T. Rowe Price's fixed-income chief investment officer, Arif Husain, forecasts that the yield on the 10-year U.S. Treasury bond might soon reach a critical level of 5%, amid rising inflation expectations and concerns about U.S. fiscal spending. Husain, who oversees approximately $180 billion in assets, suggests that this threshold could be tested within the next six months. He noted that the quickest route to this level could be a small rate cut by the Federal Reserve.
This prediction stands in stark contrast to market expectations for a decrease in yields, following the Federal Reserve's first rate cut in four years last month. The debate in the global bond market is intensifying due to strong economic data, raising questions about the pace of potential rate cuts.
The 10-year Treasury yield last touched 5% in October last year, marking the highest since 2007, as concerns over prolonged high interest rates loomed. If Husain's forecast proves accurate, it may trigger a volatile repricing event, with strategists currently projecting the yield to drop to an average of 3.67% by the second quarter of next year. Currently, the 10-year U.S. Treasury yield remains at 4.08%.
Husain also remarked on the U.S. Treasury's persistent bond issuance to cover the government deficit, resulting in an influx of new bond supply in the market. Meanwhile, the Federal Reserve's quantitative tightening policy, aimed at reducing its balance sheet after years of bond purchases, has removed a key source of demand for government bonds.
Husain, who also serves as T. Rowe Price's head of fixed income, explained that the yield curve might steepen further, as any rise in short-term Treasury yields would be restrained by potential rate cuts. He suggests that the most likely scenario for the Federal Reserve is a series of small rate cuts over time, similar to those from 1995 to 1998.
He also considered the possibility of a normal easing cycle, where the Fed might cut rates closer to a neutral level, which he estimates to be around 3%. Alternatively, if the U.S. were to enter a recession, it could lead to significant rate cuts. Husain advises investors, who like him, do not foresee a near-term recession, to prepare for rising long-term Treasury yields.
