Summer of Fear May Push Treasury Yield to 1.5%, Ignite Yen Rally

© Bloomberg. A U.S. Customs and Border Protection (CBP) officer walks next to a truck entering from Mexico at the Otay Mesa Cargo Port of Entry in San Diego, California, U.S., on May 23, 2017. The skirmish among House Ways and Means Committee Republicans over a border tax provision resurfaced during a May 24 hearing where Treasury Secretary Steven Mnuchin was testifying on the president’s proposed fiscal year 2018 budget. Photographer: David Maung/Bloomberg

(Bloomberg) — Be prepared for a summer of uncertainty, where calls for Treasuries and the yen get ever more expansive 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 that the Federal Reserve will cut interest rates. Yields would have fallen even without the U.S.-China trade war because the U.S. 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 fell four basis points Friday to 2.17% after touching the lowest since September 2017. The rose 0.6% to 108.96 per dollar, extending its biggest monthly gain this year. Mexico’s slid as much as 2.5%.

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 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 Australia and New Zealand dropping to records, while the equivalent German bunds are within a few basis points of the same.

The spread between three-month and 10-year Treasury yields — taken as an indicator of a future recession — became the most inverted since 2007 this week, suggesting more investors are expecting an economic contraction in the world’s largest economy. Treasury 10-year yields at 1.50% would be the lowest since 2016.

“It’s not a war on trade anymore, the tariffs are now being used as a weapon for a lot of different issues he has with with various countries,” said Janu Chan, 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”