Global asset prices have undergone significant adjustments this year, with 10-year US Treasury yields falling more than 50 basis points from their annual peaks and the US Dollar Index (DXY) declining over 10% from its highs. However, both assets have encountered resistance during the summer trading period.

Morgan Stanley's latest global macro strategy report, "At the Edge of Hot Summer, At the Threshold of a Larger Fall," suggests that as the Federal Reserve's rate-cutting window gradually approaches, both US Treasury yields and the dollar index could potentially reach new annual lows this fall, providing investors with clear directional guidance.

**Macro Theme: Fed Rate Cuts Drive Core Logic, Treasury Yields May Break Below 4%**

The Federal Reserve's policy pivot represents the core logic driving global asset pricing in the second half of the year. At this year's Jackson Hole Global Central Banking Conference, Fed Chairman Powell delivered clear dovish signals, stating that "current policy is in restrictive territory, and the economic outlook and risk balance may require policy stance adjustments." This directly pushed the market-implied federal funds rate trough below 3% (currently at 2.94%).

Morgan Stanley notes that this rate trough has further downside potential. On one hand, current levels remain above 2.87% for April 2025 and 2.69% for September 2024. On the other hand, Fed economists anticipate the terminal federal funds rate could fall to 2.625% (versus the market's current 3% pricing), primarily due to tighter US immigration policies slowing labor market growth and thereby reducing potential economic growth and the neutral rate (r*).

The correlation between Treasury yields and federal funds rates will continue to dominate bond market performance. The report shows that after briefly diverging in April 2025, the two have resynchronized.

If the federal funds rate trough falls below 2.69%, 10-year Treasury yields could break below 4%.

Additionally, improved US fiscal deficit expectations provide support for Treasuries. The Congressional Budget Office's (CBO) latest projections show that tariff adjustments from 2025-2035 will reduce the federal deficit by $4 trillion (up from the June forecast of $3 trillion), reducing Treasury issuance demand and further suppressing long-end yields.

**Core Investment Strategy: Long Treasury Duration, Short Dollar**

Based on these macro assessments, Morgan Stanley offers two core investment recommendations covering Treasury and foreign exchange markets:

**1. Treasuries: Long Duration + Yield Curve Steepening, September May Present Loading Opportunity**

Long 5-year Treasury duration: 5-year Treasuries combine "low volatility + high nominal yield" characteristics (current yield 3.75%). During yield decline cycles, duration strategies directly benefit from price appreciation. Simultaneously, 5-year Treasuries show higher sensitivity to rate cut expectations than longer-term bonds, capturing policy pivot dividends more quickly.

3-year/30-year Treasury yield curve steepening: Short-end (3-year) rates face direct Fed rate cut pressure with greater downside potential, while long-end (30-year) rates receive support from economic outlook and deficit expectations, limiting declines. The spread between these will continue widening.

The report suggests that if September Treasury index extensions (expected 0.07 years, above monthly average) trigger temporary curve flattening, investors can use this opportunity to add steepening positions.

The report also recommends exiting short positions in 10-year Treasury Inflation-Protected Securities (TIPS), as current inflation expectations have fallen in sync with term premiums, limiting further downside with rising negative carry risks.

**2. Foreign Exchange: Firmly Short Dollar, Euro and Yen as Top Choices**

Morgan Stanley maintains a clear bearish dollar stance, recommending long Euro (EUR) and Japanese Yen (JPY) positions to hedge dollar downside risks, based on three core rationales:

Interest rate differentials increasingly unfavorable to dollar: Fed rate cuts will far exceed ECB cuts. ECB President Lagarde has clearly stated that "current 2% rates are near neutral levels, raising the bar for further cuts." Morgan Stanley has raised its 2025 German 2-year bond yield forecast by 10 basis points. While the Bank of Japan maintains no rate hikes for now, market expectations for narrowing US-Japan rate differentials have intensified, significantly increasing USD/JPY sensitivity.

Dollar negative risk premium may expand: Since April, the dollar index has consistently traded below levels implied by rate differentials, reflecting market pricing of US policy uncertainties (Fed independence, trade policy). Although this "negative premium" has narrowed from 7%-8% to 6% recently, the report believes factors such as EU legislative dependence for US-EU trade agreement implementation, tariffs remaining US diplomatic policy tools, and policy continuity questions after Powell's term ends will re-expand the negative premium.

Investor positioning structure reversal: Investors are no longer shorting the dollar (Morgan Stanley's dollar positioning index has returned to neutral), meaning "short covering" pressure during dollar declines has disappeared, opening further downside space.

Specific strategies include: maintaining EUR/USD long positions (entry 1.17, target 1.20, stop-loss 1.11), USD/JPY short positions (entry 147.40, target 135, stop-loss 151), while going long GBP/CHF (carry/volatility ratio leads G10 currencies, entry 1.084, target 1.12, stop-loss 1.055).

**Major Economy Policy Analysis: Differentiated Strategies for Eurozone, UK, Japan**

Beyond global themes, the report provides differentiated strategies for major economies:

**1. Eurozone: Focus on October-December Curve Flattening and September Extension Opportunities**

Interest rate strategy: Recommending Eurozone October-December yield curve flattening strategies (December ECB rate cuts as base scenario, short-end rates declining faster), while tactical OE swap spread widening strategies during September bond future extensions (historical data shows short positions push swap spreads wider during extensions).

Asset allocation: German 10-year bond yield year-end target raised to 2.40% (from 2.25%), with green bonds (FRTR 6/44) offering allocation value due to yields significantly above regular curves.

**2. UK: Bank of England Rate Hike Cycle Ending, Long Short-End Rates**

The Bank of England voted 5:4 for rate cuts in August, with markets pricing 10 basis points of cumulative cuts by year-end. The report recommends: entering November Bank of England policy rate (MPC) receiver positions (current pricing shows 5 basis points cumulative cuts in November, reasonable risk-reward ratio), while maintaining 3-year/10-year UK gilt steepening strategies (September gilt supply increases pressuring long-end).

**3. Japan: Buy 10-Year JGB Dips, Watch Yen Volatility**

Bank of Japan Governor Ueda's Jackson Hole speech omitted mention of "wage-price virtuous cycles," suggesting no immediate rate hikes, but market expectations for declining US Treasury yields have already boosted JGB sentiment.

The report recommends: maintaining 10-year JGB long positions, adding on significant breakeven inflation rate (BEI) declines; USD/JPY may face short-term US nonfarm payroll data disruption, but long-term downtrend remains clear.

**Risk Warnings: Three Factors Could Disrupt Asset Rhythms**

Despite Morgan Stanley's clear second-half asset trend assessments, three risks are highlighted:

Fed rate cuts falling short of expectations: If US inflation stickiness exceeds expectations (energy price rebounds) or nonfarm employment remains strong, rate cut timing could be delayed, causing Treasury yields and dollar to rebound temporarily.

Geopolitical shocks: Escalating Middle East situations or European conflicts could strengthen the dollar short-term due to safe-haven demand.

Major central bank policy surprises: Such as ECB turning more dovish due to accelerating economic recession, or Bank of Japan raising rates earlier than expected, potentially reversing euro and yen trends.

**Summary: Asset Allocation Logic Under Rate Cut Cycle**

Morgan Stanley believes second-half 2025 global assets will center around the "Fed rate cuts" theme, with declining Treasury yields and dollar weakness as core trends. Investors can focus on two directions: capturing bond market benefits through 5-year Treasury and 3s30s steepening strategies, and capturing non-dollar currency opportunities through euro and yen long positions.

Meanwhile, close attention should be paid to September Fed meetings, US nonfarm and inflation data, and major economy policy implementation timing, with timely position adjustments to address short-term volatility.