The Federal Reserve’s hawkish tweaks this month - discussing when to taper quantitative easing and updating its forecasts to show its fed funds rate is likely to be increased from 2023 - are the start of its gradual exit from its very dovish stance. The Fed’s moves have thus hit reflation trades by raising fears that future growth will be undercut.
Source: Bank of Singapore, Bloomberg
We think the Fed’s leadership, however, is more dovish than the central bank’s new forecasts imply. We expect tapering will only begin in 2022 and the fed funds rate may remain at 0.00-0.25% until as late as 2024. But the Fed’s tweaks are affecting sentiment now. The first chart shows 2Y Treasury yields have reached 0.25% for the first time since the pandemic began in early 2020 as the bond market anticipates earlier rate hikes.
Source: Bank of Singapore, Bloomberg
Conversely, long-term 10Y and 30Y yields have fallen as investors mark down future growth. This has flattened the yield curve. The second chart shows the spread between 2Y and 10Y yields now stands at 125bps. In May it was over 150bps.
Source: Bank of Singapore,
We thus tweak our own Treasury rate forecasts and now expect 2Y yields will rise further to 0.50% over the next 12 months as speculation about early Fed rate hikes continues. We also think 30Y yields will reach 2.60% but that is lower than our earlier estimate of 2.90% as we see the curve being less steep now. Our forecast for 10Y yields, however, is still 1.90%. The strong US recovery, buoyant risk assets, Fed tapering and inflation from America’s reopening are set to push the benchmark yield closer to 2% in 12 months’ time.Disclaimer applicable to recommendation
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Version: July 2020