US Rates Strategy: Now Is the Time to Re-Enter Treasury Curve Steepeners

Research evidence excerpt

US Rates Strategy: Now Is the Time to Re-Enter Treasury Curve Steepeners

IdeaMIf the recent improvement in the unemployment rate carries more noise than signal, we

think investors may grow more concerned about a higher unemployment rate if the

Conference Board labor market differential deteriorates further.

A further deterioration in consumer sentiment toward the job market would likely

surprise investors who have become much more optimistic on the labor market. And given

our economists expect another run of softer employment data, we think risks skew

toward such deterioration.

The combination of softer employment data and what's in the price set the scene for

investors to re-engage with Treasury curve steepeners.

What's in the price after a double-dose of Warsh?

Despite the softer payroll number, the market continues to price in rate hikes - almost

40bp worth by March 2027. The market prices the policy rate to be 25bp higher than

today by the end of 2027 - in contrast to how our economists see the probability-

weighted outcome of 25bp lower than today (see Exhibit 3 and Exhibit 4 ).

Exhibit 3: Target fed funds range upper bound and Exhibit 4: Target fed funds range upper bound and

Morgan Stanley US Economics baseline forecast and economist-assigned probability-weighted mean vs.

4 alternative scenarios market pricing

% %

6 6

5 4.75 5

4 3.75 4 4.01

3.50

3.25

3 3.00 3

2.25

2 2

1 1

0 0

'16 '17 '18 '19 '20 '21 '22 '23 '24 '25 '26 '27 '16 '17 '18 '19 '20 '21 '22 '23 '24 '25 '26 '27

Baseline (45%) Demand (20%) Productivity (10%) Economist probability-weighted mean

Recession (10%) Oil premium (15%) Market pricing (upperbound)

Source: Morgan Stanley Research estimates, Federal Reserve, Bloomberg Source: Morgan Stanley Research estimates, Federal Reserve, Bloomberg