Wall Street, despite the uncertainty surrounding President-elect Donald Trump’s trade and tax policy, is aligning itself with the Federal Reserve’s outlook. They anticipate a decline in US Treasury short-term yields by 2025.
This consensus view suggests investors are primarily focused upon the Fed’s policy on interest rates, and expect a decrease in the yields, even though the future economic outlook remains somewhat clouded.
Short-term yields are expected to drop
The forecasts of strategists are mostly in agreement that the yield on the two-year Treasury notes will decrease, as it is highly sensitive to the Fed’s interest rate decisions.
They predict a drop of at least a half-point from current levels in the next 12 month.
According to David Kelly and his team at JPMorgan Asset Management, “While investors will likely be myopically focusing on the pace and the magnitude of rate reductions next year, investors should step back and realize that the Fed will still be in cutting mode by 2025.”
This view suggests that there is a general expectation that the Fed would continue its easing cycles, even if they are slower than some may desire.
The Fed’s Signal and a Shifting Yield Curve
The Fed’s recent signal that it would be cutting rates less often adds another layer of complexity to the outlook.
The median view of Fed officials suggests a half-point rate cut in 2025. This aligns with Wall Street’s forecast of two-year yields but also highlights the risks of a pause to the central bank’s easing cycle.
The yield curve steepened sharply on Thursday, reaching its highest level since June 2022 as investors reassessed the positions they held in longer-dated bonds.
Tracey Manzi is a senior investment analyst at Raymond James. She noted that the curve’s front-end will follow the outlook of a shallower easing. The long-end will lead any steepening we see.
Forecasts by strategists
The median forecast of 12 strategists is that the yield on 2-year notes will drop by approximately 50 basis point to 3.75% in a year, after climbing almost 10 basis points since Wednesday’s updated economic predictions from the Fed.
Strategists expect that the yield on longer-term 10-year Treasuries will end 2025 at around 4.25%, a 25 basis point decrease from current levels.
Noel Dixon is a macro-strategist at State Street. He says that “however you slice it… whether it’s inflation expectations, real growth or term premias, the long end will be under pressure.” Dixon also predicts that 10-year yields may rise above 5% by 2025.
These projections are based on a combination fiscal policy uncertainties and Fed management of its Treasury holdings.
The central bank could stop its balance sheet unwinding, or quantitative tightening. This would reduce the bond supply and increase demand. As the Barclays team headed by Anshul pradhan wrote in their note, “Even though the Fed will likely continue to lower the policy rate and pull front-end yields down, many of those forces that argue for higher long-term yields are still in play: a high rate neutral, elevated rate volatility and a large net issuance amid a price-sensitive market.”
Trump’s policies & divergent outlooks
These market forecasts could be affected by the uncertainty surrounding Trump’s tax and tariff policies.
According to Pradhan “Higher tariffs, tighter immigration controls and slower growth argue for higher inflation” which could further complicate market outlook.
Ira F. Jersey, a strategist at Bloomberg Intelligence, and Will Hoffman stated that a steady-state economy in 2025 could cause the Federal Reserve’s interest rates to be cut slowly, possibly to only 4% above the upper bound. It may take a major shift in the economy for the 10-year Treasury to not hover between 3,8% and 4,7%.
Morgan Stanley and Deutsche Bank have the most divergent perspectives of the bond market.
Morgan Stanley predicts an “unexpected bear market” and a faster pace of Fed rate reductions, predicting the 10-year yield to fall to 3.55% in December next year.
Deutsche Bank, on the other hand, forecasts that there will be no Fed cuts until 2025. They expect the 10-year yields to rise to 4.65% citing high growth, low unemployment and sticky inflation.
As a team led by Matthew Raskin at Deutsche Bank noted, “We expect that the main catalyst for this view will be a realization of inflation and labor market conditions that warrant a more restricted Fed path than is currently priced.”
This post Wall Street’s bets on lower bonds yields in 2025 aligned with Fed’s Outlook may be modified as new developments unfold.
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