• Median estimate shows 10-year yield climbing to 2.55% by June
  • Policy makers, derivatives traders differ on rate expectations

Treasuries are forecast to decline during the first half of 2016, with yield increases moderated on speculation the Federal Reserve’s monetary-policy normalization will prove more gradual than central bank officials foresee.

The median estimate of strategists and economists surveyed by Bloomberg shows the 10-year Treasury note yield rising to 2.55 percent in six months from its 2.27 percent level Thursday. The yield on the two-year note, the shorter-maturity security more closely tied to the outlook for Fed policy, will rise to 1.33 percent by the end of June, which would be the highest since 2008, from 1.05 percent, forecasters say.

“You have a Fed that will slowly raise rates, with the market still taking the under with really how fast the Fed can lift them,” said Scott Buchta, the head of fixed-income strategy at Brean Capital in New York and a nearly three-decade bond-market veteran. Traders “still see a lot of different headwinds from the tax and regulatory side, wage growth that really hasn’t been there yet and slack still in the labor force.”

Plunging oil prices and a strong dollar have curtailed upward price pressures in the U.S., where signs of economic strength contrast with weakening growth in China and Europe. Tame inflation gives little impetus for Treasury yields to surge as Fed officials seek to normalize policy without crimping economic activity.

Awaiting Inflation

Forecasters have repeatedly called for higher yields in recent years, as the Fed was seen moving closer to tightening monetary policy, only to be proven wrong as yields fell or remained low. Forecasters lowered estimates in 2015 as global central banks added stimulus while China’s slowing economy and plunging commodity prices stymied inflation, capping yields.

The derivatives market is pricing in slightly more than two Fed increases in 2016, compared with the four moves that Fed officials laid out in their latest quarterly forecasts. Interest-rate derivatives traders see the fed funds rate at about 0.94 percent at the end of 2016, compared with the median outlook of central bank officials of 1.375 percent.

U.S. economic growth, which slowed to an annualized rate of 2.1 percent in the third quarter of 2015, is forecast to be 2.5 percent for all of 2015 and remain at the same pace in 2016, according to a Bloomberg survey of 81 economists. Amid tepid growth, inflation has been below the Fed’s 2 percent target for more than three years, with the central bank’s preferred gauge rising 0.4 percent in the 12 months ended in November.

The difference between yields on government debt and similar-maturity Treasury Inflation Protected Securities, known as the break-even rate, shows traders are pricing in a sub-2 percent U.S. inflation rate for the next 30 years.

“We are not clicking on all cylinders from the economic point of view yet,” said Buchta, who spent two decades at Bear Stearns Cos until its 2008 purchase by JPMorgan Chase & Co.

History shows long-term Treasuries often fare well in a rising-rate environment. Every time the Fed has raised rates over the past four decades, betting that longer-term Treasuries would outperform short-term debt has proved to be a big winner, as higher rates stemmed inflation and kept economic growth from overheating, according to data compiled by Bloomberg.

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