March 29, 2018 / 12:27 AM / 7 months ago

U.S. Treasury yields not likely to spike, even with abundant supply due: Reuters poll

(Reuters) - Rock-bottom government bond yields may be a thing of the past, but there is no reason to expect a sudden spike, even with an oncoming flood of U.S. debt supply, a Reuters poll showed.

U.S. Treasury yields are forecast to rise over the coming year, but with the U.S. government focusing most of its new issuance on shorter maturities, that is likely to further flatten the yield curve as long bond yields stay low.

A package of $1.5 trillion worth of tax changes signed into law by President Donald Trump on Dec. 22 will lead to a budget shortfall and result in increased supply of Treasuries at a time when the Federal Reserve is unloading them.

The Reuters poll of 75 bond strategists taken March 22-28 showed consensus expectations for U.S. 10-year Treasury yields at their highest than in any poll taken in almost four years.

But the expected 40- to 50-basis-point rise in the coming year is less than might otherwise be suggested by an impending series of Fed interest rate hikes to manage a strong economy that is near full employment.

“Concerns about heavier Treasury issuance and an over-heating economy made for a powerful combination and raised fears of much higher bond yields, which in turn started the global equity correction in early February,” said Ajay Rajadhyaksha, head of macro research at Barclays. “We believe these fears are overblown.”

The latest poll forecast U.S. 10-year Treasury yields would rise about 50 basis points to 3.20 percent in a year and the two-year yields is expected to rise about 60 basis points to 2.80 percent.

That suggested an expected compression of the yield spread between two- and 10-year Treasuries to be less than 50 basis points, which would be the lowest expected yield since a poll in January 2010 and the lowest spread since November 2007. (Graphic on expected yield moves: reut.rs/2pLxl5r)

“Clearly there are concerns. We are introducing new fiscal measures at a stage in the cycle which we have never done before in the past, and there is uncertainty there,” said Sam Bullard, senior economist at Wells Fargo.

“With most of the duration of those issuances at the short end of the curve, you may see higher rates there which may lead to a flatter yield curve.”

The yield spread has narrowed - a move generally seen by financial markets as a sign at this stage of an economic cycle of potential trouble ahead - in recent months from its peak of around 300 basis points in 2010.

But over 80 percent of 31 strategists expect it will be more than two years before the yield curve inverts. One strategist expected it to invert within a year. The rest said expected it to invert in one to two years.

An inverted yield curve, when the two-year yield trades above the 10-year, has preceded all five past recessions.

Some analysts have said an inversion does not necessarily mean an impending recession as it has in the past. But nearly 70 percent of 30 respondents said it was still an indicator of recession.

CLOSING IN ON POLICY AND YIELDS

Benchmark bond yields in the euro zone and Britain are also expected to climb along with U.S. Treasuries as the European Central Bank is expected to end its stimulus this year and the Bank of England is forecast to raise interest rates.

The spread between 10-year Treasuries and much lower-yielding German bunds over the forecast period is predicted to be roughly around the current 230 basis points.

That reflects expectations the ECB is closing the monetary policy gap with the United States.

The latest findings are in step with a separate Reuters poll of foreign exchange strategists earlier this month, which showed the dollar was expected to retreat further, giving way to a rising euro despite the Fed outlook.

While speculation had risen the Bank of Japan would follow in the footsteps of its major peers on removing monetary stimulus after Governor Haruhiko Kuroda hinted at that on March 1, the latest poll showed almost no change in expectations compared to three months ago.

The consensus was for 10-year Japanese government bonds to yield 0.10 percent in a year, a view held for well over a year now.

“The fact that bond yields have remained firm through bouts of volatility suggests that the recent leg-up in yields has staying power,” said Beata Caranci, chief economist at TD.

“Nevertheless, despite the efforts of central bankers to remove stimulus in a measured, non-disruptive fashion, the process of interest rate normalization could trigger future episodes of financial market volatility.”

(For a graphic on expected yield moves, click reut.rs/2pLxl5r)

Polling by Vivek Mishra and Shrutee Sarkar, editing by Larry King

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