Sizable deviations remain between our modelled (comprising of three different models with differing independent variables and timeframes) and tactual 10Y US Treasury yield even after the recent decline in yields. We think that elevated yields is probably a function of increased IG issuances in the US over the past few months that led to some crowding out of Treasuries (investors demanding higher yield). Considerable optimism in the markets on the AI build out had also led to the curve being steeper than it otherwise would have been in a Fed tightening cycle. We suspect that this gap would close only if IG issuances slow and economic optimism gets deflated.
That said, we note that dynamics have shifted somewhat over the past week amidst as investors begin to question the AI narrative. As stocks corrected, there was a meaningful bid to USTs as investors sought safety.
At this point, we reckon that the UST rally would need a pause. 30Y yields are already down more than 20bps since the early part of October, with the bulk of the adjustment taking place over the past week. Meanwhile, we are not convinced that there is imminent downside to shorter-term yields given that inflation figures (especially PPI) came in hotter than expected. A couple more Fed hikes remain our base case, and we would not really argue with the market pricing in of about 3 hikes currently. Risks to yields are balanced at this point.
Forecast changes
We have extended our forecasts to 2028.
- PHP Rates: Rates have been recentered.
- IDR Rates: Rates have been adjusted higher as we now see a higher terminal rate for BI in this cycle.
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