Yield outlook: Inflation = higher rates and yields

We expect US rates and yields to continue to tick up over the next 3-6 months as the US recovery gains speed, inflation expectations and real interest rates continue to rise and markets really begin to discuss the timing of Fed QE tapering.

10Y US yields look set to hit 2.0% on a 6M horizon and 2.2% 12 months from now. While we expect no US rate hikes for the next two years, the market could probably begin to speculate with a vengeance in the Fed starting to hike as early as H2 22.

The Fed will probably begin to sound slightly less dovish at the FOMC meeting in June or September 2021.

We expect reopening to come to the eurozone within the next three months. With higher inflation and inflation expectations, the ECB is likely to ‘normalise’ the pace of buying under its Pandemic Emergency Purchase Programme (PEPP) at its June meeting. That is probably also when the market will begin to discuss what QE purchases could look like in 2022.

We expect 10Y Bund yields to edge up a modest 10bp to -0.1% over the next three months and to increase a further 40bp to 0,3% on a 12M horizon.

While we do not expect the ECB, the BoE or the Swedish Riksbank to change policy rates over the next two years, the Norwegian central bank, Norges Bank, looks set to hike in September 2021 and Danmarks Nationalbank will likely deliver a unilateral Danish rate cut of 10bp, taking key policy rates to -0.6%, within the next few months.

Higher European yields and steeper curve

European yields have begun to rise again in the past month after stabilising in March. The yield on the benchmark 10Y Bund has increased by almost 15bp in the past month to stand at just below -0.2%. Worth noting here is that the US 10Y yield fell a little to 1.60% over the same period. Hence, the spread between German and US 10Y yields has narrowed from around 200bp to 180bp. Note, too, that the disappointing US jobs report for April, when just a quarter of the expected 1 million new jobs were created, only had a passing impact on the global fixed income market.

Hence, we are not far from our 3M target of -0.1% for the 10Y Bund yield. We keep our 3M forecast unchanged at -0.1%, but now expect 0% (-0.1%) on a 6M horizon and 0.3% (0.2%) 12 months from now. However, the main reason for our slightly higher yield expectations is that we have rolled the forecast by one month.

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