Why the best bond forecasters say the good times are over

Signs of a slowdown in both helped drive the US bond market to its biggest gain since the mid-1980s last month, with yields tumbling sharply on speculation that the Fed would cut its benchmark rate by more than a full percentage point in 2024, starting in the first half of the year.

“Markets are pricing too much policy easing too soon,” Mr Korapaty said.

The calls aren’t particularly worrisome, given that they would mean the debt market would effectively steady after being hammered by losses in 2021, 2022 and most of this year.

But they highlight the risk that markets are prematurely dismissing the chance the Fed will keep rates elevated until inflation is safely reined in. The average forecast of those surveyed by Bloomberg is that 10-year yields will slide to 3.9 per cent by the end of 2024.

BMO’s Mr Anderson said the low rates of the pre-pandemic era were unlikely to return soon due to economic shifts that have increased the so-called neutral interest rate, or the level that did not affect the pace of growth.

That meant policymakers would need to keep rates higher than they once did just to avoid stimulating the economy.

The Fed concludes its next meeting Wednesday and may provide insight into where it’s headed.

“Our longer-term forecast on the Fed over the next five years is that the Fed funds rate won’t be moving back down to pre-pandemic levels anytime soon,” he said.

With inflation remaining above the Fed’s 2 per cent target and few signs of a recession in sight, Goldman Sachs’s economists see a half-point cut by the Fed next year, starting in the third quarter. That’s roughly half as much as the futures market has been pricing in.

While Mr Korapaty isn’t ruling out the risk of an economic contraction, he said there’s a slightly bigger risk that yields may rise above his base-line scenario of 4.55 per cent if inflation proved sticky or the spreading adoption of artificial intelligence led to a productivity boom.

He said that last year most of his peers were too pessimistic about the economy. They were also blindsided by other factors, such as de-globalisation and large government spending on green energy, that he said contributed to stickier inflation and higher interest rates globally.

“They failed to forecast this kind of regime shift,” he said.

RSM’s Mr Brusuelas, along with colleague Tuan Nguyen, were also more accurate than most others this year, predicting that 10-year yields would end 2023 at 4.5 per cent.

Mr Brusuelas sees limited room for bond yields to fall next year because the resilient labour market indicates inflation will likely be slow to pull back to the Fed’s target.

A government report on Tuesday will likely show that the US consumer price index rose at a 3.1 per cent pace in November, a five month low, according to the median forecast of economists in a Bloomberg survey.

Even if consumer price increases continued to slow gradually, a 2.5 per cent inflation rate, plus 2 per cent economic growth, suggested 10-year yields should be around 4.5 per cent, he said.

“I’m not in the recession camp,” said Mr Brusuelas. A structural labour shortage – due to baby-boomer retiring and more stringent immigration — means inflation would “run a bit hot for the next couple of years”, he said.

Bloomberg