© Reuters. FILE PHOTO: The American flag flies over the U.S. Treasury building in Washington, U.S., January 20, 2023. REUTERS/File Photo
By Sarupya Ganguly
BENGALURU (Reuters) – U.S. Treasury yields will broadly fall over the coming year on expectations the Federal Reserve will soon end its hiking cycle, according to fixed-income strategists polled by Reuters, who also predicted a steeper yield curve in the year ahead.
Since its March 24 low, the yield on the U.S. 2-year Treasury note surged over 150 basis points, reaching a sixteen-year high of 5.12% last week as a tight labour market and still-sticky inflation suggested further rate hikes are needed.
But the yield has since fallen around 25 bps as the U.S. economy created the fewest jobs in about two-and-a-half years and markets interpreted recent statements from Fed officials as indicating the hiking cycle was nearing its end.
This recent decline in yields will continue over the coming year, according to the July 5-12 Reuters poll of 75 bond strategists.
“Economic data right now reflects decent momentum. That is going to dissipate in the next couple of months,” said Thomas Simons, senior money markets economist at Jefferies, who expects yields to broadly fall in coming months.
“The market will price in a pretty aggressive path of rate cuts coming up.”
Yields on the interest-rate-sensitive U.S. two-year note will drop about 70 basis points by end-year to 4.15%, the poll showed.
The benchmark U.S. 10-year note yield, currently at 3.95%, will fall to 3.50% in six months as was predicted in last month’s poll.
If realized, this would narrow the spread between the two-year and ten-year Treasury yields to 65 bps by end-2023, down from around 90 bps currently.
“The curve is likely to remain deeply inverted as the Fed threatens more hikes later this year. We expect gradual steepening in Q4 and more dramatic steepening in Q1 2024 when we expect the first cut,” noted Gennadiy Goldberg, head of U.S. rates strategy at TD Securities.
“Slowing inflation and labour market data should help steepen the curve.”
In a continued divergence from the Fed’s view, market expectations based on interest rate futures see only one more rate hike this year, versus two predicted by the Fed. The first rate cut is currently priced in for March 2024.
This has led to a decline in yields and a rise in bond market volatility.
The MOVE index, the most widely-followed volatility indicator, hit a five-week high last week and is currently about 50% above its long-term average.
Meanwhile, the Fed’s inflation projections are considered to be too hawkish by many who expect a steeper decline in price pressures and lower bond yields.
“Even if one assumes slower progress on inflation, six-month rolling inflation (180-day moving average) will still break out of its range in the next two months – heralding the end of ‘sticky inflation’ that has consumed markets in the last two years,” noted Guneet Dhingra and Allen Liu, bond strategists at Morgan Stanley (NYSE:).
