Let’s cut right to the chase. With the Fed set to hike rates next year, Treasury yields are staying supportive for the time being – more so on the short-end of the curve.
But the question is, how much of those rate hikes have already been factored into the equation?
Fed fund futures have already fully priced in the first 25 bps rate hike by the Fed for May next year. Meanwhile, eurodollar futures suggest that the move could come either in May or June.
In any case, the baseline is set that the first rate hike will come by the middle of next year. That is pretty much what has been communicated to the bond market as well. As long as economic conditions allow for that to happen and more rate hikes to follow, there is a case for Treasury yields to trend higher still.
Adding to that is the tapering by the Fed, which will reduce demand for bonds in general. And on the supply side, Yellen & co. may still need to keep up with large issuances to finance public spending. That is also one argument that can be made for yields to rise.
So, where exactly can we expect yields to be headed next year?
The market consensus for now seems to be 10-year yields trending towards 1.8% to 2.0%. That’s entirely fair if economic expectations and the inflation/Fed outlook plays out as it should. But a lot of that hinges on pandemic-related developments and how much the Fed will stick to its word.
I reckon the short-end of the curve will see a more likely rise but the further flattening of the curve will certainly be something to eye.
As for the short-term outlook, I would say the technicals will do the talking:
10-year yields are stuck in a wedge and eventually, something’s gotta give. There might be points for talking up yields now but ultimately, the chart will decide what happens next.