How high could U.S. Treasury yields rise this year?
On the latest edition of Market Week in Review, Investment Strategist Alex Cousley and Head of Portfolio & Business Consulting Sophie Antal Gilbert discussed the outlook for U.S. government bond yields, market reaction to U.S. President Joe Biden’s infrastructure plan and the economic growth outlook for China.
U.S. interest rates may be nearing peak levels for 2021
Long–term interest rates, which have been rising in many developed countries since the start of the year, fluctuated a bit the week of March 29, Cousley noted. “Yields on government bonds in both the U.S. and Germany rose for the first few days of the week, before falling in the latter part, ending the week up slightly,” he remarked.
U.S. government bond yields, which have climbed sharply since January, are probably nearing their peaks for the year, Cousley said, noting that he expects the benchmark 10–year U.S. Treasury note to trade between 1.5% to 2.0% through the end of 2021. “Some volatility in Treasury yields appears likely as markets continue to digest the economic reopening—but as discussed in our just–released Q2 Global Market Outlook, we believe there is an upside cap to how high rates are likely to rise this year,” he stated. One of the main reasons for this, Cousley explained, is that the U.S. Federal Reserve (the Fed) is unlikely to raise short–term rates for at least two years, due to its new average inflation targeting approach.
He noted that in areas outside the U.S., such as in Europe and Japan, yield curves haven’t steepened as much, mainly due to more aggressive central bank policies that maintain some control over long–term rates. However, Cousley does expect European bond yields in particular to increase a bit as the economic recovery accelerates and the region’s vaccine rollout improves.
Key takeaways from Biden’s infrastructure plan
Turning back to the U.S., Cousley said that market reaction to the official unveiling of President Biden’s US$2.3 trillion infrastructure plan was a bit interesting. “The benchmark S&P 500® Index actually topped 4,000 for the first time ever, one day after details of the package were announced,” he remarked.
The Biden administration plans to fund the infrastructure plan through tax increases, Cousley explained, including by raising the corporate tax rate from 21% to 28%. He noted that this increase would amount to unwinding roughly half of the corporate tax cuts passed by Congress in late 2017. “Prior to the Tax Cuts and Jobs Act, the tax rate for corporations was 35%,” he said.
One of the key takeaways in the wake of the bill’s unveiling, Cousley stressed, is that several rounds of negotiations among members of Congress are likely—especially when it comes to the funding of the plan. “There are some individuals in the Democratic Party who are a bit hesitant to increase tax rates, so expect more discussion around this over the next several weeks,” he stated.
Strong growth outlook for China
Switching to China, Cousley said that the outlook for the world’s second–largest economy remains quite positive. PMI (purchasing managers’ index) surveys conducted after the country’s Lunar New Year celebrations in February indicate strong growth in both manufacturing and services, he noted, even when accounting for seasonality.
“The most encouraging part of these reports is that forward–looking data points, such as new orders and new export orders, came in even stronger than expected,” Cousley noted, adding that the broader global reopening appears to be benefiting Chinese manufacturers.
Given the nation’s strong recovery from the COVID–19 crisis, he expects China to begin policy tightening this year, but emphasized that the transition is likely to be gradual. “I believe that authorities will be sensitive to any economic volatility that crops up in the data, and will likely pare back on tightening if this becomes the case,” Cousley concluded.