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Despite The Fed’s Focus On Inflation, Strategists Continue To Cut Their Expectations For U.S. Yields

According to fixed-income experts surveyed by Reuters, who also anticipated the U.S. yield curve to continue to steepen, U.S. Treasury yields will trade far lower a year from now than was anticipated only a few weeks ago.

Following the failure of a few regional US banks last month, yields on 2-year Treasury notes have dropped by almost 100 basis points. On March 8, after aggressive remarks from Federal Reserve Chair Jerome Powell, they reached a peak above 5%.

Although the Fed has subsequently toned down its rhetoric a little, policymakers have mostly reaffirmed their commitment on containing inflation, which is currently running at more than twice the 2% objective. As a result, at least one more interest rate increase in May is still in the cards.

However, markets are pricing in a series of interest rate reductions beginning just two months from now, highlighting an extraordinarily significant divergence from the central bank’s own perspective.

The poll of more than 60 bond strategists conducted between April 5 and 12 found that the current decreasing trend in yields is expected to continue.

Although yield predictions across maturities were substantially revised downward from last month, the prognosis for the short end of the yield curve—which is most sensitive to changes in the policy rate—was revised downward by a larger margin, pointing to a steeper yield curve.

U.S. 2-year Treasury rates, which are now hovering around 4.0%, were projected to drop by approximately 50 basis points to 3.45% over the course of the following year, downgrading by roughly 40 basis points from a survey done last month.

However, rates on both 2-year and 10-year notes were anticipated to rise 20 and 25 basis points, respectively, during the next three months before continuing to decline.

“The curve became significantly steeper as the price of the rate drop increased. The head of rates strategy at TD Securities, Priya Misra, stated, “We prefer to be positioned for steepeners but don’t want to pursue the move as cuts are unlikely to be forthcoming.

According to Misra, “pricing for immediate cuts is probably too aggressive, but markets continue to overreact to weaker data.”

The benchmark 10-year yield in the United States, which was already down more than 50 basis points from its cycle peak on March 2, was predicted by the poll to decline by another 10 basis points over the course of the following year.

According to the most recent study, the inverted difference between 2-year and 10-year Treasury bonds, which is typically a reliable sign of an approaching recession, will close to around 10 basis points during the course of the next year. Since July of last year, that would be the narrowest.

A sturdy economy is being shown in the meantime by a still-strong labor market and persistently high inflation, which is not the usual setting for pricing in impending rate decreases.

According to a second Reuters poll of analysts, the Fed will maintain its benchmark interest rate at least through the end of 2023 after raising it by 25 basis points in May to 5.00%–5.25%.

The fixed-income strategist survey indicated that U.S. 2-year rates will continue to decrease, although a sizable majority of respondents in the most recent economic poll predicted at least one 25 basis point rate cut before the end of Q1 2024.

Over the previous few months, yield projections have also been driven by relatively strong volatility.

Strategists who responded to a separate question were divided on what would happen to volatility over the next three months because the widely-watched MOVE index, which measures volatility in bond markets, is now running almost 50% higher than its long-term average.

12 out of 23 respondents, or a slim majority, predicted increased volatility. The remainder predicted a decline.

Bas van Geffen, senior macro strategist at Rabobank, stated in a client note that “calm appears to be returning to markets at this time after no further bank casualties.”

But he added, “the unrest could easily resurface, and the tightening of credit conditions that would follow could range from mild to severe.”

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