Yield Outlook: Higher yields depend on a host of factors

The next three months: What would drive up bond yields?

China growth concerns, Brexit concerns, fears of a trade war and specific production issues in the German car industry due to new environmental regulations are all factors that have broken the growth momentum in the euro area. These factors are not likely to come off investor agendas anytime soon, and they will contribute to keeping bond yields low for the coming months.

In other words, we expect the benchmark Bund to be trading in a tight 0-0.30% range over the next three months with investor risk appetite the main determinant of where in that range yields will be.

Important central bank policy meetings in March

We would expect the ECB to discuss the growth slowdown at its meeting on 7 March and to lower its growth forecast and perhaps even extend its forward guidance (of staying on hold) until the other side of summer. The Fed's next FOMC meeting is scheduled for 20 March, and we expect the Fed to officially go on hold at that time.

In effect, the markets have already priced in the central banks going on hold, expecting only a 10bp ECB rate hike by summer 2020 and a similar Fed rate cut within the same time frame. However, despite the already soft market pricing, confirmation by the central banks could well push bond yields a tad lower.

Possibly a different picture on a 6-12M horizon

We believe that many of the factors pushing bond yields lower during the past couple of months are of a temporary nature, and the outlook will probably be much different on a 6M-12M horizon. Our main scenario is for the global economy to be picking up in the second and third quarters. Already, there are budding signs that the Chinese economy is recovering, and we project the Germany domestic economy to strengthen in Q2 19. Avoiding a hard Brexit and the US and China coming to terms on a trade agreement are also part of our main scenario.

Our forecast thus relies on many factors developing favourably, and we continue to expect bond yields to climb slightly over the next 12M period. For example, we expect Germany's 10Y Bund yield to rise from currently 0.1% to 0.5% (previous forecast 0.7%). This brings our range forecast back to 0.35-0.75%. We expect the 10Y US Treasury yield to rise from currently 2.7% to 2.9% (previous forecast 3.15%).