US bond yields are set to keep rising, thanks to tightening monetary policy and a growing uncertainty of just how the incoming president will manage the world's largest economy, say experts.
Investors are cashing in their bonds as global growth optimism coupled with rising inflation expectations sweeps through markets, sending the US 10-year yields to a fresh two-year high above 2.6 per cent overnight.
Aussie bonds have been caught up in the selloff, which on Friday sent the yield on the 10-year government bond to a fresh 2016 high of 2.932 per cent (bond prices and yields move in opposite direction).
The selloff in global bonds began in August and gathered pace after the US elections on expectations that stimulus spending by the incoming Trump administration will drive up inflation, prompting the Federal Reserve to tighten monetary policy.
Capital Economics chief market economist John Higgins believes the selloff still has some way to go, saying a faster than expected pace of Fed rate hikes coupled with the unpredictability of the incoming Trump administration would keep investors from snapping up US bonds, thus sending yields even higher.
"We suspect that investors will demand more compensation for the uncertain outlook for policy under a Trump administration," Mr Higgins said, citing Mr Trump's attitude towards monetary policy as a possible risk.
"If the President-elect meddles with the Fed's independence, we think yields could rise substantially."
In addition, Mr Higgins is wary of how much demand there will be for US government debt should the President-elect go ahead with his stimulus spending plans.
"Needless to say, supply is set to increase significantly if there is a substantial fiscal expansion," he says. "In the past, strong "structural" demand might have absorbed such an increase. But such demand is not what it was."
Mr Higgins points to the US Federal Reserve no longer adding to its holdings of Treasuries as one source of demand drying up, and suggests the central bank may in fact start selling them depending on who President-elect Trump appoints to the committee.
In addition, China is more focused on supporting its currency in the face of a surging US dollar, rather than adding to its holding of US government debt and banks' appetite for Treasuries, previously propelled by regulatory pressures, looks to have eased.
For these reasons, Capital Economics has revised up its forecasts for the 10-year Treasury yield, to 3.5 per cent for the end of 2017 and 4 per cent for the end of 2018.
While Capital Economics expects demand for Treasuries to weaken, Mr Higgins did point out inflation was unlikely to rocket higher and the public debt should remain manageable.
"The equilibrium level of interest rates is also lower than it used to be, so yields should not rise as far as they did in the past, all else equal," he said.
"What's more, other factors could conceivably depress them, such as the persistence of low interest rates in much of the rest of the world (we don't see a reason to revise our forecasts for other government bond markets) or a flight to safety."
Australian bonds tend to move largely in line with their US counterparts, signalling local yields may be in for a bumper year as well.
But AMP Capital Investors head of investment strategy Shane Oliver reckons that at least in the short term, local bonds were oversold at current yield levels.
"Ten-year bond yields at 2.9 per cent look out of whack with the likelihood that the Reserve Bank will cut rates again next year or at the very least won't be raising them until 2018 at the earliest," Mr Oliver said.
But on a medium term view, the gradual using up of spare capacity in the economy and a shift in policy focus from monetary to fiscal stimulus indicated that the decades-long rally in bonds was probably over, he said.
"So expect the medium term trend in bond yields to be up."