Yield outlook - QE beats supply, keeping long EUR and USD yields low for now

COVID-19 and its economic consequences, together with the monetary and fiscal policy response, have set the direction for global fixed income markets over the past month. 

We expect the development in new infections and the likely reopening of economies to continue to set the agenda in coming months. Once we get to late summer and autumn, a key theme will probably be how hard the global economy was hit and how fast the recovery will materialise. 

In addition to business cycle conditions, we expect two factors to set the direction for global fixed income markets in coming months and quarters: firstly, eurozone and US funding needs and, secondly, the new QE programmes launched by the ECB and the Fed.

Overall, we expect 10Y Bund yields to trade at around current levels of -0.50% or slightly lower for the next 3-6 months, increasing to -0.2% on a 12M horizon. We expect US 10Y Treasury yields to fall to 0.5% on a 3M horizon and to rise to 0.9% 12 months from now. 

In addition to business cycle conditions, we expect two factors to set the direction for global fixed income markets in coming months and quarters: first, eurozone and US funding needs and, second, the new QE programmes launched by the ECB and the Fed. The eurozone has already announced crisis measures amounting to nearly EUR435bn, or 2.5% of GDP. Furthermore,anumberofguaranteeshavebeenputinplaceandweexpectfurtherfiscaleasing infuture.TheUShaslaunchedalargefiscalpackageworthUSD2,000bnandPresidentTrump is talking about further fiscal measures.

Normally such a huge funding and issuance requirement would cause long yields to jump higher. Investors are not likely to be able to rapidly absorb such large government bond sales, although a crisis situation like the current usually boosts interest in safe haven assets.

Both the ECB and the Fed have launched major QE programmes as a counterweight to the large supply of government bonds. Under its new Pandemic Emergency Purchase Programme (PEPP), the ECB will be buyingEUR750bn worth of European government bonds, including agency bonds from issuers such as KfW. This comes on top of an extension of the ECB’s existing APP in government and agency bonds by EUR120bn, takingthe APP programme to EUR300bn. There are very few restrictions on the new PEPP as regards asset classes and ISIN limits. The purpose is not only to keep ratesand yields low in particularly exposed countries, such as Italy and Spain, but also to anchor general yield levels as represented by Germany. If even larger purchases should be needed, the ECB is likely to extend/increase the programme, so it would come to look even more like the Fed’s QE programme. The Fed has made its QE flexible and open-ended, allowingit to continue buyingassetsuntil it no longer sees a need for keeping rates and yields under control.

In other words, the world’s three largest central banks (BoJ, ECB and Fed) have now all put an explicit or implicit cap on long-term yields levels. We expect this cap to remain in place for at least the next three months.