- UBS said the 10-year Treasury yield should fall to 3.5% by the end of 2024.
- It is now down from about 4.3% as the Fed will likely cut rates two to three times next year.
- It said credit supply concerns would be managed due to high levels of bank reserves.
UBS said in a Friday note that the bond rally should continue through 2024, as debt markets get a boost from accommodative Federal Reserve monetary policy.
The 10-year Treasury yield should fall to 3.5% by the end of next year, from about 4.3% now, as the Fed implements two to three interest rate cuts.
Already, market expectations of a central bank pivot have boosted Treasury prices, partially reversing the massive selloff that began in 2020 and lasted through October. In fact, November has been the best performing month for US fixed-income since 1985, while global bonds are enjoying their best month since 2008.
“But despite this strong run, our view is that bonds could rise further next year,” UBS said.
UBS said that given the recent moderation in inflation and labor market softness, it is likely that the Fed has reached the end of its hiking cycle. The decline in excess savings should continue to weigh on inflation next year, allowing the Fed to lower rates.
While markets are predicting the possibility that Fed rate cuts could begin in March, UBS has predicted that they will likely begin in July. Additionally, the decline in yields may not be sustained, especially since Fed officials have recently sent mixed signals about monetary policy improvements.
For example, while some officials have called for an accommodative outlook, New York Fed President John Williams said Thursday that rates could remain restrictive for longer, pushing 10-year yields higher.
Meanwhile, other bond market concerns may also return, such as concerns about a flood of new Treasury issuances.
Term premiums – or the additional compensation investors expect for holding assets – surged this year due to increased loan supply, as buyers balked at the rising federal deficit. Some auctions have also seen a decline in demand for Treasuries in recent months.
“The biggest risk to the market is a failed bond auction, where the Treasury receives bids lower than the face value of the securities it wants to sell,” UBS warned.
But this is unlikely, it said, should future credit supply concerns be managed. That’s because bank reserves have remained stable, despite earlier warnings that the Fed’s continued reduction of its balance sheet would drain them of their liquidity. This allows dealers to continue acting as buyers in weak auctions.
Meanwhile, UBS also expects the Fed to intervene in the bond market if necessary to restore stability.
“Therefore, we continue to recommend high quality (especially high grade/government and investment grade) bonds with a tenor of 1-10 years, especially the five-year segment,” the note said.