Let’s get right to the point. As the Fed prepares to hike rates next year, Treasury yields remain favorable for now, especially on the short end of the curve.
But the question is, how many of those rate hikes have already been factored into the equation?
Fed funds futures have already fully captured the price of the Fed’s first 25bp rate hike for May of next year. Meanwhile, Eurodollar futures suggest the move could take place in May or June.
Either way, the baseline scenario is that the first rate hike will occur in the middle of next year. That’s pretty much what was communicated to the bond market as well. As long as economic conditions allow this to happen and more rate hikes follow, there are reasons for Treasury yields to trend even higher.
Added to this is the Fed’s tapering, which will reduce demand for bonds in general. And on the supply side, Yellen & co. may still have to deal with major issues to finance public spending. It is also an argument that can be made for yields to increase.
So where exactly can we expect returns to head next year?
Market consensus for the moment 10-year rates seem to be trending towards 1.8% to 2.0%. It is quite fair if economic expectations and the inflation / Fed outlook are going as they should. But much of that depends on developments related to the pandemic and how well the Fed will deliver on its word.
I think the short end of the curve will experience a more likely rise, but the further flattening of the curve will definitely be something to see.
As for the short term outlook, I would say the techniques will talk:
The 10-year yields are stuck in a corner and eventually something has to give. There might be points to talk about returns now, but ultimately the chart will decide what happens next.