A recent Reuters survey indicates that US long-term Treasury yields are expected to remain stable in the near term but will rise later this year due to inflation concerns and worries over Federal Reserve independence. Meanwhile, short-term yields are projected to decline slightly as markets anticipate interest rate cuts by the Fed.

In the survey conducted between February 5 and 11, nearly 60% of bond strategists (21 out of 37) stated that the substantial issuance of government bonds in the coming years to finance former President Trump's tax cuts and spending plans would make it unfeasible for the Federal Reserve to significantly reduce its $6.6 trillion balance sheet.

According to the latest estimates from the Congressional Budget Office (CBO), the legislation is expected to increase the US deficit by at least $4.7 trillion over the next decade. Traders and investors are awaiting further guidance from the Treasury regarding the timing of the significant increase in debt supply.

At the same time, US gross domestic product (GDP) growth has consistently outperformed expectations, and the inflation rate has remained above the Fed's 2% target for over five years.

After several months of lowering yield forecasts, downplaying inflation risks, and lacking detailed information on future debt supply, strategists have quietly shifted their stance.

The survey's median forecast suggests that the benchmark 10-year Treasury yield will rise to 4.29% within a year, up from last month's prediction of 4.20%.

Jean Boivin, Head of the BlackRock Investment Institute, commented, "The market may develop a narrative that inflation is declining and the Fed will begin cutting rates. However, any signs to the contrary could introduce short-term volatility, serving as a minor wake-up call. This would, in turn, push up inflation and risk premiums."

"Combined with the broader debt backdrop, this will drive a sustained increase in yields for 10-year and longer-dated Treasury bonds."

A separate survey indicates that markets expect the Fed to implement two rate cuts this year, with the first cut potentially occurring after June, when a new Fed Chair takes office.

The interest rate-sensitive two-year Treasury yield is forecasted to decline from 3.50% at the end of April to 3.45%, and further to 3.38% by the end of July.

The 10-year Treasury yield has recently hovered around 4.16%, with many analysts expecting this trend to persist for several months.

Significant reduction of the Fed's balance sheet is considered unfeasible.

By allowing bonds to mature without reinvestment, the Fed has reduced its balance sheet by approximately one-quarter from its peak of nearly $9 trillion in mid-2022, following large-scale bond purchases during the pandemic.

However, several experts note that further substantial balance sheet reduction will be challenging, given the large volume of US Treasury issuance expected in the coming years.

There is also considerable uncertainty regarding the potential policy direction under the new Fed Chair. While earlier statements advocated for tighter policy and balance sheet reduction, recent signals have leaned toward interest rate cuts.

Meghan Swiber, Head of US Rates Strategy at Bank of America, stated, "Pursuing both policy rate cuts and balance sheet reduction simultaneously represents two conflicting policy paths."

"Although the new Chair's more hawkish stance on balance sheet issues has raised questions, we believe the likelihood of such a scenario actually occurring is relatively low."