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Analysts at TD Securities note that the US treasuries have risen by 51bp in the 10y since early-September and are reaching levels not seen since before the Fed began easing rates in July.

Key Quotes

“Much of the move was driven by a rise in term premium. Global rates have also kept pace, with 10y bunds and Gilts rising by 49bp and 41bp respectively. We believe this move has been the result of the market pricing in lower odds of a global recession amid the removal of tail risks such as additional Chinese tariffs or hard Brexit.”

“Over the next few months we think that term premium will remain lower due to continued strong foreign demand for Treasuries and the declining net supply of Treasuries due to Fed buying.”

“Fed expectations have been more stable despite the rise in rates. This makes sense as the Fed has signaled a high bar to reverse the insurance cuts due to inflation running below target and risks persisting.”

“We believe that at least 25bp of rate cuts should be priced into 2020 as the market is implicitly penciling in just 10% odds of a recession in the next year based on their cut pricing. If the economy slows as we expect, the market should price in additional rate cuts.”

“We therefore continue to like owning duration and remain long 10y Treasuries. We also like 5s30s steepeners as the front end should remain anchored due to the Fed remaining on hold.”

“The near term risk to owning duration is convexity hedging flows in a thin market, which can exacerbate selloffs. The longer-term risk is that a spike in inflation can lead the Fed to hike rates, but we do not see this as likely.”