T. Rowe Price anticipates that the U.S. 10-year Treasury yield could soon reach 5% due to rising inflation expectations and concerns over U.S. fiscal spending. Arif Husain, Chief Investment Officer of the firm's fixed income division, managing around $180 billion in assets, suggests this could occur within the next six months as the yield curve steepens.
Husain's outlook contrasts with market expectations of declining yields following the Federal Reserve's recent rate cut, the first in four years. This divergence highlights growing debates surrounding the world's largest bond market after robust economic data cast doubt on potential rate cuts.
The last time the 10-year Treasury yield hit 5% was in October of the previous year, marking a high since 2007 amid fears of prolonged high rates. If Husain's forecast proves correct, it may trigger significant repricing, as strategists currently predict the yield to average 3.67% by the second quarter of next year. As of Monday, the yield was steady at 4.08%.
Husain, with nearly three decades in the industry, attributes the yield increase to the U.S. Treasury’s continued bond issuance to cover government deficits, flooding the market with new supply. Concurrently, the Federal Reserve's quantitative tightening, aimed at reducing its balance sheet after years of bond buying, removes a critical source of demand for government bonds.
Husain notes that the yield curve might steepen further, as any rise in short-term Treasury yields will likely be restrained by potential rate cuts. He envisions the Fed might adopt a gradual rate cut approach, similar to the period from 1995 to 1998. This scenario could involve more stimulus from China to boost its economy, consequently supporting global growth and offering Fed officials clearer insights.
Alternatively, the Fed might engage in a standard easing cycle, adjusting rates to a more neutral level, which Husain estimates around 3%. He also considers the possibility of a U.S. recession, which would prompt substantial rate cuts.
Investors who share Husain's view that a recession is unlikely in the near term should prepare for higher long-term Treasury yields, according to his report.
