Light at the end of the tunnel - Treasury yields to fall

We think the 10-year US Treasury yield will end the year well below its current level.

The sell-off in Treasuries seems to have abated somewhat today. But they haven’t had too much relief: the 10-year yield still isn’t that far below the fresh cycle peak it hit recently, which was it's highest level since the Global Financial Crisis.

The timing of the rise in yields relative to the hiking cycle was arguably a bit unusual. After all, the 10-year yield hasn’t peaked after the final Fed rate hike since the early 1980s. 

What’s more, in the 1970s and 1980s cycles when the 10-year yield did peak after the last hike that typically coincided with a continued rise in core inflation for some time after the tightening cycles concluded.

So, what’s made this time different? One argument is that the timing of the recent rise in yields relative to the hiking cycle was just a coincidence, and that it reflected higher term premia due to unrelated factors. 

But we don’t think that’s the whole story. The bond market and macro backdrop at the end of this cycle has differed from most earlier ones in ways that help, in our view, to explain why yields have risen recently instead of fallen. 

With market volatility so elevated, it’s hard to rule out the 10-year yield rising again in the near term. But we remain of the view that it will fall substantially over time, for two key reasons.

First, we think that falling inflation will give the Fed the confidence to cut next year by more than the market is anticipating.

Second, in any case we think growth will eventually falter; that might help partly unwind the rise in investors’ expectations for the neutral rate.

While we’ll review our year-end forecasts as the end of 2023 approaches, we remain confident in the view that long-dated Treasury yields will fall over time. As such, we’re sticking for now with our forecasts for the 10-year Treasury yield of 3.25% and 3.00% by end-2023 andend-2024, respectively.

Source - Capital Economics

We still expect Treasury yields to fall, Thomas Matthews - 23rd August 2023

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