Buy the dip on five-year US notes, Wall Street majors urge

Two major Wall Street firms are recommending investors start buying five-year US notes after they saw their worst rout since May last week.

Morgan Stanley sees scope for a rebound in Treasuries on expectations data in the coming weeks may surprise to the downside. JPMorgan is suggesting investors buy five-year notes as yields have already climbed to levels last seen in December, though it warned that markets are still too aggressive in pricing for an early start to central bank interest-rate cuts.

“This is ‘the dip’ we have been looking to buy,” analysts including Matthew Hornbach, global head of macro strategy at Morgan Stanley, wrote in a note dated Jan. 20. “With less fiscal support and much colder weather, we see downside risks to US activity data delivered in February.”

Five-year US yields climbed 22 basis points last week, the most since the period to May 19, as traders slashed bets on interest-rate cuts from the Federal Reserve this year. Sustained pushback from central bank officials, along with healthy data on retail sales, sent the odds of a March reduction tumbling to nearly 40% on Friday. The market is now expecting five quarter-point cuts from the Fed this year, after looking for six-to-seven reductions on Jan. 12.

Treasuries advanced modestly on Monday, sending five-year yields down one basis point to 4.04%.

One Japanese investor argued that it’s better to remain cautious on bonds given the potential the Fed leaves rates unchanged this quarter. There could be “concern growing among investors that the Fed may not pivot at all or they have bought too many bonds,” said Hideo Shimomura, a senior portfolio manager at Fivestar Asset Management Co. in Tokyo. 

“Don’t be the last guest at the bond party. Once the party is over, leave the room quickly,” he said.

The next set of auctions of Treasury debt, including two-, five- and seven-year notes, are slated to begin on Tuesday, setting the stage for upward pressure on yields for those segments of the market.

The bond market also faces risks with the first reading of US fourth-quarter gross domestic product on Thursday, expected to mark the strongest back-to-back quarters of growth since 2021. The Fed’s preferred gauge of underlying inflation is due Friday and is forecast to show an 11th straight month of waning annual price growth.

The data may end up reinforcing the potential that the Fed achieves its avowed aim of a soft landing. While that should allow policymakers to deliver interest-rate cuts this year, Treasuries have been whipsawed by the potential that an easing cycle will start later and proceed more slowly than previously expected.

JPMorgan expects the first Fed cut to come in June, rather than the May move, which is now fully priced in by swaps contracts. Morgan Stanley sees central banks in both the US and Europe to be in focus in mid-March and forecasts markets pricing in at least one rate cut by northern hemisphere spring for most central banks.