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New yield forecasts

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Look for more yield increases

Mon, Jun 15 2009, 12:46 GMT
by Danske Research Team

Danske Bank A/S

Recent market developments

Long yields in both the US and Germany have moved up sharply over the past month. Economic news has surprised on the upside, and it is becoming increasingly evident that the worst of the economic downturn is probably behind us. Meanwhile, stock markets have risen and so has risk appetite on financial markets. Most recently, there has been speculation about potential rate hikes from the Federal Reserve (Fed) over the coming quarters. The market currently expects the Fed to hike rates by about 1% over the next 12 months.

The European Central Bank (ECB) stayed on hold in June, while presenting details about its planned covered bond purchases. Good economic news and higher US yields have pushed European yields upwards, and expectations of ECB rate hikes over the next year have been growing.

Macro outlook

The US economy suffered its worst downturn in many years in Q4 08 and Q1 09. However, signs of improvement are emerging. For instance, the important ISM indicator is rising sharply at the moment. We believe that the economy has begun to stabilise, and we expect a soft recovery to start in H2 09 on the back of fiscal easing, low inflation (supporting real incomes) and improved monetary transmission as the financial system rights itself.

The eurozone is also working its way out of a severe recession that was prompted by tighter credit, housing market woes and, not least, the sharp slowdown in exports following the collapse of international trade. The growth outlook is expected to remain rather gloomy for most of this year, and the eurozone will need help from the outside world to fuel growth. This will likely happen in the second half of 2009, when we expect exports to pull eurozone growth into positive territory again. Given the sharp drop in commodity prices, eurozone inflation should move below zero this year, and although we expect inflation to rise again, it should remain below the ECB’s target in the coming years.

Central banks and bond yields

The Fed will probably maintain the fed funds rate at 0-0.25% for a long time, and we believe that financial markets are pricing in far too aggressive rate hikes at the moment. Inflation is low and there is plenty of spare capacity in the economy, so there is no need for rate hikes in the very near future.

We would not rule out further quantitative easing by the Fed, following the recent sharp increase in yields, though we consider it more likely that the Fed will simply try to talk yields down, for instance, by emphasising once again that the fed funds rate will remain unchanged for a long period.

In the very short term, we see a risk of a downward correction in yields, but longer term, we expect the massive supply of government bonds and the continued improvement in the economic outlook to drive US long yields upward.

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Published on  Mon, Jun 15 2009, 12:50 GMT