US | Limited room for long-term yields to fall further if a soft landing remains in sight

Summary

Long-term yields have ceased from being driven by changes in inflation compensation, but they could decline markedly if markets begin to price in that the Fed will need to lower rates below neutral to avoid a recession.

Key points

• Key points:
• The Fed's main goal has shifted to keeping the labor market at its current sweet spot. In such a case, there would be no need to bring rates anywhere near the zero lower bound.
• Likewise, mid- and long-term Treasury yields would not have much further room to fall since markets have been pricing in the rate cut-cycle for several months now.
• The baseline expectation that the Fed will opt for a gradual cycle of consecutive 25bp rate cuts implies that the yield curve could become completely upward-sloping by mid 2025.
• The implied expectation of a policy rate below 3% by the end of next year suggests that markets are relatively less confident in a smooth soft landing than the median FOMC participant.
• Powell joined the signal sent by the updated SEP and said that “it feels [...] that the neutral rate is probably significantly higher than it was back” in the pre-pandemic period.

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