(Bloomberg) -- The bond market is too sanguine about the US fiscal picture, Barclays strategists said in an annual outlook released Thursday. 

“Current yield levels are not fully reflecting the adverse fiscal dynamics, which may be worth 50-75bp on long-term yields,” rate strategists and economists led by Anshul Pradhan and Marc Giannoni, respectively, wrote in the report. 

Long-term rates incorporate the expected path of Federal Reserve monetary policy and term premium, and “a structurally wide budget deficit can raise both,” they wrote. 

Still, Barclays expects the 10-year Treasury yield to end 2024 at 4.25%, about 20 basis points lower than current levels, as economic growth slows globally. The consensus view has the rate pegged closer to 3.75%, however. 

“Fiscal worries are going to be a headwind for the bond markets,” Pradhan said on a Thursday call with reporters accompanying the release of the report. If forced to choose, he’d sell, not buy, 10-year notes, he said. Barclays has an open trade recommendation to short the front-end of the Treasury curve.

The US budget deficit, which totaled approximately $1.7 trillion this September, has narrowed from the record levels reached during the pandemic. But persistently elevated government spending and the highest benchmark interest rates in a generation have led many investors to question the sustainability of the US debt path. Barclays estimates the deficit will narrow to $1.6 trillion during the federal government’s fiscal year 2024, then widen again to $1.8 trillion in 2025. 

Investor concerns over the deficit ultimately will flow through to yields via two channels, the Barclays team says.

First, higher deficits are correlated with either lower savings rates or higher investment rates, either of which should boost the long-run neutral rate by as much as 50 basis points. Second, growth in the supply of bonds should increase term premium, the extra compensation investors demand for investing in longer-maturity debt.

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