US: 10-year Treasury yield to rise a bit further driven by higher inflation compensation – CE

The 10-year US Treasury yield has risen by ~25bp so far this year. With a large fiscal stimulus package looking increasingly probable in the US, and the Fed unlikely to push back on higher inflation expectations, economists at Capital Economics think the yield of 10-year US Treasuries may rise a little further. 

Key quotes

“Fed policy will keep a lid on the real yield. We think the Fed will tighten monetary policy only very slowly, even if the economy recovers quite rapidly, in order to achieve its new goal of a period of sustained above-target inflation.”

“Inflation compensation could rise further still. The economic outlook has improved a bit lately. The vaccination rollout has begun relatively smoothly. And the outcome of the Georgia Senate runoff elections increased the chances of a significant fiscal boost to the economy. All of this increases the prospects of a more rapid recovery, and higher inflation, this year.”

“We doubt the Fed would push back on somewhat higher inflation compensation, either. In fact, it would probably welcome it.”

“We expect the 10-year US Treasury yield to rise a bit further over the next two years, driven by higher inflation compensation. We have revised our end-2021 and end-2022 forecasts for the Treasury yield to 1.50% and 1.75%, respectively.”

“The changes to our forecasts for 10-year government bond yields also affect our views of certain exchange rates. We have revised our end-2022 forecasts for EUR/USD and USD/JPY to 1.25 (from 1.30) and 100 (from 95), respectively.”