Treasury Yields Poised to Hit 5% Threshold
Rising inflation expectations and concerns over US fiscal spending may soon push benchmark Treasury yields to a key level, according to T. Rowe Price’s chief investment officer of fixed-income, Arif Husain. With the fastest path to 5% being in the scenario that features shallow Fed rate cuts, Husain’s prediction stands out against market expectations of lower yields.
A Contrarian View
Husain’s call underscores the increasing debate in the world’s biggest bond market, following strong economic data that has raised questions about the likely pace of cuts. While strategists currently expect yields to fall to an average 3.67% in the second quarter, Husain believes the yield curve will steepen further, with the 10-year Treasury yield testing the 5% threshold in the next six months.
Supply and Demand Imbalance
Ongoing issuance by the Treasury to fund the government deficit is “flooding the market” with new supply, while the Federal Reserve’s policy of quantitative tightening has removed a key source of demand for government debt. This imbalance is likely to drive yields higher, particularly for longer-term US debt.
Cracks in the US Fiscal Position
The country’s debt interest-cost burden climbed to its highest level since the 1990s in the financial year that ended in September, lending credence to Husain’s views. With neither former President Donald Trump nor Vice President Kamala Harris touting reducing the deficit as a key element of their campaign, US government debt remains a key risk for market participants.
Positioning for Higher Yields
Investors sharing Husain’s view that a near-term recession is unlikely should consider positioning for higher long-term Treasury yields. With prospects of a normal easing cycle where the Fed cuts to nearer to the neutral rate, which Husain said is probably around 3%, investors may want to take advantage of the current yield environment.
A Range of Scenarios
Husain considered a range of scenarios, including a period of small rate cuts, comparable to the Fed’s reductions between 1995 and 1998, and a scenario in which the US went into recession, which would spur aggressive cuts. However, he believes the most likely scenario is one in which China injects more stimulus to help its own economy, boosting global growth and creating a clearer outlook for Fed officials.
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