US: Low December rate hike odds likely to push yields slightly higher

According to analysts from Danske Bank, markets have only priced in a December rate hike from the Federal Reserve with a probability of approximately 30%, which is too low in. Hence, they see US yields trending slightly higher.

Key Quotes:

“At the meeting next week, we expect the Fed to announce it will begin ‘quantitative tightening’ in October. We still call for a third Fed hike in December with a probability of around 55%, as the Fed puts more weight on labour market data than inflation rates. We expect two hikes next year although it is more difficult to say what will happen given there are four vacant seats on the Board of Governors and possible five if President Trump does not reappoint Yellen as Fed chair.”

“We still think risks are skewed towards the Fed pausing its hiking cycle due to low inflation, which may not be just ‘transitory’ given the low inflation expectations. We have already seen increasing discussions between the doves and the hawks.”

“Markets have only priced in a December hike with a probability of approximately 30%, which is too low in our view. Hence, if our baseline scenario is correct, it should tend to push US yields slightly higher. However, we do not see a major sell-off this year. In 2018, we expect growth in the US economy to continue, which would trigger another rate hike in the summer of 2018. We continue to expect a flattening of the curve for the 2Y10Y on a 12M horizon. The short-end would be pushed higher by Fed rate hikes, while the long-end would be kept low by investors buying ‘high yielding’ US fixed income assets.”

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