The U.S. Securities Industry and Financial Markets Association says a survey of dealers forecasts lower interest rates, and a flat yield curve for the year ahead.

Interest rates will decline and a Fed rate cut is possible in the first quarter of 2007, according to a quarterly survey conducted by SIFMA’s Government Securities Research, Analysis and Strategy Committee, which is comprised of leading strategists and research analysts at its member firms.

The survey forecasts the yield on the 10-year Treasury note to reach 4.63% by the end of the first quarter and remain there until the end of June while the 2-year Treasury yield is expected to be 4.70% by the end of the first quarter and 4.60% by mid-year.

“In addition to slightly lower rates, the yield curve will likely remain inverted to flat through the first half of 2007,” said Michael Decker, co-head of research with SIFMA. “While a rate cut by the Fed sometime in the first quarter is possible, it will depend on whether questions about slowing economic growth replace the threat of higher inflation as the dominant concern about the economy.”

The survey forecasts net new issuance of U.S. Treasury coupon securities and bills to reach US$143 billion in the first quarter compared to US$158 billion during the same period last year. The decline in issuance from last year reflects a smaller budget deficit forecast as a result of continued tax revenue growth. The committee’s median projection forecasts a US$225 billion federal budget deficit for fiscal year 2007, lower than the actual US$248 billion deficit in fiscal year 2006.

“The deficit narrowed in 2006 because sustained economic growth and robust corporate profits led to a significant rise in tax revenues,” commented Decker. “Although the economy is expected to moderate in 2007, tax receipts are still expected to maintain a healthy pace, leading to a smaller 2007 deficit.”

The committee also forecast a slightly inverted to flat yield curve through the first half of 2007. The median survey response calls for the spread between 10-year and 2-year Treasuries to be inverted by seven basis points at the end of the first quarter before settling at a three basis point spread by the end of June.

When asked about risks to the interest rate forecast, committee members said rates could move higher than expected if an accelerated rate of inflation led to more aggressive action by the Fed. Conversely, the Fed could ease monetary policy if a protracted housing correction spilled over into other sectors and resulted in substantial economic deceleration that lowered bond yields.

Survey respondents expect Treasury to issue US$19 billion in Treasury Inflation-Protected Securities, or TIPS, in the first quarter which is roughly the same total as last quarter but slightly lower than the US$21 billion issued during the first quarter of 2006.

Committee members suggest that buying opportunities exist for investors throughout the yield curve in all duration sectors. This indicates continued strong demand for long duration assets and suggests Fed policy will remain on hold in the short term with the possibility of a rate cut early in 2007, SIFMA said.