US 10-Year Yields Forecast to Edge Higher After War Surge

Benchmark government bond yields in the United States are projected to drift only slightly higher in the coming months, according to a recent Reuters poll of bond strategists. Despite the potential for inflationary pressure stemming from the conflict involving Israel and Iran, market experts have maintained their forecasts from previous months. Since the outbreak of hostilities in late February, Brent Crude Oil has seen significant volatility, surging nearly 65% initially and remaining more than 20% above its pre-war levels.

The 10-year Treasury yield has climbed roughly 20 basis points to 4.16% during this period, reversing earlier declines. Similar trends are visible globally, with yields for government bonds in the Euro zone and the United Kingdom rising as investors question the timing of future interest rate cuts. While the Federal Reserve is still expected to implement two rate cuts this year, policymakers remain wary of consumer price inflation that was already trending high before the geopolitical escalation.

Robert Tipp, chief investment strategist at PGIM Fixed Income, suggested that market optimism regarding rate cuts may be misplaced given the persistence of inflation.

"What weve seen since the pandemic is inflation is just a little more stubborn than people expect, and thats likely to continue."

Short-dated yields are expected to see modest declines based on lingering hopes for Fed intervention, while longer-dated yields may rise due to concerns over significant debt issuance. The two-year yield is forecast to fall to 3.47% in three months, whereas the 10-year benchmark is expected to reach 4.20% in six months and 4.25% in one year. Vishal Khanduja, head of broad markets fixed income at Morgan Stanley Investment Management, believes the central bank will likely overlook the immediate impact of energy prices.

"As for inflation, we think the Fed will look through this transitory shock of oil that is showing up in the numbers or will show up in the numbers."

Strategists remain concerned about the lack of a clear plan for deficit control in the U.S., which reported a $1.78 trillion deficit last year. This fiscal environment is expected to maintain upward pressure on the long end of the yield curve. Khanduja noted that the absence of sustainable revenue sources, such as certain tariff plans recently struck down by the Supreme Court, adds to these pressures.

"We still dont have a sustainable and credible plan for deficit control here in the U.S., so that should show up fundamentally as a steepener bias within the Treasury curve."

Market participants, often referred to as bond vigilantes, appear skeptical of the Treasury's desire for lower long-term rates. Luis Alvarado, co-head of global fixed income strategy at the Wells Fargo & Company Investment Institute, pointed to the elevated term premium as a reflection of concerns over supply and fiscal spending.

"The Treasury has hinted they want lower long-term rates, but Mr. Market - bond vigilantes - are not buying that based on economic growth, inflation expectations and of course, the term premium."

Currently, the Treasury is meeting its funding needs by issuing more short-term T-bills, though there is limited appetite for increasing longer-term notes and bonds without addressing underlying fiscal spending issues.