NEW YORK, Feb 23 (Reuters) - Bank of America has raised its expected yield on the U.S. government benchmark note for this year to 3.25 percent, driven by increased economic growth and a rapidly expanding supply of U.S. debt.
President Donald Trump’s tax overhaul and budget deal are expected to add more than $1.5 billion to the federal deficit. Add that to the Federal Reserve’s plan to slow their bond buying to reduce their $4.4 trillion balance sheet, and the U.S. Treasury will need to double its borrowing to $1 trillion in both this fiscal year and the next to fund the fiscal and monetary endeavors, according to a report released Friday by BofA Merrill Lynch Global Research.
With yields currently above their initial target of 2.85 percent, the bank raised its expectations, arguing that demand for U.S. debt would not be enough to make up for the increased supply. While they expect to see continued appetite from foreign central banks and pension funds, demand from private foreign institutions and domestic banks was expected to shrink compared with past years.
Not everyone was convinced. Arguing that rates did not have much additional room to reprice, Edward Al-Hussainy, senior interest rate and currency analyst at Columbia Threadneedle in Minneapolis said: “I think that what’s happening at least from a market psychology perspective, is that we want to test 3 percent.”
Beyond that, the market would need new narratives in order to move higher or lower. “Positioning in U.S. Treasuries is stretched short, and I suspect that more upside to yields will be limited while that consensus position persists,” said Al-Hussainy.
The report also said that the bank had changed its view the yield curve would steepen in 2018, and now believes that the spread between 5-year and 30-year yields would shrink. Improved pension funded status was expected to increase demand for 30-year bonds, raising prices and tamping down yields, while the Fed is set to continue raising interest rates given recent evidence of rising inflation, propping up the short end of the curve.
The yield on the 10-year Treasury was last at 2.888 percent, slightly down from a four-year high of 2.957 percent hit on Feb. 21. (Reporting by Kate Duguid; Editing by Jonathan Oatis)