I think that needs to be ratcheted lower given increased recession risks,” said Damien McColough, head of fixed-income research at Westpac in Sydney.

(Updates to add quote from strategist in third paragraph, return analysis in seventh)