BofA Revises 10Y Forecast To 3.25%, Expects A “Bumpy Transition” Higher

Exactly one week after Goldman became the first major bank to raise its 10Y yield target from 3.00% to 3.25%, this morning BofA was delighted to follow in Goldman’s footsteps and also revised its 10Y year-end forecast to 3.25%, given “above-potential growth and worsening supply/demand dynamic,” the bank’s rates strategist Mark Cabana wrote.

Here are BofA’s highlights:

We revise our 10y forecast to 3.25% for end of year driven by above-potential growth and a worsening supply/demand dynamic.

We switch our position on the curve to a 5y-30y curve flattener given Fed tightening and pension demand.

Regulatory changes may also end up being supportive of higher rates.

BofA’s rate forecast consists of two parts: one for the first quarter, where the bank expects 2.85% to hold, and then for year end, which it now sees as rising to 3.25%.

Coming into this year, we had an out of consensus US 10y rate forecast of 2.85% for end 1Q18. Our thesis was that rates were set to rise as a result of improved growth and inflation via tax reform as well as a worsening supply picture. The market has caught up with our view and we continue to believe rates can reprice higher. We adjust our forecasts to remain above consensus and forwards.

We now expect the 10Y rate to reach 3.25% by the end of the year driven by above-potential growth and a worsening supply / demand dynamic. However, this transition will likely be a bumpy one due to the interplay between rates and risk assets. We continue to believe the 30Y part of the curve will be well supported as a result of ongoing pension-related demand.

Looking at the recent rip higher in yields, BofA believes that “rates in the US can continue to reprice higher and adjust our forecasts to remain above consensus and forwards (Table 1, Chart 1)” as a result of “the combination of solid growth, normalizing inflation, and higher deficits / Fed portfolio reduction should see yields rise further.”

The highlights from the bank’s revisions:

Long end: Our end Q1 10Y forecast remains at 2.85% given positioning and the potential for additional near-term risk off as rates shift higher. We now expect the 10Y rate to reach 3.25% by the end of the year driven by improved growth and a worsening supply / demand dynamic but expect the push and pull between rates and risk assets to make this transition a bumpy one. We continue to believe the 30Y part of the curve will be well supported as a result of ongoing pension-related demand.

Front end: We see the front end of the curve (2Y & 5Y) as having the greatest potential to rise in relation to forwards as the Fed continues on their gradual rate tightening path. The concentration of front-end US Treasury issuance will also likely contribute to further short-dated Treasury cheapening in the near term. We have also revised higher our LIBOR forecasts given the recent tightening in USD funding and the potential for funding to remain strained in the near term due to elevated front end supply, repatriation uncertainty, and Fed reserve draining.