Dealers See Higher '11 Yields

The Wall Street Journal

It will become more costly for U.S. consumers and businesses to borrow in 2011 as the economy gains traction, should forecasts from major Treasury-bond market dealers prove correct.

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The 10-year Treasury note's yield, a benchmark used to set interest rates such as mortgages and corporate-bond sales, may rise to 3.5% by the end of 2011, compared with 3.297% on Friday, as investors pull back from Treasurys. (Yields rise as the price falls.)

That was the median forecast from 17 respondents in a survey of the 18 U.S. primary dealers conducted Thursday and Friday by Dow Jones Newswires. One dealer, Royal Bank of Scotland Group, said its new forecasts will be released before the end of this week.

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"The rise in yields reflects that the economy is doing better," said Michael Cloherty, head of U.S. interest-rate strategy in New York at RBC Capital Markets, one of the primary dealers. That takes "the risks of double-dip recession out of the picture."

The forecasts from the dealers are closely tracked because they are a group of major financial institutions, including Goldman Sachs Group Inc. (NYSE: GS - News), Morgan Stanley (NYSE: MS - News), Deutsche Bank AG (NYSE: DB - News) and HSBC Holdings PLC. (NYSE: HBC - News)Primary dealers trade directly with the Federal Reserve and are obligated to bid on Treasury auctions, giving them a key role in providing liquidity to a Treasury market with about $8.7 trillion in outstanding securities.

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The driver that will push Treasury yields higher is a brightening economic outlook. Dealers expect that to send investors to seek higher returns in riskier assets.

Yet many dealers said the rise in bond yields will be modest due to the sovereign-debt crisis in the euro zone. Meanwhile, a 9.8% jobless rate and an inflation rate below 1% will keep the Federal Reserve from raising interest rates through the end of 2011.

Optimism on the economic outlook got a boost in the past week from President Obama's tentative deals with Republicans to extend some Bush-era tax cuts and other stimulus to encourage business investment. The Treasury market suffered the biggest two-day selloff in two years. The 10-year note's yield surged nearly 0.30 percentage point last week and traded at levels last seen in June. Jefferies & Co. (NYSE: JEF - News) had the highest forecast in the survey with a call for the 10-year note's yield to rise to 5% by the end of 2011. Morgan Stanley, Royal Bank of Canada and Bank of America Corp.'s (NYSE: BAC - News) Bank of America Merrill Lynch were also bearish on the Treasury market, predicting the yield to increase to 4% by the end of next year.

"The 30-year bull run in the Treasury market is over," said Ward McCarthy, chief financial economist within the fixed-income group at Jefferies & Co. "Bond yields will rise in coming years as the economy is getting better."

The 10-year note's yield hit a record high of 15.84% in September 1981, when the U.S. economy was feeling the pinch from runaway inflation. Since then, the yield has fallen steadily, reaching a record low of 2.034% on Dec. 18, 2008, after the collapse of Lehman Brothers caused panic buying of safe-haven Treasurys.

Though a minority in the survey, Treasury bulls weren't quite ready to call an end to the bull market.

HSBC, a consistent bull over the past couple of years, still believes the 10-year note's yield will drop back to 2.2% by the end of 2011. It is the only dealer in the survey to predict the yield will fall back below 3%. UBS (NYSE: UBS - News) expects the 10-year yield at 3% by the end of 2011.

The unemployment rate is likely to stay above 9% on average next year, and the Fed is likely to remain accommodative toward the economy, said Kevin Logan, chief U.S. economist at HSBC Securities USA Inc. in New York.

The near-zero policy rate, which has been in place since December 2008, is likely to anchor yields on short-dated Treasurys, Mr. Logan said. Another support for the bond market comes from tame inflation, which reduces the risk of a major threat to the fixed returns of bonds, he said.

Richard Berner, chief U.S. economist at Morgan Stanley in New York, agreed that the Obama tax-cut deal is a "game changer" that will boost the economy in 2011, but he said other factors could limit the pace of a rise in Treasury yields.

"One risk is that home prices are likely to fall further in 2011, which will temper consumer spending," Mr. Berner said. Sovereign-debt problems in the euro zone remain a "bumpy process," while inflation remains below the Fed's informal target. That means the Fed is unlikely to raise interest rates through the end of 2011, he said.

Write to Min Zeng at


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