Overview
Long-dated U.S. Treasury yields are expected to remain broadly steady in the short run but to move higher later in the year, according to a survey of bond strategists conducted Feb. 5-11. The group also signaled that short-dated yields could drift lower on increased market expectations for Federal Reserve rate cuts.
Survey findings and fiscal backdrop
Of the 37 strategists polled, 21, or nearly 60%, said that heavy Treasury issuance in the coming years tied to financing President Donald Trump’s tax-cut and spending plans would make a meaningful reduction in the Fed’s $6.6 trillion balance sheet unfeasible. Congressional Budget Office estimates referenced in the survey indicate the legislation would add at least $4.7 trillion to U.S. deficits over a 10-year period.
Dealers and market participants are awaiting clearer guidance from the U.S. Treasury on the timing and scale of the planned increase in debt supply. In the meantime, observers note that GDP growth has been stronger than anticipated and that inflation has lingered above the Fed’s 2% target for roughly half a decade.
Yield forecasts shift
After several months of cutting yield projections and downplaying the odds of an inflation surprise, strategists have begun to slightly revise forecasts upward despite limited details on future debt issuance. Median survey estimates now call for the benchmark 10-year Treasury yield to rise to 4.29% in one year, versus a 4.20% projection one month earlier.
Market pricing for the interest-rate-sensitive 2-year Treasury shows an anticipated decline from 3.50% to 3.45% by the end of April and to 3.38% by the end of July, reflecting expectations for Fed easing later in the year.
At present, the 10-year yield has been trading around 4.16% and many market participants expect that range to persist for months.
Market voices
“There will likely be a narrative of inflation being on its way down and the Fed cutting, and once we see some evidence of the opposite, it’ll come as a bit of a wake-up call with some volatility in the near term. That’ll lead to a bit more inflation and risk premium as a result,” said Jean Boivin, head of the BlackRock Investment Institute. He added that this dynamic, together with the broader debt backdrop, would contribute to an ongoing upward trend for 10-year yields and beyond.
“We’ve pretty much traded in a tight range of 4.0-4.3% on the 10-year and there’s nothing really to drive us out of this range in coming months,” said John Madziyire, head of U.S. Treasuries and TIPS at Vanguard.
Fed balance sheet outlook
The Federal Reserve has reduced its balance sheet by about a quarter since its mid-2022 peak of nearly $9 trillion, primarily by allowing securities to mature without reinvestment. Several strategists in the survey said that, given the anticipated scale of Treasury issuance, materially shrinking the balance sheet further would be challenging.
There is also notable uncertainty about how Kevin Warsh, who is expected to take over as Federal Reserve chair in June, will approach policy. Earlier commentary from him suggested a preference for tighter policy and a smaller Fed balance sheet, while more recent signals point toward support for lower interest rates.
“You’re moving in two different directions to be cutting policy rates and looking to shrink the balance sheet at the same time,” said Meghan Swiber, director of U.S. rates strategy at Bank of America. “Even though there have been a lot of questions around Warsh given his more hawkish stance on the balance sheet, we see a relatively low likelihood that actually materializes.”
Alejandra Vazquez Plata, interest rate strategist at Citi, said she expects Warsh would likely prioritize rate cuts before pursuing removal of longer-dated Treasury securities from the Fed’s holdings, at least for this year. “The Fed will probably let coupon holdings roll off and instead of purchasing coupons, start purchasing T-bills instead. That’s probably the path of least resistance for now,” she said.
Policy expectations and market implications
The survey also reflected forecasts that the Fed would implement two rate cuts later this year, with easing to begin in June when Warsh is expected to assume the chair. Those expectations underpin the projected modest decline in the 2-year yield over the coming months.
Meanwhile, the combination of stronger-than-expected GDP growth, persistent inflation above the Fed’s 2% target, and the prospect of substantial additional Treasury issuance has prompted some strategists to edge upward their medium-term 10-year yield outlooks.
Conclusion
Market participants are balancing near-term signals of stability in long-term yields with growing concerns about the fiscal backdrop and central bank policy direction. The survey indicates a market view in which short-term rates respond to expected policy easing, while long-term rates face upward pressure from inflation persistence and increased debt supply.
Survey period: Feb. 5-11. Survey size: 37 strategists, 21 of whom indicated that large Treasury issuance will impede a significant Fed balance sheet reduction.