By Sarupya Ganguly
BENGALURU (Reuters) -U.S. Treasury yields will trade sharply lower a year from now than was forecast just a few weeks ago, according to fixed-income strategists polled by Reuters, who also expected the U.S. yield curve to steepen further.
Yields on U.S. 2-year Treasury notes have plunged over 100 basis points following the failure of some regional U.S. banks last month. They had peaked above 5% on March 8 following hawkish testimony from Federal Reserve Chair Jerome Powell.
While Fed rhetoric since then has softened a bit, policymakers have by and large reiterated their focus on taming inflation, running at more than twice the 2% target, and so at minimum one more interest rate rise in May is still in store.
But markets are pricing for a series of interest rate cuts starting just two months later, underscoring an exceptionally large divergence from the central bank's own view.
That recent downward trend in yields is forecast to continue further, according to the April 5-12 poll of over 60 bond strategists.
While yield forecasts were largely downgraded across maturities from last month, the outlook for the short end of the yield curve, which is most sensitive to policy rate changes, was slashed by a bigger margin, suggesting a steeper yield curve.
U.S. 2-year Treasury yields, currently trading at around 4.0%, were seen falling about 50 basis points to 3.45% over the next 12 months - a 40-odd basis-point downgrade from a survey conducted last month.
However, in the coming three months, yields on both 2-year and 10-year notes were expected to rise 20 and 25 basis points, respectively, before resuming their fall.
"The curve steepened sharply as (rate) cut pricing continues to rise. We prefer to be positioned for steepeners, but don't want to chase the move as cuts are unlikely to be imminent," said Priya Misra, head of rates strategy at TD Securities.
"The pricing for immediate cuts is likely too aggressive, but markets continue to react disproportionately to weaker data," Misra said.
On the longer end of the curve, the benchmark U.S. 10-year yield , which was down over 50 basis points from its cycle peak of March 2, was seen in the poll losing another 10 basis points over the coming year.
The latest survey predicted the inverted spread between 2-year and 10-year Treasuries, usually a reliable indicator of an impending recession, will close to about 10 basis points in the coming year. That would be the narrowest since July last year.
Meanwhile a still-strong labour market and sticky inflation continue to tell a tale of a resilient economy, not a typical scenario for pricing in imminent rate cuts.
A separate Reuters poll of economists showed the Fed will keep its key interest rate unchanged at least until end-2023 after hiking it one more time by 25 basis points in May to 5.00%-5.25%.
U.S. 2-year yields will decline more, the fixed-income strategist survey showed, but a significant majority of respondents in the latest economic poll saw at least one 25 basis point rate cut by end-Q1 2024.
Relatively high volatility has also been a driver of yield forecasts over the past few months.
With the widely-followed MOVE index that tracks volatility in bond markets currently running over 50% higher than its long-term average, strategists who responded to a separate question were split on what would happen to volatility over the coming three months.
A slight majority, 12 of 23, said volatility would increase. The rest said it would decrease.
"Currently, calm seems to be returning to markets after no further bank casualties," wrote Bas van Geffen, senior macro strategist at Rabobank, in a client note.
"However, the unrest could easily resurface and the resultant tightening of credit conditions could range from mild to severe," he said.