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New yield forecasts

Less fear of more hikes

Fri, Jul 4 2008, 13:39 GMT
by Danske Research Team

Danske Bank A/S

Macro outlook

• • Inflation fears and financial fears are still battling for the leader’s jersey in the financial markets. Financial fears have been in the lead in recent weeks: equities have tumbled and credit spreads have widened as risk appetite has waned. This has boosted demand for government bonds. Short yields have fallen in both the US and in Euroland since the start of June. However, inflation fears could easily regain the lead if oil prices continue to rise. Hence, uncertainty is high.
  
• • The state of the US economy still does not sit well with the expectations of upcoming rate hikes. The housing market continues to correct, the credit crisis still means tighter credit, and inflation is high due to the surge in food and energy prices, which is eroding consumer purchasing power. At the same time, the dynamic in the labour market has turned, and unemployment is rising. While the tax rebates are currently providing some support for consumption, the effects will be only temporary. We expect that growth will again retreat in the course of H2 and create renewed uncertainty.
  
• • That said, US economic policy – both fiscal and monetary – has been eased considerably to counter the downturn in growth, and the weakness in the dollar has been a shot in the arm for exports. Hence, we expect to see a new upswing emerging in the course of 2009.
  
• • In Euroland, the outlook for growth has deteriorated further. We do not expect that there will be a recession, but there is an increasing risk of a quarter with negative growth. Consumption growth is being hit by the high level of inflation, which is eroding consumer purchasing power. At the same time, export and investment growth are declining on the back of lower global growth, and a number of housing markets in Euroland are experiencing increasing problems. Finally, Thursday’s hike by the ECB does not improve the growth picture, with even Germany now showing signs of weakness. We expect that growth will deteriorate further for the remainder of 2008 and into 2009.
  
• • Inflation in Euroland is far above the ECB target of 2%, and the outlook is for it remain high for an extended period. Inflation is now expected to hit 4.2% in August, and we will most likely have to wait until some time in 2009 before inflation again drops below 3%. Central banks and bond yields
  
• • The US central bank, the Fed, has finished cutting, and will now bide its time to assess the effects of the very substantial easing of monetary and fiscal policies. The economic outlook remains too weak to justify interest rate increases – we will probably have to wait until well into 2009 before any hike comes. While the market has cut its expectations for near-term rate hikes in recent weeks, we still see a potential for yields to fall further. In the long term, yields will rise again as the economic outlook slowly improves.
  
• • The ECB hiked rates to 4.25% on Thursday as a result of the very high inflation in Euroland. We do not expect further hikes from the ECB given the weaker growth picture. In the short term, however, speculation on further rate hikes could keep yields up – especially if oil prices continue to rise. We expect that the ECB will keep rates on hold for the coming 12 months. Slowing inflation and growth will, however, mean lower market rates in Euroland. Yield curves
  
• • The US yield curve is expected to steepen in the short term as monetary policy is re-priced. The curve will flatten again in the long term, once the economy stabilises.
  
• • In Euroland, it is especially the ECB and the expectations on monetary policy that are controlling the slope of the curve. We expect the Euroland curve to steepen as the economic outlook deteriorates and market expectations on rate hikes decline. Country spreads
  
• • US bonds are expected to perform better in the near term. In the longer term, however, this picture will shift as it becomes more evident that growth is too weak for the ECB to hike rates further.

Next yield forecast will be published on 15 August 2008.

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Published on  Fri, Jul 4 2008, 13:42 GMT

Archive

• Growth concerns are back
  Published On Fri, Aug 15 2008, 09:15 GMT
• Less fear of more hikes
  Published On Fri, Jul 4 2008, 13:39 GMT
• Euro-zone yields set to fall
  Published On Tue, Apr 1 2008, 12:50 GMT
• Euroland: Lower yields – steeper curve
  Published On Mon, Mar 3 2008, 13:34 GMT
• Policy easing on the cards
  Published On Mon, Feb 4 2008, 10:43 GMT

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