Bond yields set to rise further but mostly in 2019 - Danske Bank

Analysts from Danske Bank continue to expect a modestly steeper EUR yield curve for the 2Y-10Y in 2018 and the ECB to maintain a relatively tight grip on the short end of the curve in 2018 in particular. They see the higher 10Y EUR yields to materialise primarily on a 12-month horizon.

Key Quotes: 

“We continue to see a further widening of the two-year spread between USD and EUR rates, as we expect the Fed to hike three times this year, and we are looking forward to the updated rate signal from the Fed at this weeks’s FOMC meeting. We think the Fed will maintain its signal of three hikes this year, which would probably be interpreted as soft by the market, as three hikes are already fully priced.”

“We now expect the Fed to raise the Fed funds rate above the longer run dot of 2.75% (the Fed’s estimate of the natural rate of interest when the economy is normalised) in coming years. We also now expect three hikes in 2019 (previously two) and 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.”

“Last month we revised higher our 12M forecast for both 10Y US and Bund yields. We have kept these forecasts unchanged this time. However, given the still-subdued inflation picture globally, a general lower risk appetite and a market we believe is likely to buy into the ECB ‘no taper tantrum’ story, we postpone most of the expected rise in yields until 2019, when the first rate hike from the ECB will be in sight and it will be clear that the Fed plans to continue hiking rates.”

“We continue to expect a steeper EUR yield curve. The ECB still maintains a relatively tight grip on the short end of the curve. However, this is not the case for the 10Y segment of the curve, which we still expect to be pushed by higher US yields, the end of ECB QE from the ECB and pricing of rate hikes in 2019 and 2020. An expected higher term premium works in the same direction. We have unchanged 12-month 1.2% and 3.3% forecasts for 10Y German Bund yields and 10Y US Treasury yields, respectively. The latest boost to fiscal policy in the US and the possible pricing of more rate hikes in the US is the main reason we still see upside for US 10Y yields. The latter would have a tendency to push long yields in the eurozone higher.”