US: Yields to move higher on Fed repricing and fiscal policy - Danske Bank

Analysts from Danske Bank, see that the latest boost to fiscal policy in the US and the possible pricing of more rate hikes in the US, is the main reason to see a move to the upside US 10Y yields.

Key Quotes: 

“We still expect the Fed to hike three times this year but are looking forward to the updated rate signal from the Federal Reserve when they meet next week. We think the Fed will maintain its signal of three hikes this year, which will probably be interpreted dovishly by the market, as the three hikes are already fully priced.”

“We expect the Fed to raise the Fed funds rate above the longer-run dot of 2.75% (which is the Fed’s estimate of the natural rate of interest when the economy is normalised – when the Fed funds rate is at this level, monetary policy is neither expansionary nor contractionary) in coming years, as we now expect three hikes in 2019 (previously two) and possibly could see the hiking cycle continue into 2020. Hence, we disagree with markets, as markets believe the Fed will soon be finished with hiking, as only 1.25 additional hikes are priced in next year. We believe the Fed thinks it is time to hit the brakes, as fiscal policy has become more expansionary and the output gap is nearly closed.”

“We still see a case for a Fed repricing in 2019, pushing 2Y yields higher. We continue to expect a flattening of the curve for the 2Y10Y on a 12-month horizon. However, we still see the 10Y US treasury yield at 3.30% in 12M, as we see a further repricing of the US term premium given the risk of higher interest rate volatility and as we see an effect from the more expansive US fiscal policy going forward, which will boost US bond supply.”