US Treasury yield curve predicted to steepen as investors await Biden’s planned stimulus

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Long-term US Treasury yields are predicted to rise even higher with a steeper yield curve as the economic outlook improves, with President-elect Joe Biden set to inject fresh fiscal stimulus after his inauguration on Wednesday.

Last week, yields on US 10-year debt reached their highest levels since March, rising to 1.17 per cent as expectations of a return to higher inflation and economic growth prompted investors to sell longer-dated government debt. The yield curve also steepened to levels not seen since 2016, according to ratings agency S&P.

Investor optimism was sparked initially by the outcome of run-off elections in Georgia favouring the Democratic Party, which is expected to help Biden push through a planned USD1.9 trillion relief package to support the US economy while vaccines are rolled out.

Support for the stimulus package came from Biden’s nominee for Treasury Secretary, former Federal Reserve chair Janet Yellen, who said the “smartest thing we can do is act big” as she outlined the plan before the Senate finance committee on Tuesday.

If passed by Congress, relief would include direct payments of USD1,400 to all Americans, in addition to USD440 billion aid for small businesses, and USD415 billion for fighting the virus.

Brad Tank, CIO of fixed income at US-based asset manager Neuberger Berman, says that yields have risen rapidly in 2021, and are likely to keep going up. 

Tank says that so far there has been a “fairly orderly adjustment of bond prices to improved growth and inflation expectations”. US 10-year Treasury yields have doubled since August and currently hover around 1.10 per cent yield, with almost 20 basis points of that increase coming since the start of this year.

He says that markets had priced in much of the Biden election campaign’s economic platform before the incoming president unveiled his stimulus package last week.

“Today’s level of 1.10 per cent is still lower than our estimate of fair value coming into the fourth quarter of 2020 – which is to say that we still haven’t seen a true normalisation of rates after last year’s rush to safety.” 

Tank forecasts that yields will reach 1.25 per cent in three months’ time, 1.35 per cent in six months, and 1.50 per cent by the end of 2021.

However, the Federal Reserve could seek to curb inflation later in the year by winding down its USD120 billion in monthly bond purchases. 

Several regional Fed heads made comments appearing to consider such a move as prospects for inflation rose in January, going against the widespread assumption that the central bank would continue purchasing bonds until 2022 at the earliest.

The Federal Reserve’s chair, Jerome Powell, has since reassured investors that the central bank does not plan an imminent “exit” from loose monetary policies. 

“Now is not the time to be talking about exit,” Powell said at a virtual event hosted by Princeton University last week, adding that one of the major lessons learned from the global financial crisis was to “be careful not to exit too early”.

According to Tank the Federal Reserve’s “somewhat mixed message” reflects a “return to normalcy for central bankers”.

“We do not regard this as “signalling,” let alone a departure, from the current policy trajectory,” Tank says, adding that it is “far too early for taper talk”.

Nevertheless, others argue that managing the steepening of the yield curve would help counteract the potential damage that higher bond yields could cause.

In December, Eric Vanraes, manager of the Strategic Bond Opportunities fund at Eric Sturdza Investments said that a significant steepening of the curve would be “too painful for the US economy and for the world” at this point. 

Higher long-term yields would increase companies’ capital borrowing costs and consumer mortgage rates, said Vanraes.

Vanraes argued that the Federal Reserve would be likely to “directly or indirectly” manage any significant steepening of the yield curve. “If 10-year treasuries go above 1.15, the Fed will buy treasuries in order to stop the correction.”

Mark Dowding, CIO at BlueBay Asset Management says that there has been a sense that the move in US yields has “begun to weigh on risk assets, thus pointing to a possible tightening in financial conditions”.

“Consequently, it has not been surprising to hear speakers from the Federal Reserve pushing back against the idea that it will allow yields to rise too far in the near term.”

Dowding expects US Treasury yields will be contained within a range by worsening Covid data, which may lead to further restrictions on economic activity in the early days of the Biden administration and “keep reflationary hopes in check for the time being”.

“We still believe that yields are likely to end the year materially higher than what is discounted in the forward curve, which prices the 10-year note around 1.35 per cent at the end of the year. However, in the near term, we think that this move has gone far enough,” says Dowding.

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