Here we are in the first week of 2018! As I mentioned in my last Economy & Markets article, I usually focus on short-term overreactions in the Treasury bond market and not long-term forecasting.
But since Harry and the rest of the Dent Research team have their opinions on where the markets are set to go this year, I’ll take my own stab at it.
Throughout 2017, long-term Treasury rates fluctuated between a high of 3.19% in mid-March to a low of just under 2.68% in September. Those fluctuations were significant enough to produce some nice trades in my Treasury Profits Accelerator service, but volatility was notably absent.
Like in stocks, volatility declined in the Treasury bond market significantly in 2017. That’s a problem for options strategies like mine because if prices don’t move, option premiums decline. Even though my winning percentage was excellent, low volatility hurt performance because the “snap-back” overreactions weren’t as significant as they normally would be with higher volatility.
Federal Reserve policymakers are planning on maintaining steadily increasing interest rate policy or normalizing, based on current projections.
And let’s be realistic, the Fed is usually wrong when it comes to forecasting. I’m not talking policy forecasts, but economic forecasts. Decision makers will likely be forced to change the course at some point next year.
Fed members have continually projected a 2% inflation rate since the beginning of the recovery back in 2009 – and we’re still not there, some eight years later. They’ve recently admitted that they’re confused about what drives inflation.
Better late to the party than never, I guess…
I think the Fed will be surprised that inflation actually picks up more than expected this year. That surprise inflation should create a nice selloff in Treasury bonds that will drive long-term yields to around 4%. I’m projecting this will begin to happen in the first quarter of the year.
I expect that volatility in the Treasury market will increase in 2018 for a few reasons, but there is one particularly big catalyst.
Global sovereign bond markets have been manipulated by central banks for years, and in 2018 we’ll see both the European Central Bank and the Bank of Japan start to slow down or even reverse stimulation programs. When that happens, investors will be quick to sell, and whatever the Fed does won’t matter. U.S. Treasury bonds prices will go lower and yields will jump.
As I mentioned earlier, I expect long-term Treasury yields to hit 4% in 2018 along with a significant steepening of the currently flat yield curve.
Now, after that happens, we could see the yield curve flatten more or even invert. Usually when the yield curve inverts (meaning that long-term yields are lower than short-term yields), we’re in a recession.
Rising rates will spook stock investors and likely trigger a major selloff. I believe we’ll see a major sell-off in both stocks and bonds which, is unusual because money from stock sales usually move to the safety of Treasurys. Volatility will spike across the board when that happens.
You can prepare and profit from surprises in the financial markets, and specifically in the Treasury bond market with Treasury Profits Accelerator.
Editor, Treasury Profits Accelerator