Treasury bond yields: The bulk of the increase 'is behind us,' strategist says

J.P. Morgan's Jay Barry joins Yahoo Finance Live to discuss the outlook for fixed income investments.

Video transcript

BRIAN CHEUNG: Now let's bring in Jay Barry, JPMorgan head of USD government bond strategy. It's great to have you on the program, Jay. Just kind of want to get things started with what you've been seeing this week. I mean, when you a look at the MOVE Index, measures of volatility in fixed income, it's been not very much-- you need a strong stomach, let's say, to get through all of this. What do you think of yields right now? Do you think we're possibly going to see some settling at any point in time?

JAY BARRY: Yeah, no, thanks so much for having me, Brian. And I think this week's volatility has just been a continuation of everything that we've seen this year. And it comes on the heels of what we learned from the Fed meeting last week and what the Fed Chair said at his testimony earlier this week, where they talked about being unduly focused on inflation, but not being able to rule out the possibility of a recession.

So I think this week's volatility and the decline in yields has been associated with growth concerns in the US coming from the tightening of financial conditions, as well as the increases in inflation. But we're not just seeing it in the US. We've seen it globally as well because there's been a pretty strong global rally this week.

So I think certainly, there's a fundamental story here. And but it's being accentuated by technicals as well, because after the May CPI reading, the markets were priced for a 75 basis point hike, not only at the June meeting, but at successive meetings as well. And as we've gone through the last week or so, markets price a little bit of a less aggressive path for the Fed, which has allowed long-term rates to fall with it as well.

AKIKO FUJITA: I mean, let's talk strategy here, Jay. How do you think investors should be looking at this? You're talking about not just bond yields in the US as well, but globally. What does that strategy look like for you?

JAY BARRY: Yeah, so if we look at our forecast for Treasury yields here at JPMorgan, we argue that there's a case to be made that yields should revisit the high levels that we saw about a week or week and a half ago. But that does mean that the bulk of the increase in yields is behind us. And that makes sense because the market is pricing a Fed that will get the Fed funds rate to about 3 and 1/2% by the early part of next year. That's in line with our own forecast, where we're expecting the Fed funds rate to be at 3 and 1/2% by the February meeting.

So it would tell us that with the market price for that outcome, we have the bulk of the move behind us, but we think we can revisit the highs and yields, in large part because we think that these growth fears that are sort of entering into the market psyche right now are a bit overdone. Our own growth forecasts are more pessimistic than the Fed's, but we do see a return to above trend growth for the balance of this year.

Moreover, I think another big piece of the puzzle for bond yields for the second half of the year is the demand side of the equation. And we know that the Fed has shifted from QE in March to QT, which began last week. And QT is a passive process versus in the active QE process, when the Fed was buying bonds. But nonetheless, this does bring shadow supply back to the market, at the same time where some of the strongest supports for demand in the Treasury market have disappeared this year.

So we think that makes the case for yields to kind of move back towards a 3 and 1/2% level by the end of this year or sometime this fall. But if that's the case, it means that returns in risk-free assets are going to be relatively flat for the second half of the year after delivering a down 10% return to start.

BRIAN CHEUNG: Yeah, Jay, that's a really important point that you bring up about the balance sheet side of things. Everyone's been so obsessed with rate policy that they've been forgetting about that. Now, when it comes to the overall talking point, people are saying, well, this is the Fed withdrawing liquidity. Obviously, this is going to affect the demand side of things.

But equally important, there's also the supply from the Treasury issuance. It's not just the Fed that has control over the demand and supply here, right? It's about the Treasury and how much they're issuing and where the TGA sits. So are you seeing anything on that front with the auctions that we've been seeing over the past few weeks in terms of just the supply and how that factors into this story as well?

JAY BARRY: That' a great point, Brian. And certainly, the Treasury Department's been cutting auction sizes this year because the budget deficit has narrowed sharply from where we were in fiscal '20 and fiscal '21. But we're at a point where the Treasury is moving from being over financed and cutting option sizes to being under financed, as a function of this sort of QT process. And it will mean more supply needs to be digested by non-Fed hands in the coming months.

But we think that this issuance is largely going to come at the front end of the curve, which is why the process of reducing the size of the balance sheet is a relatively muted sort of impact on rate levels overall in our minds. So it's delivering more supply to the markets, but largely at the front end of the curve.

And I think as you know, that's where market participants are sort of demanding it right now. Treasury bills are trading quite rich relative to the market's Fed expectations. There's been ongoing record usage at the domestic RRP program. So I think this would be welcome. And there will be more supply, but it will be largely at the short end of the curve, which should assuage some of the worst concerns about delivering more interest rate risk to the markets.

AKIKO FUJITA: Jay Barry, JPMorgan head of USD government bond strategy. It's good to have you on today. Really appreciate the time.