US rates review

Over the past month, US bond yields have turned higher as more hawkish rhetoric from the US Federal Reserve and stronger economic data have led markets to reassess the prospect of a rise in US interest rates by the end of the year. Following the very strong October employment report, where payrolls surged by 271k, the probability the market attaches to a December 25bp tightening has risen to around 70%. The shift brings the market into line with the longstanding forecast of a US rate rise this year. The turn in market rate sentiment has pushed US Treasury yields up by around 30bps since mid-October to 2.3%, although they had fallen back a little following the Paris terrorist attacks. 

If the Fed delivers a policy tightening at its next FOMC meeting on 16th December, it would represent the first rise in US interest rates since June 2006. Given the unprecedented nature of the financial crisis and the length of time that has elapsed since the last rise in US interest rates, quite how the market will react remains highly uncertain. While some have raised parallels with the sharp and sustained bear market that ensued following the Fed's policy tightening in February 1994, there are good reasons to suppose that market reaction this time around will be far more limited. Not only is inflation currently less of a threat - annual headline US CPI is running around zero percent - but the Fed is likely to continue to stress that the path of further policy tightening will be very gradual. 

Over the coming weeks, there is really only one piece of domestic economic data that could shift Fed thinking - the November employment report on 4th December. Following the strength last month, however, it would likely take a markedly weaker outturn and/or a sharp deterioration in international sentiment to prompt the Fed to delay further. Given the FOMC's avowed intention to proceed cautiously, only two further rate increases are expected in 2016. As the policy stance firms, Treasury yields are likely to rise. 

"We forecast 10-year yields at 2.4% by the end of 2015 and 2.7% by end-2016", notes Lloyds Bank.