By Sarupya Ganguly
BENGALURU, Aug 11 (Reuters) – U.S. Treasury yields will decline over the coming year, said bond strategists in a Reuters poll who clung to expectations that markets will abandon Federal Reserve rate hike bets. Still, most reckoned the 10-year yield was more likely to come in above their forecast than below it in three months.
Since the U.S.-Iran war began in late February a sustained selloff in Treasuries has pushed the benchmark yield up nearly 80 basis points as higher oil prices amplify fears already-elevated inflation will stay well above the Fed’s 2% target.
Financial markets have priced out Fed rate cuts entirely and are betting on at least one hike this year. Several Fed policymakers have also echoed the need for higher interest rates.
But fixed income strategists in the August 6-11 Reuters survey have still held on to their long-standing view Treasury yields will fall, suggesting those rate hike bets may soon be pared back.
The ten-year yield — currently close to an 18-month high at nearly 4.73% — was forecast to fall to 4.50% within three months, hold that level at end-January before drifting lower to 4.34% in a year, survey medians showed.
Interest rate sensitive two-year yields were expected to drop more sharply — about 20 bps to 4.07% in three months, to 3.92% in six and 3.80% in a year.
“Our base case is for lower 10-year yields. Economic data has been surprising to the downside and yields have yet to follow,” said Alex Payne, senior portfolio manager and head of the Mortgages, Agencies and Volatility team at Vanguard.
The U.S. economy unexpectedly shed jobs in July while growth came in lower than economist expectations in the second quarter as rising imports widened the trade deficit, but other indicators including consumer spending and business investment signal continued resilience.
WAVERING CONVICTION
However, persistently high inflation is testing strategists’ conviction for lower yields.
An overwhelming 82% majority of respondents — 18 of 22 — who answered an additional question said it was more likely the U.S. 10-year yield comes in higher than their forecasts in three months rather than lower.
Meanwhile, Fed Chair Kevin Warsh offering scant guidance beyond repeating the central bank’s dual mandate has left investors scratching their heads while also raising the ‘term premium’ – additional compensation investors demand to offset increased uncertainty.
“If inflation doesn’t move closer to the Fed’s 2% target, in the absence of forward guidance the market will need to see action,” Vanguard’s Payne added. “The Fed will need to demonstrate its reaction function has not changed by hiking rates and if for some reason they don’t, I would expect higher long-term yields.”
Also, heavy upcoming Treasury issuance on an already nearly $40 trillion debt pile and no clear deficit reduction plan would keep long yields elevated, several strategists said.
“To see Treasury yields move materially lower, we’d likely need to see growth slow considerably, or maybe a recession. And we’re not really seeing signs of that right now,” said Collin Martin, head of fixed income research and strategy at the Schwab Center for Financial Research, adding “current market-based inflation expectations don’t really capture the true upside risks to inflation.”
“If you get one supply shock and that’s all you get, that can be considered transitory. But if we’re getting a new one every year, that goes into the calculus – if you’re a business – of how you think about your expenses and what you want to pass through,” he said.
July consumer price inflation, releasing Wednesday, was forecast to edge only slightly lower to 3.4% from 3.5% in June, a separate Reuters poll showed.
(Reporting by Sarupya Ganguly; Polling by Aman Kumar Soni and Jaiganesh Mahesh; Editing by Hari Kishan; Editing by Toby Chopra)
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