[Weekend Money] "U.S. Treasury Yields to Peak Early Next Year... Increase Long-Term Bond Holdings Ahead of 2028 Rate Cuts"

Hana Securities Forecasts Next Year's U.S. 10-Year Treasury Yield at 4.30%-5.20%
Yields to Stabilize at Lower Levels Through Q2, Briefly Rebound in Q3, Then Stabilize Again

U.S. Treasury yields are expected to peak between the end of this year and early in the first quarter of next year, then gradually stabilize at lower levels. They are projected to rebound temporarily in the third quarter before stabilizing again through year-end. Analysts say investors could benefit from increasing their allocation to long-term bonds again as yields stabilize at lower levels toward year-end and the rate-cut cycle begins in 2028.

According to Hana Securities on Nov. 14, the expected annual range for the yield on 10-year U.S. Treasury bonds next year is 4.30% to 5.20%. The brokerage expects Treasury yields to peak following a rate hike by the U.S. Federal Reserve (Fed), then stabilize at lower levels through the second quarter, rebound temporarily in the third quarter, and stabilize again by year-end.

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Hana Securities first pointed to the fact that the structural floor for long-term U.S. interest rates has risen compared with the past. This is because long-term neutral rates and term premiums are both rising as the economy enters what is known as the "Post-Modern cycle," in which demand for capital exceeds savings due to investment in artificial intelligence (AI) infrastructure and government borrowing. As a result, real interest rates are also bound to rise, the brokerage explained.

Supply-and-demand dynamics are also supporting the floor for yields. Taking currency-hedging costs into account, German and Japanese government bonds have emerged as investment alternatives as attractive as U.S. Treasuries. In addition, the shrinking share of traditional investors with a long-term holding strategy has weakened the demand base for U.S. Treasuries.

Yields are expected to peak between December this year and early in the first quarter of next year. Hana Securities forecast that the Fed will raise its benchmark interest rate in December 2026 and March 2027, lifting the terminal rate to 4.50% at the upper end of the target range, and then hold it steady. "In this scenario, the fair value for the 10-year yield is around 5%," said Heo Seong-woo, a researcher at Hana Securities. "Historically, 10-year yields peaked within four months before or after the final rate hike, while yields fell three to four months after an election when the government became divided."

The brokerage expects conditions favorable to the bond market to take shape through the second quarter. This is because the Fed's rate-hiking cycle is expected to end, while a divided government in the U.S. Congress could give the Democratic Party the opportunity to rein in fiscal expansion.

Liquidity conditions at the U.S. Treasury were also cited as a factor that could support a bond rally. After the debt ceiling is reached at the end of February next year, the Treasury is expected to use its Treasury General Account (TGA) balance and extraordinary measures to secure funding through August. The analysis suggests that as much as $800 billion in liquidity could be injected into the market through a drawdown in the TGA balance and net redemptions of Treasury bills (T-bills).

However, yields could rebound temporarily in the third quarter after a debt-ceiling agreement is reached. Hana Securities expects the negotiations to conclude in August, shortly before the X-date, as they did in 2011, 2013, and 2023. The brokerage explained that market liquidity could tighten if the Treasury issues large amounts of T-bills to rebuild its TGA balance immediately after an agreement is reached, and also increases the volume of coupon-bearing securities issued in its August Treasury refunding.

It was particularly concerned that, unlike in 2023, reverse repo balances have been depleted, meaning that liquidity absorbed by Treasury issuance could come directly from bank reserves. "Short-term yields are expected to remain stable below the upper bound of the benchmark rate, while term premiums on long-term bonds rise, steepening the yield curve," Heo said.

However, the rebound is expected to be limited. "Since this will be after the Fed has ended its rate hikes, and short-term Treasury purchases (RMP) will serve as a liquidity buffer, the rebound is likely to be limited to within the 90-day median of 29 basis points (1 bp = 0.01 percentage point)," he estimated.

As an investment strategy, the brokerage recommended taking a gradual approach based on yield levels rather than rushing to extend duration immediately. It said a strategy of securing carry and buying in stages would be effective if 10-year yields enter the 5% range. It also recommended maintaining short-term bonds as core holdings for carry, while realizing gains mainly on long-term bonds when yields fall in the second quarter.

From late in the second quarter to early in the third quarter, the brokerage proposed reducing duration to prepare for a rebound in long-term yields and adopting a curve-steepening strategy that bets on a steeper yield curve. The strategy would then be to increase duration again as yields stabilize at lower levels toward year-end and the benchmark rate-cut cycle begins in 2028.

The brokerage also outlined scenarios in which yields could fall faster than expected. Downside risks include a sharp contraction in AI investment or AI companies' credit stress spreading beyond CCC-rated debt to the broader high-yield bond market; a steep drop in international oil prices following the end of the war in the Middle East; and a reduction in the Treasury's issuance of long-term bonds.

This content was produced with the assistance of AI translation services.