The yield on the U.S. 10-year Treasury note, which stands near a 16-year high, is likely to fall significantly for the rest of the year and in 2024, according to economists at Capital Economics.
Rising treasury yields have recently put pressure on U.S. stocks, as investors expect interest rates to stay elevated for longer.
The yield on the 10-year Treasury BX:TMUBMUSD10Y was marginally lower at 4.257% on Friday versus Thursday’s 3 p.m. level of 4.260%. It reached as high as 4.339% in August, the loftiest level since 2007, according to Dow Jones market data.
Traders are pricing in an over 90% chance that the Federal Reserve may keep its benchmark interest rate steady in September, and a 42% chance that it will raise the interest rate one more time by the end of the year. They are pricing in a 38% likelihood that the central bank will keep the policy rate at its current range of 5.25% to 5.5% until June next year, according to CME’s FedWatch tool.
However, Diana Lovanel, markets economist at Capital Economics, said she doesn’t think continued disinflation can only be achieved by central banks keeping their policy rates elevated for longer. “We don’t think a period of much slower growth is necessary for inflation to get all the way back to the Fed’s target,” Lovanel wrote in a Friday note.
Disinflation is likely to continue in the U.S. and the inflation rate is expected to fall to close to the Fed’s 2% target in the next twelve months, according to Lovanel.
The labor market has been normalizing, which could bring wage pressure back to a level consistent with the 2% inflation rate, she wrote. Cooling rents could also drag down the inflation rate in the U.S., noted Lovanel.
These moves suggest that the Fed will loosen its monetary policy by more than investors currently expect and it could result in a decline of Treasury yields over the rest of this year and next year, according to Lovanel.
John Higgins, chief markets economist at Capital Economics, said he expects the Fed to cut its policy rate by up to 200 basis points in 2024, twice as much as the 100 basis points discount investors are currently pricing in.
Still, the long-run level of the federal funds rate is likely to be higher in the future than in the 2010s, as artificial intelligence and other factors drive up the equilibrium real interest rates, wrote Higgins.