Yield outlook: Central banks becoming increasingly hawkish

During the past month, we have witnessed a significant repricing of a number of central banks amid mounting inflation, and several central banks have been sending more hawkish signals.

The Bank of England (BoE) has clearly announced that rate hikes are imminent. Markets are pricing a UK rate hike as early as November. This has prompted us to revise our forecast for UK interest rates, and our call is for three rate hikes during the next 12 months, taking the base rate to 0.75%.

We now expect two rate hikes, against previously only one, from the US Federal Reserve in 2022 (September and December).

We still do not expect the ECB to hike rates for the next few years. However, as inflation is proving to be less transitory than previously expected, and given the latest signals from the BoE, markets look likely to continue to price rate hikes into the yield curve. This has led to upward pressure on 2Y-5Y EUR swap rates.

The Fed will probably have enacted rate lift-off twelve months from now, and we expect to see continuing upward pressure on long-term yields. As such, we expect 10Y US Treasury yields to reach 2% on a 12M horizon. Higher US yields and a steeper EUR money market curve are pushing European yields higher, and we have adjusted our 12M estimate for German 10Y yields from 0.1% to 0.25%.

Rising commodity prices are causing concern that household purchasing power could be eroded, which would weigh on consumer spending and, ultimately, cause economic growth to slow. Bottlenecks and accompanying inflation pose a growing risk of some kind of stagflation scenario (with high inflation and weak GDP growth) materializing. The latter would tend to anchor long-term yields, as markets would expect weaker growth to resolve the inflation problem, reducing the need for higher short-term rates in the medium term.

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