Arif Husain, the head of fixed income at T. Rowe Price, recently made headlines with a bold prediction about U.S. Treasury yields. He pointed out that due to rising inflation expectations and concerns surrounding U.S. government spending, the yield on 10-year Treasury bonds could potentially climb towards 5% in the next six months.
In a brief commentary, Husain highlighted, “The yield on the 10-year Treasury is likely to test the 5% threshold in the coming months, resulting in a steeper yield curve.” He suggested that a modest interest rate cut by the Federal Reserve (Fed) could be the quickest path to achieving that 5% mark.
This forecast stands in stark contrast to market expectations, which have leaned towards declining yields following the Fed’s first rate cut in four years last month. However, strong economic data continues to raise questions about the pace of future cuts, intensifying debates about the direction of the world’s largest bond market.
The last time the U.S. 10-year Treasury yield reached 5% was in October of last year, marking the highest level since 2007, amid concerns about prolonged high-interest rates. If Husain’s predictions come to fruition, it could lead to a significant reevaluation in the markets, as strategists currently expect yields to drop to around 3.67% by the second quarter of next year.
As of Monday, the yield on the U.S. 10-year Treasury was hovering at 4.08%.
With nearly 30 years of market experience, Husain observed that the U.S. Treasury is continually issuing bonds to finance government deficits, which is flooding the market with new supply. At the same time, the Fed’s quantitative tightening—reducing its balance sheet after years of bond purchases—has curtailed a significant source of demand for Treasuries.
Husain, who oversees T. Rowe Price’s fixed income division, explained that rising short-term Treasury yields may be constrained by the potential for rate cuts, leading to a steeper yield curve.
His insights resonate particularly in light of the increasing strains on U.S. finances. By September, the cost of servicing U.S. debt had surged to its highest level since the 1990s. Notably, neither former President Trump nor Vice President Kamala Harris have prioritized deficit reduction in their campaign platforms, highlighting the significant risk that government debt poses to market participants.
Husain believes that the most likely scenario for the Fed involves a series of small rate cuts, akin to those seen between 1995 and 1998. In such a scenario, he anticipates that China would introduce additional stimulus measures to invigorate its economy, fostering global growth and clarifying the Fed’s decision-making path.
However, he also entertained the possibility of a more conventional easing cycle, where the Fed could lower rates closer to neutral levels, which he estimates might be around 3%. Additionally, he considered the potential for a U.S. recession, which could trigger more aggressive rate cuts.
Husain concluded, “Investors who, like me, believe a recession is unlikely in the near term should prepare for higher long-term Treasury yields.”
