Tariff inflation worry, debt deluge to prop up longer-term US Treasury yields: Reuters poll
Both two-year and 10-year yields have fallen about 25 basis points since mid-July despite nearly half a trillion dollars of new Treasury securities expected to hit the market this quarter alone.
The bulk of that yield decline followed big downward revisions to previous months' hiring data that led President Donald Trump to fire the Bureau of Labor statistics commissioner.
A September Fed rate reduction is now all but certain after a long pause, with nearly two more priced into interest rate futures by year-end following concerns about the strength of the job market as well as mounting worries over future political interference in Fed policy.
"The market, as we've seen, has a tendency to take on board a downside surprise on growth and the labor market and run with additional expected cuts. We've been reluctant to take that on board. In fact, we've been pushing back on this," said Jean Boivin, head of the BlackRock Investment Institute.
"This is a world where the Fed will have an easing bias, will want and have the intent to cut, but will be constrained in its ability to deliver that because the inflation piece of the puzzle will not be cooperating as much," Boivin added.
Although many market participants view the surge in U.S. tariffs to their highest since the Great Depression as a temporary boost to inflation, many others are concerned this will prove more persistent at a time when it is already well above the Fed's 2% target.
Consumer price index (CPI) data due on Tuesday are expected to show a further rise in July.
The U.S. 10-year Treasury yield, currently 4.27%, will edge up to 4.30% in three months and trade around there at end-January and in a year, medians from nearly 50 bond strategists in an August 6-11 Reuters poll showed.
Policy-rate sensitive 2-year Treasury yields were expected to drop about 15 bps to 3.60% in six months and then to 3.50% in a year, the poll showed.
That will further steepen the yield curve, widening the gap between those two yields from around 50 bps on Monday to 80 bps in a year.
"General uncertainty around trade policy and fiscal concerns and its impact on Treasury issuance might keep longer-term yields, like the 10-year yield, a little bit more elevated," said Collin Martin, fixed income strategist, Schwab Center for Financial Research.
"Add all that together, we'll probably see a steeper yield curve."
Large Treasury debt sales in coming quarters are expected to prevent long-term yields from falling much, even if inflation rises less than expected. That in part, is a reflection of the higher "term premium" - compensation for holding long-term debt.
"Fiscal concerns could be more of an issue based on expectations for more and more Treasury issuance coming through the pipeline," said Martin.
"And the more debt we issue, the more buyers we need to find. You might need to see yields stay a little bit elevated to attract that marginal buyer."
Those concerns have been compounded by growing doubts over the central bank's independence, stoked by Trump's barrage of attacks on Fed Chair Jerome Powell and the credibility of official U.S. statistics.
"We have been of the view long-term rates in the U.S. will be drifting up...There are forces at play that will require greater compensation to take duration risk in U.S. Treasuries over time, and that's going to continue to become apparent to investors," added BlackRock's Boivin.
Vishal Khanduja, head of broad markets fixed income at Morgan Stanley Investment Management, agreed.
"Mathematically, we don't have a deficit reduction plan in place, and that's why the market and us as investors are forcing the issue by expecting more yield...A steepening yield curve is the high-conviction structural bet in our portfolio at the moment," he said.
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