Bond strategists surveyed from Aug. 6-11 kept their long-standing expectation that U.S. Treasury yields will move lower over the next year, even as many admitted their confidence is shaky amid persistent inflationary pressures and geopolitical-driven market moves.
The Reuters poll showed the 10-year Treasury yield - trading near an 18-month high at about 4.73% - was forecast to fall to 4.50% within three months, remain around that level at the end of January, and drift down to 4.34% in a year, according to the survey medians. Shorter-dated, rate-sensitive two-year yields were expected to ease more sharply, to 4.07% in three months, 3.92% in six months and 3.80% in a year.
Those projections come against a backdrop of a sustained selloff in Treasuries since late February, when the U.S.-Iran war began. Strategists said the benchmark 10-year yield has climbed nearly 80 basis points since then as higher oil prices layered on top of already-elevated inflation, amplifying the risk that inflation will remain well above the Federal Reserve's 2% goal.
Market pricing currently shows no expectation of Fed rate cuts and instead implies at least one hike this year. Several Fed policymakers have also signaled a need for higher interest rates.
Yet despite that market positioning and Fed commentary, the fixed-income strategists in the Reuters poll maintained their forecast for lower yields. The persistence of this view suggests those aggressive rate-hike expectations may be pared back by investors at some point, according to the survey results.
"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 economic backdrop is mixed. The U.S. economy unexpectedly shed jobs in July, and second-quarter growth undershot economist expectations as rising imports widened the trade deficit. At the same time, other indicators - including consumer spending and business investment - indicate continued resilience.
Wavering conviction
Strategists’ confidence in their lower-yield calls is being tested by persistent inflation risks. When asked an additional question, 82% of respondents - 18 of 22 - said it was more likely the U.S. 10-year yield would be higher than their three-month forecast rather than lower.
Market observers cited a lack of clear forward guidance from the Fed as one source of uncertainty. The survey noted Fed Chair Kevin Warsh has provided limited guidance beyond reiterating the central bank’s dual mandate, a stance that has pushed up the term premium - the extra compensation investors demand for added uncertainty over the expected path of interest rates.
Payne warned that if inflation does not move closer to the Fed’s 2% target, and forward guidance remains absent, the market will need to see concrete action. "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," he said. "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."
Issuance and upside inflation risk
Strategists also pointed to heavy upcoming Treasury issuance on top of an already nearly $40 trillion debt pile and no clear deficit reduction plan as factors that could keep long-term yields elevated. The combination of additional supply and limited fiscal consolidation would, in their view, present upward pressure on long-dated rates.
Collin Martin, head of fixed income research and strategy at the Schwab Center for Financial Research, emphasized that materially lower Treasury yields would likely require a significant slowdown in growth or a recession - neither of which he said the data currently show. "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," he said.
Martin also questioned whether market-based inflation expectations fully capture potential upside risks. "Current market-based inflation expectations don’t really capture the true upside risks to inflation," he said.
On the topic of supply shocks, strategists noted that a single shock might be treated as transitory, but repeated shocks change business calculus on costs and pricing. "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," one strategist observed.
Looking ahead, July consumer price inflation - due to be released on Wednesday - was forecast in a separate Reuters poll to nudge down only slightly, from 3.5% in June to 3.4% in July. That modest easing would leave inflation well above the Fed's 2% objective.
In summary, the Reuters survey found a consensus among strategists that yields will fall over the next 12 months, but most respondents acknowledged a meaningful risk that market forces could push yields higher in the near term if inflation and supply-side pressures persist or if central bank guidance remains limited.
Source notes: Survey conducted Aug. 6-11. Median forecasts reported for the 10-year and 2-year Treasury yields. Responses to the additional probability question were 22 in total, with 18 indicating greater likelihood of yields landing above their three-month forecasts.