Tightening talk is in the air ahead of policy meetings this week at the Bank of England (BoE), the Bank of Japan (BoJ), and the Federal Reserve. Markets are pricing a roughly 90% chance of a 25-basis-point hike from the BoE. Press reports indicate that the BoJ is considering raising its zero-yield target on the 10-year government bond, which pushed bond yields higher around the world last week and prompted the BoJ to intervene in the bond market three times within a week. And while the Fed is not expected to change rate settings at its meeting this week, the gathering takes place against the backdrop of the fastest US quarterly GDP growth since 2014.
But we continue to believe that the world's major central banks will withdraw stimulus only gradually. As a result, we do not expect a sharp rise in bond yields.
- The Bank of Japan is unlikely to signal tighter policy at this week’s meeting. Core inflation at 0.8% for June is still less than half the BoJ's 2% goal, and the bank is expected to reduce its inflation forecast for FY2018 to 1% from 1.5%. The BoJ may adjust its yield-curve control policy to allow Japanese government bond (JGB) yields to move in a wider range, but we do not expect an increase in the 10-year yield target until 4Q18 or 1Q19 at the latest.
- If the BoE were to hike this week, which is not as forgone a conclusion as market pricing suggests, it probably would not quickly follow this move with additional tightening. The market is still pricing just three or four more rate hikes over the next three years.
- We now expect the Fed to pause its tightening in the fourth quarter. Although economic growth was strong in the second quarter, the US could hit a speed bump later this year as the trade conflict dampens activity.
So do not expect an acceleration of monetary tightening to push government bond yields significantly higher. We are overweight the 10-year US Treasury.
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