Summer of Fear May Push U.S. Yield to 1.5%, Ignite Yen Rally

(Bloomberg) -- Be prepared for a summer of uncertainty, with the range of forecasts for Treasuries and the yen getting ever wider as U.S. President Donald Trump turns tariffs into his favorite foreign policy tool.

Trump's unexpected decision to slap a levy on Mexican imports is casting renewed doubt over the prospect of a U.S.-China trade deal. While strategists have this week laid out a variety of reasons for Treasury 10-year yields to fall to 2% and the yen to strengthen, some money managers are now calling for an even stronger rally in haven assets.

“If there were some who still thought there might be a near-term resolution with China, that's now gone out of the window,” said Prashant Newnaha, senior rates strategist at TD Securities Inc. in Singapore. “This whole trade war outlook is going to be a lot more prolonged. From an outright perspective, you'd want to be buying Treasuries.”

Trump's unexpected tweet late Thursday about the imposition of tariffs on Mexico ratcheted up the concern surrounding global trade frictions that has already dragged in nations as diverse as South Korea, Japan and Canada, as well as the European Union. The U.S. president has also threatened to levy taxes on auto imports, and only this week said he doesn't see a deal with China happening soon.

Market turmoil and concern over slowing global growth will lead to even bigger bets on Treasuries, pushing the U.S. 10-year yield down to 1.5%, according to Akira Takei, a global fixed-income fund manager at Asset Management One in Tokyo.

Takei, who once called himself “the most bullish Treasury investor in Japan,” said he is buying U.S. government bonds due in five to 10 years as he bets the market will price in a higher likelihood the Federal Reserve will cut interest rates. Yields would have fallen even without the U.S.-China trade war because U.S. rate hikes through December have tightened financial conditions and hurt the economy, he said.

Mexico Tariffs Make China-U.S. Deal Less Likely, Analysts Say

The Treasury 10-year yield fell six basis points Friday to 2.16%, the lowest since September 2017. The yen rose 0.7% to 108.83 per dollar, extending its biggest monthly gain this year. Mexico's peso slid as much as 3%.

The yen may strengthen to 105 per dollar by year-end, a gain of about 4% from current levels, according to Damien Loh, chief investment officer at hedge fund Ensemble Capital in Singapore. Treasury yields are likely drop below 2% by year-end, he said.

“The Mexico news came as a surprise to everyone,” Loh said. “It's really a single person -- Trump -- that's driving everything at the moment.”

Trump said he would slap tariffs of up to 25% on Mexican goods until the country stops the flow into the U.S. of illegal immigrants. That surprised traders given that Mexico has agreed to a new North American trade pact. Tension also ratcheted higher after it was reported that China is said to have a plan ready to restrict exports of rare earths to the U.S.

Three Cuts

Swap markets are now pricing in three Fed rate cuts by the end of 2020. Bonds have rallied around the world this week, with yields on 10-year securities in Germany, Australia and New Zealand all dropping to record lows.

The spread between three-month and 10-year Treasury yields became the most inverted since 2007 this week, suggesting more investors are expecting an economic contraction in the world's largest economy. If Treasury 10-year yields fall to 1.50%, that would be the lowest since 2016.

“It's not a war on trade any more, the tariffs are now being used as a weapon for a lot of different issues he has with with various countries,” said Janu Chan, a senior economist at St. George Bank in Sydney. “It affects companies, business confidence. It's very damaging to the global economy the way he's going about it”

--With assistance from Michael G. Wilson.

To contact the reporters on this story: Ruth Carson in Singapore at rliew6@bloomberg.net;Masaki Kondo in Tokyo at mkondo3@bloomberg.net

To contact the editors responsible for this story: Tan Hwee Ann at hatan@bloomberg.net, Nicholas Reynolds

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