UBS is out with its latest forecast for the US 10-year bond yield, predicting it will rise to 4.25% by the end of 2025, with the 2-year note yield expected at 3.65%. The research firm indicated that in the near term, risks could escalate if US core PCE inflates to 2.8% in the first quarter before descending to 2% in the third quarter of 2025.
The forecast also suggests that US GDP is not expected to decelerate below trend until the second quarter of 2025. UBS highlighted potential early aggressive actions by President Trump on tariffs, immigration, and the Federal Reserve as factors that could heighten risks in the near term. Despite these concerns, UBS expressed a strong belief that the recent sell-off in UK gilts, particularly at the short end, is overdone, projecting 3.25% UK short rates by year-end.
The report by UBS also discussed the implications for bond markets, noting that bond yields exceeding 5% could be worrisome. However, if General AI technology boosts productivity by 1% starting from 2028, the equity risk premium (ERP) is estimated to be 4.3%. The current ERP is considered ‘warranted’ at 3.9%, supported by consistent ISM/PMI data and stable credit spreads.
Furthermore, UBS sees a 35% chance of a market bubble forming. In such scenarios, the price-to-earnings (P/E) ratio of bubble areas, which could include up to approximately 40% of market capitalization, would reach at least 45 times in a bond yield environment of at least 5.5%. This is compared to the current 34 times P/E ratio for the ‘Mag 6’.
The report concludes by noting the unusually strong position of corporate, especially tech, balance sheets relative to government ones, which could allow for a lower ERP.
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