Treasury market volatility is likely to increase over the coming years as stronger nominal growth, a more reactive US Federal Reserve and an unprecedented wave of artificial intelligence investment reshape global bond markets, according to T. Rowe Price.
While investors have been closely watching inflation data, Adam Marden, co-portfolio manager of the Dynamic Global Bond Strategy, said markets were placing too much emphasis on individual Consumer Price Index releases.
Instead, he argued the manufacturing cycle would become the dominant driver of rates as it fed through to stronger nominal growth.
“Much of the recent move in rates appears to have been driven by positioning, as the market had become relatively short. However, in our view, the more important issue for rates is not necessarily the next Consumer Price Index release, but the manufacturing cycle and what it implies for nominal growth.”
That backdrop, Marden said, leaves the Fed in a very different position from the decade following the Global Financial Crisis.
With both growth and inflation accelerating, policymakers have less scope to rely on forward guidance and instead must respond more quickly to incoming economic data.
Marden believes that alone should make Treasury markets more volatile, particularly at the front end of the yield curve where expectations for monetary policy are most acutely reflected.
“Reduced forward guidance and a more data-dependent Fed should translate into higher rates volatility. At the end of the day, volatility is likely to go higher because nominal growth is moving higher.”
Although commercial bank balance sheet deregulation and funding market dynamics remain important, Marden said their effects on the broader yield curve would take longer to emerge than many investors anticipate.
Nonetheless, the firm expects shorter-dated Treasuries to experience the greatest swings, noting the Fed has shown it is prepared to intervene should funding market pressures intensify.
Rather than being driven solely by monetary policy, Marden argued the next phase of bond market performance will also be shaped by structural investment trends. He described the AI capital expenditure cycle as larger relative to global GDP than the Chinese commodity supercycle, saying it should lift productivity while increasing capital intensity across the economy.
“The AI capital expenditure cycle is significant in scale; in our view, this is not a narrow theme. The scale of AI-related investment is larger, as a share of global GDP, than the Chinese commodity supercycle.”
Those forces should keep shorter-term Treasury yields elevated over the next two to three years, according to T. Rowe Price, while the long end of the curve remains comparatively anchored. Marden said that outcome depended on the Fed maintaining credibility as inflation-fighting remained central to policy.
“As capital intensity increases alongside a stronger manufacturing cycle, it is likely to reinforce a higher nominal growth environment, supporting higher front-end yields over time,” Marden said.
“As long as the Fed maintains credibility, which we believe it will, the front end and belly of the curve could remain higher over the next two to three years, reflecting stronger manufacturing-cycle dynamics and a more reactive policy environment.”
