The benchmark 10Y US Treasury yield has rebounded from 0.50% to 0.70% in August as inflation has begun to recover after April’s lockdowns and the US government increases bond sales to finance its record budget deficit.But interest rates are still at very low levels and we see recent moves as a correction rather than the start of US bond yields trending higher.
First, US inflation is set to remain low. In July, core CPI inflation rose to 1.6% YoY as the economy reopened. The 0.6% MoM jump was the largest rise since 1991. But the pop in inflation is likely to be transitory. Owners’ equivalent and tenant rents - costs that account for a third of consumer prices - are falling given very high unemployment.
Second, the US labour market is improving after the jobless rate hit 14.7% in April. But July’s 10.2% rate was still far above the Federal Reserve’s 4.1% level it sees as consistent with its 2% inflation goal.
Third, the Fed is set to move to ‘average inflation targeting’. This shift may keep its fed funds interest rate anchored at 0.00-0.25% for up to the next five years as the Fed aims to make up for missing its 2% inflation goal over the last decade by overshooting it over the next few years.
Last, the central bank remains concerned about the highly uncertain economic outlook and so is likely to increase its bond buying (quantitative easing) to stop yields from rising too quickly in future.
Thus, we expect US rates to stay at historically low levels with 10Y yields only rising modestly in a 0.50-1.00% range to 0.90% over the next 12 months.The yield curve will likely steepen as the Fed shifts to average inflation targeting and the US Treasury keeps increasing record bond sales. But the overall low level of US yields will continue to support risk assets while weakening the USD.Disclaimer applicable to recommendation
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