10-year bond yields to rise on Fed hike expectations, but still likely to end year lower: analysts

TEN-YEAR bond yields are expected to rebound as investors begin to price in the possibility that the US Federal Reserve will be more aggressive with its hikes than previously expected. Analysts said the recent fall in bond yields was likely overdone, although rates will still end 2023 lower year on year.

Inflation and jobs data in the US last week were better than expected, suggesting that the Fed is far from done with its rate hikes.

“Investors have got ahead of themselves in underestimating the resolve of policymakers... to deal a decisive blow to inflation,” said UOB interest rate strategist Victor Yong.

The yield on 10-year Singapore Government Securities had risen rapidly from 1.9 per cent in February last year to 3.48 per cent in September, in response to central bank rate hikes around the world. But it has fallen since, to 2.97 in January this year.

That trend tracks the 10-year US Treasury yield, which rose above 4 per cent in October but is now at 3.82 per cent.

US Treasury yields typically rise in tandem with increases in the federal funds rate, as bond investors demand higher returns to beat what they can get with bank deposits.

Maybank’s head of fixed-income research Winson Phoon said long-term yields may be falling because investors are getting better visibility on when interest rates might peak.

While the Fed is not done with its tightening yet, Phoon said most of the repricing in US rates has likely already taken place.

Indeed, the Fed has slowed the pace of its rate hikes. Earlier this month, it announced a 25-basis-point hike at its Federal Open Market Committee (FOMC) meeting – bringing the US policy rate to between 4.5 and 4.75 per cent. In 2022, the Fed raised rates seven times, each time by between 50 and 75 basis points.

Noting that bond pricing is forward-looking, Phoon said investors in longer-term bonds are also likely attempting to price in growing concerns of over-tightening and a US recession. This is the most forceful rate hike cycle since the 1980s, Phoon added.

There had even been speculation, after the most recent FOMC meeting, that slowing growth would force the Fed to reduce rates this year. Futures markets were implying two rate cuts before the end of 2023.

Yet, there are indications that investors may have moved too early.

Bank of Singapore’s chief economist Mansoor Mohi-uddin noted that the US labour market remains too tight for the Fed to achieve its 2 per cent inflation target.

“We therefore remain concerned that it is too early for investors to forget about the risk of more Fed rate hikes, let alone to price in rate cuts this year,” he said.

Frances Cheung, rates strategist at OCBC, also noted that recent falls in yields “appear a bit excessive”, given that inflationary pressures remain. Cheung expects the yield curve will steepen as a normalisation process, as economic growth is likely to slow without reaching a recession.

Even as yields resume an upward trajectory, however, UOB’s Yong expects 10-year bond yields will end 2023 lower than where they began, as US monetary policy switches from a tightening cycle into an easing cycle in 2024.

Maybank’s Phoon also expects 10-year yields will fall further over the next six to nine months, as the impact of US recession risks on bond pricing has not played out in full yet.

Said Phoon: “Bond volatility will likely persist as there remain significant uncertainties on the path ahead for inflation and recession, with both driving yields in opposing directions.”