US primary dealers boost Treasury yield expectations

Leading US economists are ratcheting up their outlook for interest rates on benchmark Treasuries in more optimistic expectations for economic growth, a Reuters poll found on Tuesday.
Most economists at primary dealers said they boosted their US growth outlook as a result of a deal reached last week between President Barack Obama and Republicans to continue for another two years Bush-era tax cuts.
With the stronger growth outlook, the median of forecasts given by economists at 16 of the 18 primary dealers was for a 10-year note yield of 3.35 percent by the middle of 2011, up from a median of 3.00 percent in a similar poll conducted on December 3.
Benchmark 10-year note yields were hovering at 3.49 percent on Tuesday after having surged from 2.93 percent just over a week ago ahead of the announcement of the tax deal.
"The recovery seems to be gaining momentum in the wake of what we learned last week with Obama getting behind the tax deal," said Kevin Cummins, US economist at UBS in New York. Economists had already been raising expectations for Treasury yields before the announcement of the tax deal, based on some stronger-than-expected economic data. A Reuters poll of primary dealers in November had a median of forecasts of 2.6 percent for yields at the end of the second quarter of 2011.
Ten-year yields are used extensively as a benchmark for interest rates on loans like those on mortgages. Fourteen of the sixteen primary dealers who answered the survey said they increased their growth outlook as a result of the Obama tax deal.
"Quite literally, in that 24-hour period we added one full percentage point to our growth forecasts - needless to say, but that is rather meaningful," said Tom Porcelli, chief US economist at RBC Capital Markets in New York.
The median of forecasts for US gross domestic product for 2011 rose to 3.05 percent from 2.70 percent in the poll earlier this month. As a comparative, the government in November estimated third-quarter 2010 GDP at a 2.5 percent annual rate. However, economists cautioned that higher Treasury yields could eventually become a drag on economic growth by making it more costly to borrow money.
"The backup in rates could crimp housing a bit, so there are some offsets," Cummins said.
Indeed, US bond manager Jeffrey Gundlach, chief executive of DoubleLine Capital, said on Tuesday the US economy will not be able to handle a 10-year Treasury rate rise above the current level near 3.50 percent.
"The economy, society and government is fuelled by debt," Gundlach said, and cannot run successfully in a rising interest-rate environment. While growth expectations were higher, only two of the 16 primary dealers expect the US central bank to increase interest rates from the current level near zero before the end of 2011.
The Fed on Tuesday at the conclusion of a policy meeting reiterated it intends to keep interest rates on hold for an "extended period," and said it remains committed to a program under which it plans to buy about $600 billion of Treasuries through the middle of next year in an effort to prop up the economy.
There are 18 primary dealers - large financial institutions which do business directly with the Fed. Goldman Sachs and RBS Securities did not answer the survey.