U.S. Treasury yields will decline over the coming year, but by less than half as much as they have in the last seven weeks, a Reuters poll of bond strategists showed, suggesting the market is already nearly fully priced for rate cuts next year.
Since peaking at 5.02% in October, the benchmark U.S. 10-year Treasury note yield, which moves inversely to the price, first dropped sharply on increased safe-haven demand owing the initial outbreak of the Israel-Hamas war.
Then, growing optimism inflation will fall further and perceived dovish statements from Federal Reserve officials boosted expectations of rate cuts coming sooner, leading to a further fall in yields to a three-month low of 4.10% last week.
The benchmark yield has since risen to 4.19% after the latest U.S. labour market report showed the jobless rate unexpectedly dropped to 3.7%, a reminder the world's largest economy is still resilient and not in urgent need of rate cuts.
This recovery will hold, according to median forecasts from a Dec. 7-12 Reuters poll of 50 bond strategists, mostly from sell-side firms, who said yields will only reach 4.25% by end-February though will likely stay volatile in the interim.
The 10-year yield will then fall to 4.10% by end-May, before hitting 3.88% in 12 months, lower than the 4.30% and 4.00%, respectively, expected in a November poll but considerably higher than surveys conducted earlier this year.
A smaller sample of the U.S. primary dealer banks who deal directly with the Fed provided a roughly similar result.
"At the beginning of November markets were pricing about 70 bps worth of rate cuts for next year and now it's 120. Much of the declines we saw recently were based on the front-loading of these expectations," said Zhiwei Ren, portfolio manager at Penn Mutual Asset Management.
A separate Reuters poll of economists taken last week found the Fed will keep rates unchanged until at least July and then cut by 100 basis points in the second half of next year, later and less than currently being priced in by markets.
A strong three-quarters majority, 23 of 31, who answered an additional question said the risk of a correction to the 10-year note yield over the next three months was high or very high.
This was a major shift from previous polls, where over 70% of respondents incorrectly predicted for three straight months that the 10-year note yield had peaked.
An important inflation release later on Tuesday is expected to show the annual rise in the consumer price index slowed to 3.1%, which could once again boost rate cut hopes.
Fed officials' communication following this week's two-day policy-setting meeting that concludes on Wednesday will decide where yields head in coming months.
Growing rate cut calls will also push the interest rate-sensitive U.S. 2-year Treasury note yield, currently at around 4.69%, down about 40 bps to 4.30% in six months, and then a further 50 bps to 3.80% by end-November 2024, the poll found.
If realised, the inversion between yields on U.S. 2-year and 10-year Treasury notes - a good predictor of previous recessions - will completely reverse by end-November.
"Given the locked-in low-cost financing for households and businesses and a lot of fiscal stimulus, we ended up with both sectors more insulated than expected," said Thomas Simons, senior economist at Jefferies, one of a few who expect a recession to begin in the first quarter of 2024 despite blowout growth recorded in the most recent one.
