Bond market divergence from Fed entrenched in U.S. yield forecasts: Reuters poll

By Sarupya Ganguly

BENGALURU (Reuters) – U.S. bond markets are already pricing beyond expected Federal Reserve interest rate hikes in coming months, with strategists polled by Reuters forecasting short-dated yields to fall sharply and most saying they will not revisit the year’s highs.

Since reaching a high of 5.08% on March 8 after hawkish testimony from Fed Chair Jerome Powell, followed by a safe-haven plunge related to concerns about smaller U.S. banks after a Fed-arranged rescue of Silicon Valley Bank, 2-year yields have traded well below that level.

That is despite resilience in the economy as well as the banking system, along with the latest set of Fed policymakers’ projections that suggest two additional quarter-point rate rises may be required.

Much will depend in the near-term on Powell’s testimony to Congress later on Wednesday and whether he reinforces that rate view, which could lead to a surge in yields and forecast upgrades over coming weeks.

Interest rate futures are pricing in only one more rise.

The yield on the 2-year Treasury note, traditionally sensitive to the near-term monetary policy outlook, is forecast to fall about 70 basis points in six months to 4.00% from around 4.70% currently, according to median forecasts in a June 15-21 poll of 26 strategists.

That would be far below the near 16-year high it reached in March following Powell’s previous Congressional testimony but still above a low of 3.55% on March 24.

“That is essentially the markets getting ahead of the anticipated tightening,” said Bas Van Geffen, strategist at Rabobank. “It is going to be very difficult for the Fed to convince markets they will keep rates higher … and that there won’t be a quick pivot,” he said.

Three-quarters of strategists, 15 of 20, who answered an extra question said the 2-year Treasury yield was unlikely to revisit its cycle peak over the coming three months.

Only two of 27 respondents had the 2-year yield trading higher than the current level at the end of August. The highest forecast was 5.00%.

The benchmark 10-year note yield, meanwhile, was forecast to decline by much less, about 25 basis points over the coming six months.

Although the 2- to 10-year yield spread was expected to remain inverted, it was forecast to narrow about 50 basis points from nearly 100 bps now, the poll showed.

An inverted yield curve has historically been a reliable indicator of an oncoming recession but so far, having been inverted for almost a year, that has not happened.

“The economy has been more durable, and inflation higher for longer than market expectations,” said Robert Tipp, chief investment strategist at PGIM Fixed Income.

“Persistence of this configuration — continued growth along with above target inflation — will keep mild upward pressure on two-year and 10-year yields.”

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