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New yield forecasts

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More yield increases ahead

Fri, Aug 14 2009, 14:23 GMT
by Danske Research Team

Danske Bank A/S

Recent market developments

Yields have climbed over the summer months after falling in the latter half of June and they are now running close to their 2009 highs. Economic data have continued to surprise on the upside and a number of major European economies, as well as the US, have now put the recession behind them. Meanwhile, the financial markets have continued to recover. Stock markets have surged to record highs for 2009 and credit spreads in many markets have narrowed to levels seen before the crisis started accelerating last autumn.

Markets have begun to look for rate hikes and are now pricing in about 100bp from the Federal Reserve and 50bp from the ECB on a 12M horizon. Until now, central banks have interpreted the improvement in economic data very cautiously, although both the ECB and the Fed have indicated that they will not ease monetary policy any further.

Macro outlook

The US economy suffered its worst downturn in many years in Q4 08, but showed signs of stabilisation in Q1 09. We now see clear indications of the US economy having put the recession behind it, and the US is set for a relatively strong rebound in H2 09. Recently, the favourable outlook has been supported by continued improvement in manufacturing indicators (including the ISM), clear signs of housing market stabilisation and surging car sales. We believe that economic growth could be relatively strong in the coming two to three quarters. In spite of fiscal and monetary stimuli, we still see a risk of renewed weakness some time into 2010 if consumer spending fails to gather real momentum.

The eurozone has also come out of recession. Germany and France – the hubs of the eurozone – even saw positive growth rates as early as in Q2 09. Recent data suggest that Germany could be set for a surprisingly strong recovery in H2 09 based on the positive trends in exports, manufacturing orders and investment. The German rebound should, not least, be driven by a production catch-up and a strong recovery in Asian export markets. However, we also see a risk of renewed weakness in Europe next year – but this will depend mainly on developments in Asia and the US. Inflation in the eurozone is about to bottom and should move gradually upward over the next 12 months as commodity prices increase, but the inflation rate should stay below the ECB’s target over the coming years.

Central banks and bond yields

The Fed has announced that it will stop buying Treasuries by October and is generally signalling that it does not intend to expand quantitative easing any further, although it has left the door ajar. We expect the Fed to maintain the Fed funds rate at 0-0.25% for a relatively long time. US inflation is low and there is plenty of spare capacity in the economy, so there is no urgent need for rate hikes. We expect US yields to increase on the back of the outlook for further improvement in economic indicators, massive supply of Treasuries and the phasing-out of the Fed’s Treasury purchase programme. Most of the increase in yields is expected to come over the next six months. On a six to 12M horizon we expect yields to move sideways.

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Published on  Fri, Aug 14 2009, 14:26 GMT