The yield on the benchmark 10-year Treasury note will fly past 3 percent this year, a key technical and psychological level, according to Bank of America Merrill Lynch.
Strategists at the bank now forecast the 10-year yield at 3.25 percent by year’s end, roughly 35 basis points above its current level.
“Our thesis was that rates were set to rise as a result of improved growth and inflation via tax reform as well as a worsening supply picture. The market has caught up with our view and we continue to believe rates can reprice higher,” wrote Mark Cabana, a rates strategist at Bank of America. “We now expect the 10-year rate to reach 3.25 percent by the end of the year driven by above-potential growth and a worsening supply-demand dynamic.”
Treasurys stole the limelight on Wall Street earlier in February, with rising rates blamed for a brief 10 percent slide in the Dow Jones industrial average and the S&P 500. But the attention on fixed income remains as the yield on several notes float near multiyear highs.
On the supply side, Cabana noted that the U.S. Treasury Department’s borrowing needs will nearly double versus last year and amount to more than $1 trillion in each of the next two fiscal years due to aggressive fiscal spending. And while Treasurys saw some buying Friday, Cabana isn’t optimistic that there will be enough appetite to offset the flood of incoming debt.
“We expect 2018 to see lower demand from foreign private and domestic banks compared to the past few years,” the strategist wrote. “While this will likely be partially offset by foreign official and pension buying, we think rates will need to rise to attract sufficient demand.”
The yield on the U.S. 10-year note briefly touched a four-year high of 2.95 percent Wednesday following the release of the Federal Open Market Committee’s latest meeting minutes, which revealed that central bankers were confident inflation was on track to hit their 2 percent target.
The Federal Reserve is also winding down its own debt portfolio and is unlikely to increase its own purchasing in the near term, a potential bane for bonds.
“If you breach 2.95 percent, then the technicals will tell you that 3 percent is a forgone conclusion,” said Kevin Giddis, head of fixed-income capital markets at Raymond James.
“The FOMC minutes seemed to put the Fed’s view into perspective, and with every Fed speech, this is being reinforced,” Giddis added. “Concern about inflation, yes. Concern about runaway inflation and growth, not likely.”