The yield on the 10-year US Treasury rose briefly above 2.5% this week, having closed higher on only 11 trading days during 2017. That suggests the market may be readying itself for the effects of the US tax cuts, including a faster pace of rate rises by the Federal Reserve.
But there are reasons to expect that the recent pick-up in US 10-year yields will not go much further.
- Financial history provides some reassurance that gradual monetary tightening will not push the long end of the yield curve much higher. The curve has flattened in previous rate hike cycles. Also, the 10-year yield has increased only marginally from 2.3% since the Fed embarked on the most recent rate rise cycle.
- It appears unlikely that the fiscal stimulus from tax cuts will accelerate the pace of Fed tightening. In the latest quarterly projections, the Fed left its inflation forecasts for 2018 and 2019 unchanged at 1.9% and 2%, despite revising up its growth estimate from 2.1% to 2.5% for 2018. Only if the Fed starts to factor in faster inflation would the risk of more aggressive tightening increase.
- The Fed is still predicting a relatively shallow cycle, with longer run rates peaking at around 2.8%.
So we believe the 10-year US Treasury yield will be relatively stable, and maintain our 2.5% forecast over three, six, and 12 months.
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