U.S. bond yields to rise above 4% even as Fed prepares rate cuts, Deutsche Bank says

By Harry Robertson

LONDON, Aug 28 (Reuters) - The U.S. 10-year Treasury yield is likely to rise back above 4% in the coming weeks, Deutsche Bank has said, with markets currently over-confident about the amount of rate cuts the Federal Reserve will deliver.

A slowdown in inflation and signs of labour market weakness have caused investors to price in around 100 basis points of interest rate cuts from the Fed this year.

That has helped the 10-year Treasury yield, which sets the tone for borrowing costs around the world, fall almost 40 basis points over the last month to 3.8%

A move to around 4.1% in the coming weeks was likely, the bank reckons.

Deutsche Bank's global head of rates research Francis Yared recommends shorting 10-year U.S. Treasuries, which essentially means the bond price is expected to fall and yields rise.

Yared told Reuters on Wednesday that investors were too optimistic in pricing 100 bps of rate cuts, which implies a 50 bps cut at one meeting.

He pointed to metrics that show the U.S. economy remains relatively sturdy, including a stabilisation in commercial and industrial loans in the second quarter.

"It's no longer consistent with below potential growth," he said. "And...you're not seeing an acceleration of the weakness in jobless claims."

Yared also said longer-dated yields should rise to compensate investors for a more uncertain inflation outlook and for higher levels of supply hitting the market as U.S. deficits balloon.

"Inflation risks, even though inflation is coming down now, they're quite different from what they were pre-COVID... and supply and demand is also in a materially different place," he said. "That, I think, is not reflected well enough at the moment."

A weak August U.S. jobs report at the start of September could scupper the short 10-year U.S. Treasury trade, Yared said, by justifying steep Fed rate cuts over the rest of the year. (Reporting by Harry Robertson)