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Morgan Stanley US Rates Strategy: Post-April 2 Yields Rebound - Neutral Duration Stance

Key Insights

• Curve Reassessment: On April 2 ("Liberation Day"), yields dropped sharply before rising just as dramatically (though not crossing prior assessment levels). This led the team to revert to a neutral stance on U.S. Treasury duration from their earlier recommendation due to the volatility and round trip.
• Curve Steepeners Continue: Despite conflicting messages on duration, the enthusiasm for yield curve steepeners from the mid-January position remains intact. The positive performance in scenarios involving trade and fiscal policy persists. The team expects significant flight to quality globally, but believes Treasury curve steepeners will continue to perform well. They are also maintaining positions like term SOFR 1y1y vs. 5y5y steepeners and bundling structure steepeners (e.g., SFRM5, SFRZ5Z7 front/mid/long steepeners).
• Duration Selling Dynamics: Pre-April 2 analysis identified that broad fixed income selling contained corporate bond duration, implying potential Treasury hedging. The team believes the global repatriation flow is significant enough potentially to strain equities liquidity but shows Treasury own duration demand in absolute terms is smaller.
• Market Stress Assessment: The Treasury market experienced stress, particularly affecting SOFR swaps and mid-to-long end Treasuries this week, exacerbating broad flight to quality. However, the cash-futures basis held up relatively well, supported by orderly SOFR funding, dealer inventories, and similar trade volumes in both cash/T-notes and futures markets.
• Liquidity Support Buybacks: Treasury's "liquidity support" buyback program is unlikely to be activated to deal with current levels of stress, which according to their FAQ, are not considered acute market stress episodes.

Core Recommendations & Positions

1. Trade Idea: Maintain Long UST 3s30s Steepener (Entry: 0.75%, Target: 2.10%, Stop: 0.25%)
2. Trade Idea: Maintain Term SOFR 1y1y vs. 5y5y Steepener

Key Risks & Conditions Reiterated

• Loss of the current positive curve scenario due to a rapid resolution of trade negotiations or recessionary pressure.
• Potential dominant risk assets performance diverging from Treasuries when duration returns.
• Fiscal cliff/growth policy outlook.
• Central bank policy shifts.

Stance

Duration: Neutral
Curve Steepeners: Continue