Earlier this month we revised our Treasury yield forecasts higher after projecting the Federal Reserve will raise its fed funds rate five times this year to push inflation back towards its 2% target. The table below shows we expect 10Y Treasury yields will reach 2.35% over the next 12 months.
Source: Bank of Singapore, Bloomberg.
But Treasury yields are still set to remain low by historic standards to the benefit of risk assets. We also expect the Treasury curve will flatten further but not invert in 2022. The first chart shows the spread between 30Y and 2Y Treasury yields has fallen sharply recently. The Treasury curve has flattened as expectations of Fed rate hikes have lifted short term 2Y yields while long term 10Y and 30Y yields have lagged on fears that tighter monetary policy will pare back future growth.
Source: Bank of Singapore, Bloomberg.
An inversion of the yield curve here would signal the Fed is hiking rates too much and the US economy is set to fall into recession. But this is not a scenario we envisage occurring this year.
Source: Bank of Singapore, Bloomberg.
In the table we have also updated our US swap rate forecasts based on the new Secured Overnight Financing Rate (SOFR) benchmark. The second chart shows the swap curve has also been flattening and given 30Y SOFR swap rates trade well below 30Y Treasury yields, the swap curve is more at risk of inverting periodically. But in the long-term, we expect both curves will slope upwards as the US economy expands during most years of its business cycle. This would limit periods of curve inversion to the minority of years when the US economy falls into recession.
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