Photographer: Michael Nagle/Bloomberg

Wall Street Again Slashes 2017 Yield Forecasts Ahead of Fed Hike

  • Consensus for 10-year Treasury yield at year-end falls to 2.7%
  • U.S. debt attracts investors as inflation expectations subdued

Another month gone by, another rethink on Wall Street about how high U.S. yields can climb.

The weighted average year-end estimate for 10-year Treasury yields fell to 2.7 percent, based on a Bloomberg survey published last week, down about 20 basis points from two months ago. The result brings the consensus forecast back to lowest level of 2017, set in January. The third straight monthly downward revision in the survey’s median projection came less than a week before Federal Reserve officials are expected to tighten policy for the third time in six months. The note ended the week at 2.2 percent.

Reasons abound for the sanguine outlook on the world’s biggest bond market.

For one, the fast money is betting that after June, the Fed will wait to go again until at least December. And even if officials proceed with a balance-sheet reduction this year, they’ve signaled it will be more gradual than traders had anticipated. There’s also the matter of domestic politics. Last week’s testimony from former FBI Director James Comey reinforced the potential distractions ahead for the Trump administration as it pursues its fiscal-policy agenda, helping explain why traders’ inflation expectations are near the lowest since November.

“In March, the market was reasonably priced for something above 2 percent on inflation going outward, and now it’s a struggle to price that in going forward,” said Stephen Gallagher, chief U.S. economist at Societe Generale. “When we have minimal inflation and low yields globally, the Treasury just becomes an extremely attractive product.”

With that backdrop, it’s not too surprising that big money is flowing in. China has resumed buying Treasuries in 2017 and is prepared to add more under the right circumstances as the yuan stabilizes, according to people familiar with the matter. Meanwhile, Dan Ivascyn at Pacific Investment Management Co. and Bill Gross at Janus Henderson Group both said last week that Treasuries are one of the best bets among developed-market bonds. 

Cash Haul

And bond-fund managers are getting more cash to put to work. Fixed-income funds added about $16 billion in the week through June 7, the most since the first quarter of 2015, according to EPFR Global.

Ivascyn, Pimco’s global chief investment officer, said he could see 10-year yields reaching 1.5 percent, echoing a similar view from April by Scott Minerd at Guggenheim Partners. 

They won’t find anyone sharing that view in the Bloomberg survey. Steven Major at HSBC Holdings Plc and Lindsey Piegza at Stifel Nicolaus & Co. have the lowest year-end forecast for the 10-year yield, at 1.9 percent. Major raised it last week from 1.6 percent, citing a Fed that has actually stuck to its path of boosting its benchmark.

“With economic fundamentals pretty much certain to imply growth is not going to accelerate a whole lot the rest of the year, there’s no reason why rates should go up significantly,” said Joel Naroff, president of Naroff Economic Advisors. He now predicts the 10-year yield will end 2017 at 2.5 percent, down from 3.2 percent in April.

In minutes of the Fed’s May meeting, a few participants expressed concern that progress toward their inflation objective has slowed. 

They’ll get another glimpse at price growth hours before their rate decision is announced, with the release of May consumer price index data on June 14. Expectations are for the headline number to slip to 2 percent, from 2.2 percent in the prior month.

With inflation cooling, it only makes sense that yield forecasts are sinking as well.

Here’s what else to watch in the week ahead:

June 12Monthly Budget Statement
U.S. to Sell $24 Bln 3-Year Notes
U.S. to Sell $20 Bln 10-Year Notes Reopening
June 13NFIB Small Business Optimism
PPI 
U.S. to Sell $12 Bln 30-Year Bonds Reopening
June 14CPI
Retail Sales
Business Inventories
FOMC Rate Decision
June 15Import and Export Price Index
Empire Manufacturing
Initial Jobless Claims
Industrial Production
Manufacturing Production
June 16Housing Starts
Building Permits
U. of Mich. Sentiment
U. of Mich. 5-10 Yr Inflation
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