Stuck in a low-yield environment
We remain neutral on US Treasuries, recognising their safe-haven status, while seeing limited scope for a further fall in yields in our central scenario. In this scenario (to which we assign a 60 % probability). we expect US Treasury yields to remain stuck at low levels, probably well into 2021, in to light of Federal Reserve asset purchases and forward guidance. We also expect the 10-year US Treasury yield to stay low (in a range of 0.6–0.9% in H2), with a year-end forecast of 0.9% (down from a previous forecast of 1.4%). Rising confidence about a US economic recovery in 2021 could lead the Fed to taper its asset purchases next year, while making clear that rate hikes are still a long way off. This should lead to rises both in long-term inflation expectations and the 10-year TIPS yield.
For this year, however, our central scenario is for the Fed to increase quantitative-easing measures in September and to stand ready to increase its purchases of long-term US Treasuries should their yields rise too fast. We would expect the Fed to step in to ensure that any spikes in the 10-year yield above 1% in H2 are short lived. The development of a vaccine against covid-19 or a bold fiscal stimulus package following a November presidential election that gives the US president full control of Congress could cause such spikes.
Should the Democrats take control of the White House and both houses of Congress, we would probably see more propensity towards Modern Monetary Thinking, which could lead to explicit yield curve control (probably at the short end of the curve first) as soon as 2021. This eventuality is encompassed in our alternative negative scenario (probability of 30%), which would see the 10-year yield remaining in an even lower range of 0.2–0.5%, with a year-end forecast of 0.5%. This scenario could also come into play should a second wave of covid-19 strongly derail the economic recovery in H2 or if a re-elected President Trump enters a full-blown trade war with China, frustrated by Democrats control of the House of Representatives.
Finally, our positive scenario (10% probability) foresees a stronger US economic recovery as we move into 2021, potentially due to a vaccine and a fiscal stimulus aimed at infrastructure spending (contributing to improved US productivity over the longer term). In this scenario, we could envisage a sharp rebound in inflation expectations that sees the yield hit 1.5% by the end of the year.
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