By Sarupya Ganguly
BENGALURU, March 11 (Reuters) - Benchmark U.S. Treasury yields will drift only slightly higher over coming months despite potential inflationary pressures sparked by the U.S.-Israel war against Iran, according to a Reuters poll of bond strategists who have barely changed their forecasts from last month.
Brent crude oil surged by almost 65% after the conflict started on the last day of February and is still more than 20% higher than levels seen immediately prior to that.
Despite early
expectations for a flight to safety into the bond market, the U.S. 10-year yield has climbed nearly 20 basis points over the same period to 4.16%, reversing a similar decline in yields in the immediate run-up to the war.
Euro zone government bonds and British gilt yields have also risen sharply as investors become less confident about further interest rate reductions from those central banks.
The U.S. Federal Reserve is still widely expected to cut rates twice this year, but several policymakers have expressed concerns that consumer price inflation was already elevated before the war.
"There's a good case to be made that markets are too optimistic about Fed rate cuts from the perspective of inflation that has been persistently above target," said Robert Tipp, chief investment strategist at PGIM Fixed Income.
"What we've seen since the pandemic is inflation is just a little more stubborn than people expect, and that's likely to continue."
Short-dated U.S. yields were forecast to fall modestly on those lingering expectations for more Fed rate cuts, while longer-dated yields were seen edging higher, in part reflecting concerns around heavy debt issuance over coming years, medians from the March 5-11 poll showed.
The rate-sensitive two-year yield will fall 13 bps to 3.47% in three months and further to 3.40% in six months, the poll showed.
The benchmark 10-year yield will trade around its current level at end-May before rising to 4.20% and 4.25% in six and 12 months, respectively.
LITTLE WORRY ABOUT ANOTHER YIELD SURGE
For now, strategists don't expect another big rise in yields.
"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," said Vishal Khanduja, head of broad markets fixed income at Morgan Stanley Investment Management, who expects 10-year Treasury yields to trade in a range between 3.75% and 4.25%.
About two-thirds of respondents, 19 of 30, said the U.S. yield curve would bear-steepen by the end of March, predicting long-term yields would rise faster than short-term ones.
"We still don't 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," Khanduja said.
The U.S. government reported a $1.78 trillion deficit last year.
A late-February U.S. Supreme Court ruling striking down key parts of President Donald Trump’s tariff plans has also rekindled some worries about additional borrowing requirements.
"Tariffs were one sustainable way the U.S. was showing some more signs of deficit reduction because it was direct hard-dollar revenue," Khanduja added. "Not having those...will bring the pressure back to the long end of the yield curve."
STRATEGISTS DIVIDED ON CORRECT INFLATION PRICING
About 41% of survey respondents, 15 of 37, said the 10-year yield was underpricing inflation expectations. Around 51% said the pricing was about right.
"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," said Luis Alvarado, co-head of global fixed income strategy at the Wells Fargo Investment Institute.
The term premium, or the compensation demanded by investors for holding longer-dated debt, has been elevated for a while, reflecting concerns over Treasury supply, central bank independence and inflation.
"The Treasury is attempting to fulfill its needs by issuing more short-term T-bills, and there's not a lot of appetite to increase notes and bonds on the longer end of the spectrum - the easy way out if you're not going to tackle fiscal spending," Alvarado added.
(Reporting by Sarupya Ganguly; Polling by Shaloo Shrivastava and Debrah Gomes; Editing by Ross Finley, Kirsten Donovan)
