“We do not exclude a short-term rebound towards 1.8% driven by upside US inflation surprises, but risks are clearly tilted towards lower yields.”

The impressive 52 basis points fall in the US 10-year Treasury yield to 1.5% made August a remarkable month.

Unsurprisingly, the fall owed much to the fear that additional US tariffs on Chinese imports could prolong the global manufacturing recession, thereby increasing the risk of contagion to the services sector and hence sparking a general US slowdown. It seems that market participants see the escalation in trade tensions as the main risk for US economic growth, although so far the main impact has been on the manufacturing sector, which represents only a small part of the US economy.

The Fed’s concerns about the global manufacturing slowdown and the economic impact of the US-China trade tensions meant this summer saw the first cut from the US Federal Reserve (Fed) since 2008. Justified as being for ‘insurance’ purposes, we expect the Fed to announce two more quarter-point rate cuts before the year, probably this month and again in October.

Two additional quarter-point rate cuts this year clearly place a question mark over our previous forecast for Treasury yields.

We have revised our year-end target for the 10-year US Treasury yield down sharply from 2.5% to 1.4% in our central scenario. We do not exclude a short-term rebound towards 1.8% driven by upside US inflation surprises, but risks are clearly tilted towards lower yields, with a target of 0.9% in our negative scenario (which could signal a US recession in 2020).

The yield could move above 2% if the Trump administration decided to remove most of the tariffs on Chinese imports, thereby boosting trade and the manufacturing sector. But due to the geopolitical tensions between the two superpowers, we expect continued talking rather than a comprehensive trade deal.

In this uncertain environment, we remain neutral on US Treasuries. They continue to fulfil their safe-haven role, as shown by the stellar 12.5% total return posted year-to-date (to August 30).

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