Treasury yields will likely climb to a 2-year high in 2021 despite recent stabilization, Bank of America says

The stunning rally in Treasury yields this year has stabilized for now but look for rates to resume their rise, says Bank of America, which foresees the 10-year Treasury marching up to a nearly two-year high of 2.5%. The 10-year yield hasn't been above 2.1% since July 2019.

A spike in Treasury yields during 2021 has been a major focus for both bond and stock market investors. US debt has sold off massively this year in anticipation of hotter inflation rates that will likely accompany the US economy's recovery from the COVID-19 pandemic.

Treasury yields rise as bond prices fall, with the march higher in yields implying more expensive borrowing costs for businesses and consumers.

The surge in long-dated yields, notably the 10-year yield's rise to 14-month highs in mid-March, has largely cooled. The 10-year Treasury yield on Monday was around 1.587%, below the 1.76% level a month ago.

"We think technical factors combined with revised expectations on US growth are mostly responsible for the recent stabilization in US rates," said Bank of America in a note Monday, saying the stabilization "subsequently justifies" a rally in emerging market and US equities and a selloff in the US dollar.

The 10-year yield, which is tied to a range of lending programs, during the first quarter scaled up quickly from about 1% at the start of 2021. Safe-haven bonds sold off as the US government rolled out more coronavirus vaccinations to millions of Americans and after lawmakers in March approved a $1.9 trillion fiscal stimulus program.

But now, "it should not be a surprise to anyone that the US economy will keep recovering at a fast pace. We started the year expecting 4.5% growth for 2021 and now we expect 7% and 5.5% for 2021 and 2022, respectively. The inability of US rates to selloff on the back of a strong March payroll number was the tipping point to stabilize the US rates market, the signal that most of the good news were priced in," said Claudio Irigoyen, head of Latin America economics, equities, fixed income & FX strategy at Bank of America, in the note.

The US economy added 916,000 jobs in March, blowing past expectations of 660,000 jobs.

Irigoyen noted that there was a climb last week in yields in tandem with a rally in so-called risk assets. Last week, investors received a fresh round of strong US economic data including a nearly 10% jump in March retail sales and new unemployment filings hitting at a pandemic-era low.

"[Global] investors significantly reduced risk exposure on the back of the selloff in rates in 1Q21. Positioning clean up. Since asset managers didn't observe redemptions, cash levels were abnormally high, in particular for EM dedicated investors. Investors with cash on the sidelines were waiting for US rates to stabilize to redeploy capital into risky assets," he said, adding that "price action was dominated by short-term flow pressure."

Investors, meanwhile, are still keeping tabs on communication from the Federal Reserve. The central bank has signaled that it plans to keep its benchmark interest rates near zero until at least 2024 but market participants have been questioning whether the Fed can stand still in the face of hotter inflation, which it aims to do to accommodate the economic recovery.

"Despite the recent stabilization in US rates, we keep our forecast of 2.15% and 1.5% for 10-year and 5-year Treasuries by year end," said BofA. US economic growth "can surprise updated expectations to the upside during the summer, combined with positive (i.e. higher-than-expected) inflation surprises," it said.

"In addition, fiscal policy in itself will continue pressuring on real rates as more infrastructure spending is still more likely than tax hikes, adding more to the already sizable fiscal deficit. Finally, the Fed in itself remains an important source of volatility," wrote Irigoyen.