Latest market developments: The nature of the crisis has changed from fears of a systemic financial col-lapse to concern about a global recession. Yields have continued plummeting, and monetary policy has been eased. The economic outlook is bleak, with both the US and euro-zone economies mired in recession. Stock market fluctuations often set the agenda for fixed income markets at the moment.
Macro outlook: The US economy has been hit by a sharp tightening of credit to both households and busi-nesses. Moreover, consumer spending is reeling under falling employment, big stock market losses and a continued decline in house prices. GDP fell in Q3 and is likely to contract further in the coming quarters. We could hope for a modest recovery in H2 09 on the back of fiscal easing, a boost to real income from a turnaround in inflation and better monetary transmission as the financial system recovers.
The weakening of the global growth outlook and the difficulties in Eastern and Central Europe are weighing heavily on investment activity in Euroland at the moment. European banks are also tightening credit con-ditions, and housing market problems are growing in several countries. Meanwhile, unemployment num-bers are rising as labour markets turn round. Euroland will probably need a helping hand from the global economy to kick-start its economy. Hence, the growth outlook for the euro zone will remain gloomy long into 2009. That said, falling commodity prices mean euro-zone inflation will come down rapidly, so there is a good chance the ECB's 2 % inflation target will be met as early as in spring next year.
Central banks and bond yields: The Federal Reserve has so far cut its benchmark rates to 1%. We are looking for another 50bp rate cut in December after which the Fed will probably be done easing. Given the sharp rise in the supply of Treasuries, the Fed finishing its easing cycle and already-low yield levels, we do not see much further downside in Treasury yields. Swap rates could decline further, though, as swap spreads narrow. On a longer-term horizon, we expect yields to start rising again as the economy recovers.
The ECB will probably lower rates by 50bp in December and by another 25bp in Q1 and Q2 2009, respec-tively. This could take the benchmark euro-zone rate down to 2.25%. There is room for further falls in long yields during the next few quarters. Not least swap rates are expected to decline on continued monetary easing and poor economic news, coupled with improving money markets and hence narrowing swap spreads.
Yield curves: The US yield curve could steepen a little further short-term but should flatten again as the Fed finishes its easing cycle and the economy stabilises next year. In the euro zone, the yield curve is likely to steepen over the next 3-6 months as yields decline and monetary policy is eased. In the long term, the yield curve should again flatten a little.
