Short term rates are priced to continue diverging across countries as the Fed appears inclined to continue on its hiking campaign, while the BoJ and the ECB remain ﬁrm in their support for ultra-low (and negative) policy rates, explains Francesco Garzarelli, Research Analyst at Goldman Sachs.
“Responding to the additional demand from international trade, central banks in several smaller open advanced economies wish to tighten, and the FX channel is doing some of the work for them. On balance, market discounts a very shallow trajectory for short term real rates compared to past cycles, and in relation to the current pace of the global economic expansion. Still, the expected returns to cash appear better than what they have been in the past 3-4-years, and opportunities to generate ‘alpha’ on cross-country trades abound.”
“The term premium on government bonds – the additional compensation investors require for taking duration risk in longer dated ﬁxed income instruments - is exceptionally low (in most cases, negative) and, unlike short term rates, highly correlated across countries. As we explored in previous work, part of the decline in term premium can be traced back to ongoing economic expansion (given its counter-cyclical properties), the depressed level of consumer price inﬂation and especially the widespread agreement among analysts that these dynamics are set to continue. Large scale purchases of government bonds by the major central banks have further contributed to inﬂating bond prices, pushing the term premium below what can be justiﬁed by historical relationships with macro factors. On our estimates, which attempt to control for these factors, QE policies have cumulatively subtracted around 50bp from 10-year US Treasuries and about the same amount from German Bunds.”
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