Lack of bonds to push 10Y German yields to zero or below

International rates – more spread widening between EUR/USD

European government bond yields have continued to fall as the ECB purchase programme continues unabated. The programme has already pushed the average German yield below zero and German bonds with a maturity up to nine years are now trading in negative territory and bonds with a maturity up to five years are trading with a negative yield below 20bp, which is the threshold level for ECB buying.

We believe the trend for lower EUR rates and yields will continue for the rest of 2015, albeit at a somewhat slower pace than seen so far in 2015. The ECB has basically created a bond ‘scarcity premium’, which we expect to continue to flatten the curve and we expect new record lows over the next three to six months. We now forecast that 10Y German bond yields will fall to zero, or even below, over the next couple of months. We expect the move lower in EUR yields irrespective of our more positive view on the eurozone economy and inflation outlook. Although we forecast that US yields will rise, we expect this to have little impact on EUR rates in the near future.

US yields have also moved lower recently as the market has postponed the timing of the first Fed hike due to the weaker-than-expected key numbers for Q1. There also seems to be a growing investor interest in buying the ‘high yielding’ US treasuries, as EUR and JPY rates are stuck at zero or below. However, we believe the Q1 weakness in US data will be temporary and that growth will be above trend for the rest of 2015. Hence, we still expect the Fed to start its hiking cycle this year. We pencil in the first hike in September 2015, followed by a second rate hike in December. For 2016 and 2017, we forecast a gradual hiking pace of 100bp on average. Therefore, we project a significant rise in US rates in the 2Y-5Y segment, while we expect long rates to be kept more in check by investor demand and a market that is not ready to price in an aggressive hiking path given still modest global inflation pressure. Hence, we expect further flattening of the curve 2s10s, 5s10s and 10s30s in the US.

Our forecasts imply that we continue to expect a further widening of the EUR/USD rate spread.

Scandi rates – still flatter curves

We expect Danmarks Nationalbank to leave interest rates unchanged over 12M. We expect some of the recent underperformance in Danish fixed-income markets to reverse and the spreads to narrow slightly versus the EUR.

Over the coming three to six months, we see limited scope for lower SEK swap rates out to five years, while there is further downward potential from five years and out. We expect the Riksbank to remain proactive, which implies a high probability of further rate cuts (possibly in relatively small steps) and further expansion of purchases of government bonds (and possibly other assets).

In Norway, we believe the market is too optimistic, pricing in more than two rate cuts, and expect to see a further flattening of the swap curve 2s10s.