Yield Outlook: Market rates and yields set to continue rising

As we wrote in the previous issue of Yield Outlook, 17 December 2021, there is increasing concern that high inflation is not just transitory but is proving more persistent, hence requiring far more resolute action by the central banks.

The inflation outlook does not seem to have become less of a concern since then. US CPI headline inflation surged to a 40-year high of 7.1% and German headline inflation hit 5.3% in December. Furthermore, inflation expectations have remained high and labour markets in both the US and Europe continue to tighten. In late 2021, inflation was driven, not least, by rising commodity and input prices but underlying inflation has also edged up everywhere. The central bank nightmare of rising commodity prices and tight labour markets fuelling price and wage pressures is perhaps coming true.

This is the uncomfortable truth that the Fed has already addressed. The ECB will have to do so in 2022, and risks are skewed towards 2023 spelling the end of negative ECB policy rates, in our view.

The market has already started pricing this scenario. 10Y German yields have turned positive for the first time since 2019 and 10Y US yields are moving towards 2%. We expect yields to continue rising through 2022. As we wrote in the November edition of Yield Outlook, 16 November 2021, this development is, not least, prompting upward pressure on 3Y-5Y EUR yields, as this part of the yield curve is particularly sensitive to market pricing of the ECB.

While an ECB rate hike in 2022 is not our baseline scenario, we expect markets to increasingly price rate hikes in 2023 and 2024. We expect 10Y US Treasury yields to hit 2.25% in 2022, up from our previous 2.0% forecast. 10Y Bund yields are likely to increase to 0.3% in 2022.

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