Higher long-end global real yields spook markets
Higher long-end global real yields spook markets
Long-end global real yields have moved higher which in turn resulted in market nervousness in the beginning of January. Inflation fears have resurfaced amid the outlook for pro-growth and inflationary policies in the US, commodity prices have tracked higher, and political uncertainty has risen with Trump's impending return to the Oval Office. In the UK, the ripple effects from higher long-end yields have been felt given the country's fragile fiscal position. That said, lower-than-expected inflation data in the US and UK have recently offered some relief to markets raising the bar for a further fixed income sell-off. In the euro area, while hard data continues to show tight labour markets, survey indicators have significantly softened over the past months, lending support to a dovish ECB. We note how markets have reacted strongly to any news and rumours regarding tariff policy from incoming President Trump.
The past month, the USD has gained further tailwind from US real rates moving sharply higher, a re-tightening of financial conditions and risk-off sentiment. Conversely, the same forces have left GBP vulnerable given the UK's fragile fiscal position as it runs a large public debt and deficits, only further amplified by its current account deficit. During the past days, JPY has outperformed following hawkish comments from the BoJ, signalling a rate hike at the upcoming meeting.
Outlook: Bullish on the USD and bearish on Scandies
We maintain a bearish medium-term view on EUR/USD, expecting the pair to gradually decline towards 1.00 over a 12M horizon on the back of anticipated pro-growth and inflationary policies in the US along with our expectation of relatively stronger US growth dynamics. In the near term, however, we believe many USD-positive factors are overcrowded, leaving the USD vulnerable to a setback, driven by potential downside surprises in US data or softer-than-expected initial tariff measures by the Trump-administration. We remain medium- to long-term negative on NOK on elevated unit labour cost, continued tightness in global monetary conditions and below-trend global growth. For the SEK, we expect a continued weak cyclical outlook, a stronger USD, structural saving flows and a Riksbank continuing to front run peers to remain medium-term headwinds for the SEK.
Risks to our forecasts primarily lie in a sharper economic downturn than what we pencil in and a resurge in inflation. A much harder landing than what we pencil in would require sharp easing of global monetary conditions, which would likely entail a much weaker USD (after an initial squeeze higher) and much weaker cyclically sensitive currencies than in our base case. With the US Red sweep, the risk of a re-acceleration of US inflation and hence USD real rates in the coming years has also risen.
Author
Danske Research Team
Danske Bank A/S
Research is part of Danske Bank Markets and operate as Danske Bank's research department. The department monitors financial markets and economic trends of relevance to Danske Bank Markets and its clients.
