Our US Treasuries outlook for 2021
We expect 2021 to be divided into two distinct parts for US Treasuries. During the first half of the year, market participants’ attention will likely focus on the covid-19 vaccine rollout in the US. In our central scenario (65% probability), we expect an effective roll-out to allow policy makers to lift restrictions fully by Q2. This should lead to a gradual return to normality, with economic data improving meaningfully in the second half of next year.
Market participants will begin to anticipate economic recovery as soon as Q1 as vaccination gathers pace. An improved macroeconomic outlook at the same time as accommodative US Federal Reserve (Fed) policy often translates into a rise in long-term inflation expectations. Hence, we would expect the 10-year inflation breakeven rate to move above 2%. However, the 10-year US Treasury yield may not go significantly above 1% in the first half, as we would expect the Fed to indirectly intervene to push the 10-year real yield even further into negative territory.
By contrast, in the second half of 2021 better economic data coupled with some loosening of the Fed’s grip on long-term Treasury yields through quantitative easing (QE) could lift the 10-year nominal yield towards 1.3% by year end, driven by a build-up of the term premium and hence a rise in the 10-year real yield to -0.7%. Overall, we expect the US 10-year nominal yield to remain in its current range of 0.7-1% in the first half, moving decisively above 1% only in the second half, but still remaining in the historically low range of 1-1.4%.