Why bond yields are likely to end the year lower

The US bond market continues its volatile performance in 2024, with Treasury yields recently reaching four-week highs. However, despite near-term strength, UBS strategists believe bond yields are likely to end the year lower, due to several macroeconomic factors.

Primarily, US inflation is among the key catalysts influencing bond yields. According to the latest data from the Federal Housing Finance Agency, US house prices edged up just 0.1% month-over-month in March, down from a 1.2% rise in February. On an annual basis, prices increased by 6.7% in March, compared to 7.1% in February.

According to UBS, the softening housing market and the slowing price trend in new rental leases hint at a further inflation slowdown.

“Hard data continues to suggest that inflation should trend lower for the rest of this year following April’s encouraging print,” they noted.

The Federal Reserve’s monetary policy is another crucial factor that may contribute to a decline in bond yields. While Minneapolis Fed President Neel Kashkari indicated that further rate hikes are not yet ruled out, the overall tone from the Fed remains patient.

Kashkari mentioned that the odds of the Fed raising rates “are quite low,” aligning with recent Fed communications and Chair Jerome Powell’s view that the central bank’s next move is unlikely to be a hike.

“With a softening labor market and slowing economic growth, we continue to expect the Fed to start policy easing in September, with a total of 50 basis points of rate cuts this year,” strategists wrote.

In addition, UBS’s team believes that the pace of the Fed’s balance sheet runoff is set to taper. Starting next month, the Fed will slow its quantitative tightening (QT) efforts, reducing the monthly cap on the sale of US Treasury securities from $60 billion to $25 billion.

This reduction in QT is likely to lower upward pressure on real rates, contributing to a decrease in bond yields.

“We believe this should reduce upward pressure on real rates and drive the next leg lower in yields,” UBS continued.

Also, the growth in the US economy is another factor that will make an impact. As highlighted by UBS, the world’s biggest economy is showing signs of slowing, with a softening labor market and reduced economic momentum, further supporting the case for lower yields as investors seek safer assets amid economic uncertainty.

“We continue to believe that US sovereign yields should end the year lower as inflation and economic growth slow and the Fed cuts rates in the last months of the year,” strategists said in the note.

“We expect the yield on the 10-year US Treasury to fall toward 3.85% as the year progresses, underpinning our most preferred view on fixed income,” they added.