Can US Treasury yields go higher?

A SHARP selloff in the world’s biggest government bond markets and a continued rise in the US dollar early this year sent shockwaves through financial markets. The benchmark 10-year US Treasury yield surged to a 14-month high of nearly 4.8% last week before easing to around 4.6% in recent days.

This movement has placed the trajectory of 10-year US Treasury yields at the centre of economic discussions in 2025.

As yields hover around 4.6%, analysts remain divided on their future direction, with contrasting perspectives from Nomura Research and JP Morgan.

Nomura Research points out that while the current 10-year US Treasury yield appears elevated compared to its 21st-century average of 3.3%, it remains significantly lower than levels seen in previous decades.

For instance, yields averaged 6.7% in the 1990s and a staggering 10.6% in the 1980s.

“Against this longer-run view of history, 10-year US Treasury yields still seem somewhat low, particularly given the prospective impact of Trump’s nationalistic policies,” Nomura Research argues.

JP Morgan, meanwhile, highlights the peculiar dynamics of the current bond market.

“Yields on 10-year US Treasury are over 100 basis points higher than their September lows – while the US Federal Reserve (Fed) has been lowering its target policy rate. That’s unusual,” the investment banking group notes, pointing to robust economic growth as a key factor driving yields upwards.

Economic resilience

Both investment banks agree that the resilience of the US economy is pivotal.

JP Morgan highlights that 2024 growth estimates were revised up from 1.2% to 2.7%, with much of the momentum occurring in the fourth quarter of last year.

This robust performance has tempered expectations of Fed rate cuts, exerting upward pressure on yields. Nomura Research sees parallels with the mid-1990s, when the Fed cut rates cautiously despite inflation nearing target levels.

“Signs of a rising R-star, strong productivity growth, very loose financial conditions and inflation stuck above the Fed’s 2% target all exist today,” it argues.

However, Nomura Research also highlights a critical difference: the US fiscal position is far weaker now than it was in the 1990s.

The budget deficit, at around US$2 trillion, or 17% of gross domestic product, and rising debt issuance pose challenges.

“Higher US Treasury yields directly raise the government’s net interest payments, at a time when a large amount of low-coupon bonds are also maturing,” it cautions.

JP Morgan, however, is less concerned about fiscal pressures. It observes that the recent rise in yields is not driven by deficit worries.

“The yield on longer-dated government bonds compared to interest rate swaps has remained stable since the middle of last year,” it explains, contrasting the United States with the United Kingdom, where deficit concerns have weighed on bond prices.Yields to go even higher?

Inflation remains a wildcard in the yield equation. Both investment banks acknowledge its role, but their perspectives differ.

Nomura Research warns that tariffs and supply-side reforms under US President Donald Trump administration could push inflation higher, potentially driving yields to 5% to 6% this year.

“Our US team expects the Trump administration to strike fast and hard on imposing tariffs, while disinflationary supply-side reforms – such as deregulation and increasing government efficiency – will take time to pass through Congress,” it says.

JP Morgan offers a more subdued view, pointing to easing wage pressures and a softening labour market.

“Increases in wages paid to employees peaked at 5.1% in 2022 and have since declined to 3.9%,” it notes.

Additionally, sectors sensitive to interest rates, such as housing, continue to lag.

This underperformance suggests limited room for yields to rise further, in its view.

The supply of US treasuries and the demand for safe assets are crucial factors shaping the yield outlook. Nomura Research highlights declining official buying as a significant concern.

“The Fed is unwinding its holdings via quantitative tightening, while the share of foreign holdings of US Treasury debt has decreased from 49% in 2012 to 29% in 2023,” it explains.

Rising geopolitical tensions and central bank interventions to support local currencies have exacerbated this trend. JP Morgan, however, is more sanguine, emphasising opportunities in the current environment.

“For US taxpayers, moving from cash into municipal bonds – which have yields above their 25-year average – can provide tax-advantaged income and an opportunity for capital gains amid falling yields,” it says.

Meanwhile, Nomura Research acknowledges there are risks to its expectations of yields rising to 5% to 6% in 2025.

“US economic exceptionalism may buckle if higher long-term rates cause a sharp growth slowdown, a large equity market correction and investor portfolio rebalancing in favour of US Treasury bonds,” it suggests.

Conversely, if global financial turmoil ensues, the United States could benefit from a flight to safety to perceived safer US dollar assets, keeping 10-year US Treasury yields in check.

JP Morgan focuses on the Fed’s stance, arguing that rate hikes are unlikely.

“We think that the Fed won’t hike rates, and thus rates are priced aggressively high for that scenario,” it asserts. This opens opportunities for investors to add duration to their portfolios.

“For those looking to take on extended credit risk, US preferreds and direct lending offer near double-digit yields,” it says.