Bond yields have started the New Year on the up. Ten-year US Treasury yields rose 5.8 basis points (bps) on 2 January and 10-year breakevens climbed above 2% for the first time since March 2017. German 10-year Bund yields increased by 4.1bps to their highest level since 25 October, partly on the back of more hawkish rhetoric from European Central Bank officials.
While we do expect monetary policy to tighten through the year, we do not expect this to translate into a strong boost in yields:
- Normalization will only be gradual. The Federal Reserve is reducing its balance sheet, but we estimate it will shrink by less than 10% this year. Until September 2018, the major central banks (Fed, ECB and Bank of Japan) will remain net providers of liquidity to the global financial system.
- The Fed estimates that its entire quantitative easing program lowered long-term bond yields by just 100 basis points – if correct, a withdrawal of part of this would have only a minimal impact.
- Structural factors holding down rates still persist; for example, regulation continues to force pension and insurance fund managers to stock up on long-term fixed income assets.
We don’t expect much further upside in US and German 10-year bond yields. Our six-month forecasts are for yields of 2.5% for US and 0.6% for German 10-year yields, from current levels of 2.47% and 0.45%, respectively.
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