Yield Outlook - Turkey and Italy keep German/Scandi yields low for now

The focal points in the European bond markets at the moment are the uncertain situation in Turkey, the political situation in Italy and the global trade jitters. The result has been renewed support to core bond markets. German 10Y yields have once again traded with a yield as low as 0.30% and the first 10bp hike from the ECB is now priced very late 2019. The drop in German government bond yields has been mirrored in the Scandinavian markets given the strong underlying fundamentals of Denmark, Norway and Sweden. 

However, we also know that financial markets will not be able to focus on these kinds of events for a prolonged period of time. If there is no material damage done to the underlying economy, focus will slowly move away from these 'events' and back to fundamentals. And the fundamental picture is in our view not damaged materially with the eurozone economy growing 0.4% in Q2 and PMI still well above the 50-level. The Fed is also still on track for two more rate hikes this year and it will take a genuine surprise for the ECB not to end its QE programme in December.

We have in this update assumed that the crisis dynamics in both Italy and Turkey have peaked and we have kept our yield forecasts more or less unchanged though we have lowered our 12-month forecast slightly, as we have lowered our 12M forecast for German 10Y yields to 0.8% from previously 1.0%. We continue to expect a steeper 2Y10Y German yield curve. The ECB still maintains a relatively tight grip on the short end of the curve, especially with the first ECB rate hike expected late in 2019.

We expect 10Y US Treasury yields to reach 3.20% on a 12-month horizon (previously 3.3%). The curve 2Y10Y is expected to flatten to just 10bp in 2019 and a temporary inversion is certainly not unlikely.

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