March 23, 2017 / 7:25 PM / a year ago

U.S. bond market outlook at odds with stock market optimism

(Reuters) - U.S. Treasury bond yields are set to rise this year, but not as much as many currently expected, according to a Reuters poll of top fixed-income strategists who appear skeptical the Federal Reserve will manage to raise rates several times more this year.

Central banks, not finance ministries and their borrowing plans, will still wield the strongest influence on sovereign bond markets, the poll found, led by the Fed, which teed the market up for a rate hike this month they duly delivered.

This stands in sharp relief to what has been driving U.S. stock markets to daily record highs over the last several months: hopes that the Donald Trump White House will successfully usher in financial deregulation and sweeping tax cuts through a Republican-led Congress.

That is otherwise known as the “Trump reflation” trade.

But bond strategists as a whole still do not appear very concerned about global inflation, despite rising demand for inflation-indexed bonds since the start of the year.

These forecasters, who were all-but spot-on as a group a year ago on where the 10-year U.S. Treasury yield would trade now, mostly are of the view that the Fed’s recent activism with rates is not likely to turn into an aggressive tightening cycle.

“The market is too optimistic about the impact of Trump’s plans,” said Elwin de Groot at Rabobank. “We actually see a bigger risk (that) his plans, especially on trade, will backfire for global growth.”

The conclusions are broadly in line with global fund managers who have remained conservative in their recommended portfolio allocations, still including a hefty amount of bonds despite historically-low, and in some cases negative, yields.

A small sub-set of fixed-income analysts who have consistently predicted lower-for-longer yields over the period since the financial crisis are still saying they will even be lower this time next year than where they are now.

That comes despite widespread expectations in a Reuters poll of over 100 economists, as well as interest rate futures pricing, for another two Fed interest rate hikes this year and more hikes into 2018. (reuters://realtime/verb=Open/url=cpurl://apps.cp./Apps/cb-polls?RIC=USFOMC%3DECI poll data)

The latest Reuters poll median puts the U.S. 10-year Treasury yield at 2.90 percent in a year from now, with the highest forecast at 3.50 percent. (reuters://realtime/verb=Open/url=cpurl://apps.cp./Apps/mm-bondyield-polls?s=6J&st=G poll data)

Rabobank puts the 10-year at 2 percent by end-March 2018, more than 40 basis points lower than where it is now. HSBC is even more aggressive, expecting it to fall by 80 basis points to 1.60 percent.

“Caution should be taken about reading too much into the synchronized nature of the improvement,” noted HSBC’s Global Chief Economist Janet Henry.

“It is not the case that every region of the world has simultaneously discovered that the elixir to the growth malaise is simply to ignore the structural growth constraints and simply allow animal spirits to take hold.”

Strategists in the latest Reuters poll said central banks, through their policy moves, followed by institutional investor plays, were likely to be the top two drivers of sovereign yields over the next three months.

For years, bond strategists and economists have consistently forecast higher yields on expectations that central banks’ stimulus will lead to inflation, which has not materialized.

Only in the past year have predictions for higher bonds yields have turned out to be right.

Benchmark bond yields in the euro zone, Britain and Japan are also expected to climb along with U.S. Treasuries as the Bank of England contemplates an eventual rate rise and as the European Central Bank and Bank of Japan look to move away from exceptionally stimulative policy.

“The real question much are real yields a function of Trump reflation versus a retreat from central bank (quantitative easing) measures?” noted Deutsche Bank strategist Alan Ruskin. 

“In all probability higher real yields started with a Trump reflation trade, but has tended to slowly evolve to a point where (euro zone and Japanese) policy is having more impact on global real yields. However, even if the ... retreat from QE has come into focus, this is also in part because the global economy is in better shape inclusive of trends for these two economies.”

Polling by Krishna Eluri and Khushboo Mittal; Analysis by Hari Kishan and Rahul Karunakar; Writing by Ross Finley; Editing by Jeremy Gaunt

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