The US bond market continues its volatile performance in 2024, with Treasury yields recently reaching four-week highs. However, despite the near-term strength, strategists at UBS believe bond yields are likely to end the year lower, due to several macroeconomic factors.
Primarily, inflation in the United States is among the main catalysts affecting bond yields. According to the latest data from the Federal Housing Finance Agency, US home prices rose just 0.1% on a monthly basis in March, down from a 1.2% rise in February. On an annual basis, prices rose by 6.7% in March, compared to 7.1% in February.
According to UBS, the housing market decline and slowing price trend in new leases point to a further deceleration in inflation.
“The hard data continues to indicate that inflation should trend lower for the rest of this year after the encouraging reading in April,” they noted.
The Federal Reserve's monetary policy is another critical factor that may contribute to lower bond yields. While Minneapolis Fed President Neel Kashkari noted that further rate hikes have not been ruled out yet, the overall tone from the Fed remains patient.
Kashkari said the odds of the Fed raising interest rates are “very low,” in line with the Fed's recent communications and Chairman Jerome Powell's view that the central bank's next move is unlikely to be a hike.
“With the labor market weak and economic growth slowing, we continue to expect the Fed to begin easing policy in September, with a total of 50 basis points of interest rate cuts this year,” the strategists wrote.
Additionally, the UBS team believes the pace of runoffs on the Fed's balance sheet is set to slow. Starting next month, the Fed intends to slow its quantitative tightening efforts, reducing the monthly limit on the sale of US Treasuries from $60 billion to $25 billion.
This decline in the QT period is likely to reduce upward pressure on real interest rates, contributing to lower bond yields.
“We believe this would reduce upward pressure on real interest rates and drive the next move lower in yields,” UBS continued.
Growth in the US economy is another factor that will have an impact. As UBS highlighted, the world's largest economy is showing signs of slowing, with a sluggish labor market and declining economic momentum, further supporting the case for lower yields as investors look for safer assets amid economic uncertainty.
“We continue to believe that US sovereign bond yields should end the year lower as inflation and economic growth slow and the Fed cuts interest rates in the final months of the year,” the strategists said in the note.
“We expect the 10-year US Treasury yield to decline towards 3.85% as the year progresses, supporting our preferred view on fixed income,” they added.