The US 10yr Heads Back to 4%, But then it’s 5%+ for 2025

Central Bank

Economic

Summary:

Front-end yields can get lower and remain low, but will still end up at least 50bp above what we see as neutral (2yr at 3.3% is neutral). The 10yr yield is ending 2024 below neutral, but will revert to above neutral by around 50bp to 100bp as we progress through 2025 (10yr at 4% to 4.5% is neutral). The 2yr trends around 4% while the 10yr heads for 5%+ in 2025.

The US 10yr should settle above neutrality, heading for 5%+

US market rates reached local highs following Trump’s win but have been drifting lower since. A significant retracement is appropriate after the nearly 100bp rise in the 10yr yield, which was triggered by the first Fed rate cut in mid-September. This move culminated in Trump’s clean sweep in the November elections. But as we pushed through December, we returned to basic data watching. To the extent that if the data softens, there is justification for testing lower yields.

Another factor is the end-of-year effect. It's not uncommon for bonds to do well into the turn of the year. Cash is often parked as risk trades are wound down to some extent. January is often a month in which liquidity comes back into the market, acting to help all types of bond products. That said, we identify a floor at 4% for both the 2yr and the 10yr yield. The rationale for the 4% floor centres on the market discount for the funds rate, which is only just under 4% by late 2025 (now around 3.75%).

As we progress through 2025, our vision is for the US 10yr Treasury yield to head toward the 5-5.5% range. Today a 4% SOFR rate coincides with a 4.5% 10yr Treasury yield (50bp spread vs SOFR), and 4.5% was the average Treasury yield seen during the noughties. We find this relevant as during this decade, US inflation averaged 2.5% and the Fed funds rate averaged 3%, which smacks of an equilibrium (on average).

The noughties as a neutral reference?

The difference between the 2yr and the 10yr is that the latter is far too low

Trump's tax-cutting agenda likely means the Federal Reserve lands above neutrality by some 50bp. Specifically, at 3.50%-3.75%. We also think the 10yr rate should end up above neutral. Given the inflation risk from tariffs and issues relating to the fiscal deficit, logic suggests that the 10yr rates should land at least 50bp north of neutrality. The 5-5.5% range translates to 50-100bp above a neutral 10yr yield, and translates to 10yr SOFR getting to at least 4.5%.

When we look to the front end, we find that the 2yr Treasury yield averaged 3.3% during the noughties, effectively at a 30bp spread over the funds rate. Currently, the 2yr yield trades some 40bp through the effective funds rate. If, as we expect, the Fed cuts by 100bp and nothing else happens, that would pitch the funds rate at 60bp through the 2yr yield. Based on that, there is some room for the 2yr yield to test lower, likely to the 4% area. And there is scope to dip below 4%, even if briefly.

The difference between the 2yr yield and the 10yr yield is that the 2yr yield is more likely to be held down by the pull of the funds rate as it dips below 4% and likely stays there as a theme for a decent chunk of 2025. In contrast, if the 10yr yield gets down to 4%, it’s unlikely to stay there. It’s far more likely to get pulled higher, up to the 5-5.5% area, partly on a pull from deficit pressure. That can be negated to the extent that the Trump administration manages to take action on it. It remains to be seen.

Deficit pressure, tax cuts and tariffs are all issues for longer rates to worry about

Even if the deficit pressure is reduced (and we won’t assume this just yet), the rates market will still have to contend with the impact of a tax-cutting agenda to be legislated in 2025, taking effect from 2026. On top of that is the threatened implementation of tariffs, whose effect on prices would be a thing through the second half of 2025 and 2026. We view 2026 as being closer to a 3% inflation environment than a 2% one based on this.

Currently, we have a 2% real 10yr yield. On top of that, there's a 3% inflation risk and that brings the nominal 10yr yield to 5%. Then bear in mind that the 10yr real yield averaged 2.3% during the noughties (our preferred neutral reference), and that adds another 30bp to our 10yr yield. Hence the 5% to 5.5% range.

The direction of travel for the funds rate beyond the bottoming process envisaged is a tad opaque. Normally, a bottom in the funds rate would mean just that, a bottoming. And that would mean the next move is up. The markets will likely view it this way until or unless there is a material impulse in the other direction. At this juncture, we don’t have enough policy clarity to develop a conviction view in either direction. No doubt this will evolve as we progress through 2025.

We like structural fixed-rate payers and short duration positioning for 2025

In the meantime, the call is for the 10yr yield to touch 4% around the turn of the year, but then to target 5% to 5.5% as we progress through 2025. And for the 2yr yield to hit 4% but then to retrace back up towards 4.5%. The implied curve hits 100bp. This applies to the 2/10yr Treasury curve, and the Fed funds to 10yr SOFR curve, as the 10yr SOFR rate ultimately heads to 4.5%. Based on that and our neutral references, we like structural fixed-rate payers and short-duration positioning for 2025.

Source:ING

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Justin

Commodity

Gold (XAU/USD) is hesitating on Wednesday after having rallied about 2.5% over the previous three days. The precious metal has been capped at the $2,700 round level during the early Asian session, with investors reluctant to bet against the US Dollar (USD) ahead of the release of the US Consumer Prices Index (CPI) reading at 13:30 GMT.

Price pressures in the United States are expected to have remained sticky in November, with headline inflation picking up. While the data is unlikely to deter the Federal Reserve (Fed) from cutting rates by 25 basis points (bps) next week, it might limit the scope of the easing cycle heading into 2025.

Beyond that, the situation in the Middle East remains uncertain. The Syrian rebels have appointed a prime minister for a transitional government while Israel has stepped up its attacks on the Syrian army’s facilities. Ongoing tensions in the area are buoying safe-haven flows into Gold.

Daily digest market movers: Gold rally stalls as US Dollar firms up

US consumer prices are expected to confirm that inflation remains sticky above the Fed’s 2% target rate. The headline CPI is seen growing by 0.3% in the month and by 2.7% yearly, faster than the 0.2% and 2.6% increases seen in October. The core CPI is expected to have increased at a steady 0.3% monthly and at a 3.3% yearly pace.

The CME Group’s Fed Watch Tool shows that futures markets are pricing an 86% chance of a 25 bps Fed cut after the December 17-18 meeting, and between two to three more cuts in 2025.

In Syria, the rebels have appointed the Islamist Mohammed al-Bashir as the transitional prime minister. The US and Israel have been attacking the infrastructure of the Islamic State and Syrian army bases. There is a tense calm but uncertainty about the success of the provisional government remains high.

Later today, the Bank of Canada (BoC) is expected to deliver a second consecutive 50 bps cut. The Swiss National Bank (SNB) and the European Central Bank (ECB) are expected to cut their respective benchmark rates by a quarter-percentage point on Thursday.

Technical analysis: XAU/USD consolidates gains right below $2,700

Gold’s recent rally has lost some steam, with US Treasury yields bouncing up and the US Dollar appreciating ahead of the US CPI release. The broader trend, however, remains positive, with downside attempts limited above the top of the last two week’s previous range at $2,675.Above the mentioned $2,700, the November 24 high at $2,720 will come into view ahead of the November 4,5 and 6 highs at around $2,750.

On the downside, immediate support is the intra-day low at $2,675 and then the December 9 low at $2,630, followed by the channel bottom (November 26 and December 5 lows) at $2,610.

Source: FXSTREET

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Devin

Economic

Central Bank

Chinese top leadership surprised the market Monday by signaling a shift in its monetary policy stance after 14 years, indicating the economic challenges facing the country are quite entrenched, yet an outsized stimulus is unlikely, according to experts.

China is looking to switch its policy stance next year to “moderately loose” from “prudent” — a phrase they haven’t used since the depths of the global financial crisis in 2008, when they loosened the stance and stuck with it until 2010.

This is the first time the current leadership has acknowledged that monetary policy should be loose, setting the stage for “a new monetary easing cycle,” said Larry Hu, chief economist at Macquarie.

“Such a tone suggests that policymakers are deeply concerned about the economic outlook, given the sluggish domestic demand and the threat of another trade war,” Hu added.

Despite a flurry of stimulus measures since late September, recent economic indicators have showed the world’s second-largest economy is still struggling with deflationary pressures, amid tepid consumer demand and a prolonged housing downturn.

“Potential monetary easing leeway is much more limited than 15 years ago,” said Tao Wang, head of Asia economics and chief China economist at UBS Investment Bank, who expects “over 50 basis points policy rate cut” over the course of next two years.

Policy shift

Chinese government had unleashed a “historically large monetary stimulus in response to the global financial crisis,” Gabriel Wildau, managing director of Teneo said.

Beijing had announced a 4 trillion yuan ($586 billion) package in November 2008 — which was about 13% of China’s GDP at the time — to sustain growth and wean off the impact of the worst global economic downturn in over 70 years.

When the authorities adopted the “moderately loose” policy stance in 2008, the People’s Bank of China cut its benchmark 1-year lending rate by a total of 156 basis points and the cash reserves ratio by 1.5 percentage points during the easing cycle, Ming Ming, a former official at the PBOC monetary policy department, told state-backed media Economic Observer.

Last month, China unveiled a five-year stimulus package totaling 10 trillion yuan to tackle local government debt problems, while indicating more economic support would follow next year. That was just about 2.5% of China’s annual GDP, Ting Lu, chief China economist at Nomura, said in October.

The debt swap program needs to be significantly scaled up to offset the local government financial vehicle debt, which was nearly half of the size of country’s GDP, economists at Morgan Stanley said.

Morgan Stanley expects the central government fiscal deficit to widen by 1.4 percentage point next year, as the government borrows more to shore up the economy. China has kept its central government deficit target at 3% this year.

PBOC constraints

The PBOC has been cutting key interest rates since late September, after the U.S. Federal Reserve’s started its easing cycle with a large 50-basis-point cut in mid-September.

U.S. Fed rate cuts offered room for China to lower its domestic borrowing costs without prompting a sharp decline in Chinese yuan. However, the PBOC has held back from more aggressive rate cuts over concerns of potential capital flight, if the gap between Chinese rates and those elsewhere grows wider.

Securing the growth momentum would have higher priority than stabilizing the exchange rate.

The tone from Monday’s Politburo meeting reinforced market’s expectation that the PBOC will likely cut key interest rates by 40 to 50 basis points to close to 1%, towards the end of 2025, said Ju Wang, head of Greater China FX & rates strategy at BNP Paribas said in a note on Tuesday.

Bets on further rate cuts have fueled a prolonged rally in Chinese government bonds, pushing the 10-year benchmark yield to record lows on Tuesday.

While monetary easing might put depreciation pressure on the Chinese yuan, “securing the [economic] growth momentum would have higher priority than stabilizing the exchange rate,” Bruce Pang, chief economist of Greater China at JLL told CNBC.

Pang expects the central bank to cut the reserve requirement ratio, or RRR, a key lever to adjust liquidity, within a month.

Not a ‘bazooka’

More details on Beijing’s macro policy plans will be revealed at the annual economic work conference, that is reportedly underway and will end Thursday, UBS’ Wang added.

That said, most of the key policy targets and details of stimulus measures will only be announced at the National People’s Congress next March, she added.

Investors and economists are watching for any concrete policy follow-through, particularly on additional fiscal support and direct consumption incentives.

The stronger language on Monday does not signal that “bazooka-style stimulus will arrive immediately,” Wildau said, who sees the top leaders to roll out new stimulus measures in an “incremental, data-dependent fashion, while keeping some ammunition in reserve” in response to potential U.S. tariffs next year.

Reviving household consumption is a top priority for policymakers, Wang said, forecasting the government to more than double its trade-in program to over 300 billion yuan to incentivize domestic spending.

China in July had announced allocation of 300 billion yuan ($41.5 billion) in ultra-long special government bonds to support the trade-in and equipment upgrade policy, in a bid to bolster consumer demand.

Beyond the trade-in program, existing fiscal stimulus package has placed little emphasis on boosting consumption, which is key to reflating the economy, Sunny Liu, lead economist at Oxford Economics said in a note on Wednesday, stressing that China will continue to face deflationary pressures in the near term.

Source:CNBC

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Warren Takunda

Stocks

December S&P 500 E-Mini futures are trending up +0.10% this morning as investors awaited the all-important U.S. inflation report for clues on whether the Federal Reserve will lower or hold interest rates next week.

In yesterday’s trading session, Wall Street’s main stock indexes closed in the red. MongoDB tumbled over -16% and was the top percentage loser on the Nasdaq 100 after the company announced that its Chief Operating Officer and Chief Financial Officer, Michael Gordon, would step down on January 31st.

Also, Moderna slumped more than -9% and was the top percentage loser on the S&P 500 after BofA reinstated coverage of the stock with an Underperform rating. In addition, Oracle slid over -6% after the IT giant reported weaker-than-expected FQ2 results. On the bullish side, Walgreens Boots Alliance soared more than +17% and was the top percentage gainer on the S&P 500 after the Wall Street Journal reported that the drugstore chain was in talks to sell itself to private equity firm Sycamore Partners.

Also, Alphabet climbed over +5% and was the top percentage gainer on the Nasdaq 100 after the tech titan discussed breakthroughs made through the use of its new Willow quantum computing chip.

Economic data released on Tuesday showed that U.S. Q3 nonfarm productivity was unrevised at +2.2% q/q, while Q3 unit labor costs were revised lower to +0.8% q/q from +1.9% q/q, a smaller increase than expectations of +1.3% q/q.

Today, all eyes are focused on the U.S. consumer inflation report, which is set to be released in a couple of hours. Economists, on average, forecast that the U.S. November CPI will come in at +0.3% m/m and +2.7% y/y, compared to the previous numbers of +0.2% m/m and +2.6% y/y.

The U.S. Core CPI will also be closely watched today. Economists anticipate the core CPI to be +0.3% m/m and +3.3% y/y in November, matching October’s figures.

A survey conducted by 22V Research showed that 37% of investors expect the market response to the consumer inflation report to be “risk-off.” Also, investors are evenly split between those predicting a “risk-on” reaction and those expecting it to be “mixed/negligible.”

“A softer print can clear the path for a year-end rally, with the second half of December being the second strongest period of the year. On the contrary, a firmer print can revamp volatility,” a team led by Ohsung Kwon said.

U.S. rate futures have priced in an 86.1% chance of a 25 basis point rate cut and a 13.9% chance of no rate change at the December FOMC meeting.

On the earnings front, Photoshop maker Adobe is set to report its FQ4 earnings results today.

In the bond market, the yield on the benchmark 10-year U.S. Treasury note is at 4.245%, up +0.52%.

The Euro Stoxx 50 futures are down -0.04% this morning as investors digested a batch of downbeat corporate updates and looked ahead to key U.S. inflation data. Retail stocks led the declines on Wednesday, while media stocks gained ground.

Meanwhile, market participants are also gearing up for the European Central Bank’s monetary policy decision on Thursday, with the central bank widely expected to lower its policy rate by 25 basis points for the fourth time this year amid a deteriorating economic outlook and ongoing political instability in France and Germany.

In corporate news, Industria DE Diseno Textil Inditex Ord S slid over -6% after the Zara owner posted weaker-than-expected Q3 sales. Also, Zalando Se slumped more than -4% after the German retailer agreed to acquire rival About You Holding SE. In addition, Siemens Energy Ag fell over -1% after the CEO of U.S. rival GE Vernova offered a cautious outlook for the struggling wind energy sector.

The European economic data slate is empty on Wednesday.

Asian stock markets today settled in the green. China’s Shanghai Composite Index (SHCOMP) closed up +0.29%, and Japan’s Nikkei 225 Stock Index (NIK) closed up +0.01%.

China’s Shanghai Composite Index closed higher today, extending gains from the previous session. Retail stocks outperformed on Wednesday. Investor focus turned to the annual Central Economic Work Conference, which began today. The key policy meeting is anticipated to outline China’s economic priorities and targets for 2025, with investors encouraged by stimulus signals from a readout of a Politburo meeting earlier this week.

According to economists, China might increase its budget deficit to the highest level in three decades and implement the steepest interest rate cuts since 2015. At least seven Chinese brokerages predict that the fiscal deficit target for next year could widen to 4% of gross domestic product.

Meanwhile, the offshore yuan slid as much as 0.5% on Wednesday after Reuters reported that Chinese policymakers are considering allowing the currency to weaken in anticipation of higher tariffs under a second Donald Trump presidency. In other news, the Asian Development Bank maintained its gross domestic product forecast for mainland China at 4.8% for 2024 and 4.5% for 2025. In corporate news, JCHX Mining Management gained over +3% after announcing the acquisition of a 51% stake in Terra Mining.

Japan’s Nikkei 225 Stock Index closed just above the flatline today as investors digested mixed economic data from the country and cautiously awaited the key U.S. inflation report. Gains in defense stocks helped offset losses in utilities stocks on Wednesday. The Reuters Tankan survey released on Wednesday showed that Japan’s manufacturing sentiment deteriorated significantly in December due to concerns about U.S. protectionist policies and the Chinese economy, with pessimists outnumbering optimists for the first time in 10 months.

At the same time, the Cabinet Office reported that the business survey index for large manufacturers in Japan rose to a 3-year high in the October-December period. Meanwhile, the yen strengthened slightly after Japan’s producer prices rose at their quickest rate in 16 months in November, highlighting growing inflationary pressures in the economy and bolstering expectations for further policy normalization by the Bank of Japan.

In other news, Kyodo News reported on Wednesday that Japan’s government plans to propose an increase in the country’s corporate tax starting in April 2026 to finance additional defense spending. In corporate news, Topcon Corp. soared more than +23% after the eyecare products maker announced it is considering going private, among other measures, to boost corporate value. The Nikkei Volatility, which takes into account the implied volatility of Nikkei 225 options, closed down -0.71% to 22.40.

The Japanese BSI Large Manufacturing Conditions Index arrived at 6.3 in the fourth quarter, stronger than expectations of 1.8.

The Japanese November PPI has been reported at +0.3% m/m and +3.7% y/y, stronger than expectations of +0.2% m/m and +3.4% y/y.

Pre-Market U.S. Stock Movers

Dave & Buster’s plunged over -15% in pre-market trading after the company reported a wider-than-expected Q3 loss and announced a CEO transition.

Stitch Fix surged more than +20% in pre-market trading after the company reported better-than-expected FQ1 results and raised its full-year revenue guidance.

Source: BarChart

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ING

Central Bank

Economic

Quarterly re-funding is running at some $1tr and expected to hold there

In cash terms, the US fiscal deficit is running at around $2tr. Of this, about half is net interest and the other half is the primary deficit. On top of that, debt redemptions run at around $2tr, which translates into an annual re-funding requirement of a little more than $4tr. That breaks down to a quarterly re-funding of US$1tr. That was running at around $0.4tr in the fourth quarter of 2016 when Donald Trump was first elected president, when the deficit was running at some 3% of GDP (versus 6%+ now).

Looking ahead to 2025, it remains to be seen whether there is material success in cutting discretionary spending. This is currently running at around 6% of GDP. In fact, it’s around the same level as the fiscal deficit itself. It’s important that discretionary spending as a percentage of GDP gets cut in the years ahead as compensation for the rise in interest payments. The Congressional Budget Office projects that interest spending rises from 3% of GDP today to 4% of GDP in the coming decade. Discretionary spending must fall as an offset.

Even as discretionary spending falls as a percentage of GDP to offset the rise in interest rate spending, it won’t be enough to cut the fiscal deficit, unless some material action is taken. The tax cuts executed during the first Trump presidency were advertised as self-financing but weren’t. There is nothing to suggest that projected tax cuts this time around will be any different. And the jury is out on the extent to which tariffs can bring in material revenue income. And if nothing changes, the debt/GDP ratio keeps rising.

Re-funding at current levels still ends up in a bad place for overall debt ...

US Bond Market on the Precipice When it Comes to Funding the Deficit_1

The spread from 10yr SOFR to 10yr Treasury yield at 50bp contains a 25bp concession already

These are issues the Treasury market must grapple with as we progress through 2025. And indeed into 2026 as tax cuts that get through the legislative process will take effect from January 2026 onwards. Meanwhile, the rising fiscal deficit continues to increase the supply of Treasuries in the market. This is occurring alongside the Federal Reserve’s quantitative tightening, which has already reintroduced approximately $2tr worth of Treasuries into the market.

The main impact of this fiscal pressure has been to cheapen Treasury yields relative to SOFR rates. For example, in the 10yr tenor, the spread from the SOFR rate to the Treasury yield is now about 50bp. That was averaging around 25bp through to the middle of 2023. Since then, there has been a ratchet higher in the spread. It has not been destabilising. Rather it’s been a slow and steady process. In its simplest terms, it effectively translates to an extra 25bp demanded by investors to take down Treasuries.

As we progress through 2025 there is no reason to expect this spread to narrow unless there is some material progress made in terms of deficit reduction. Even deficit containment is liable to pressure the spread wider, as this still equates to a growing supply of cumulative Treasury bonds on the market. Should the fiscal deficit numbers worsen, the risk is the 50bp spread trends wider by another 25bp to the 75bp area. There is no real science to this beyond a possible repeat of the widening seen so far.

We view this as the most likely mechanism whereby the elevated fiscal deficit position impacts the Treasury market. There would not be much market tolerance for a ratcheting higher in the quarterly re-funding requirement. The basic market assumption is that the re-funding amounts have broadly peaked, apart from a natural rise in line with the size of the economy. Any rise from here is a pure reflection of fiscal pressure risks pushing Treasuries participants toward demanding more price concessions.

Watch the SOFR to Treasury yield spread as a measure of fiscal stress

The bottom line is it’s too early to conclude that there is about to be a blowout in the Treasury market on account of deficit pressure. But such pressures clearly risk mounting should action to cut the deficit not materialise, or worse, should the deficit go on a rising pattern. It seems, in fact, that this is more of a risk for 2026 when the proposed tax cuts kick in. But even a lack of action to get the deficit on a downward path through 2025 can still spill over into Treasury market vulnerability.

That being said, an impact is already being felt through the prism of the wider spread of Treasuries over SOFR. Watch this spread as the clearest barometer of stress (or de-stress) through 2025.