- We have revised our government bond yield forecasts lower
- SNB blunder to lead to further CHF strength, but will also pressure EUR/USD
- India joins the Asian monetary easing block, following Japan, China and South Korea
Lower trajectory for Bund and Treasury yields
We have revised our forecast for 10y Bund yields for the end of this year down to 1% from 1.3% previously. At the same time, we have downgraded our forecast for 10y Treasury yields to 2.7% from 3%. In the near term Bund yields could well fall further and will any case remain at around 0.5%. This reflects that markets will price in large scale asset purchases by the ECB, while consumer price inflation will lurch further into negative territory.
Modest rise later in the year
Bund yields are expected to rise modestly later in the year. We expect the effects of oil prices on inflation to be transitory and we do not expect persistent ‘bad’ deflation. In addition, the economic recovery should gain pace. Ongoing monetary easing and the scarcity of high quality government bonds will limit the extent of the rise in yields. US Treasury yields should rise somewhat faster than those in Europe given buoyant growth and likely Fed rate hikes. However, they will also be restrained by the low yields in Europe, which make US Treasuries relatively attractive for yield-hungry investors.
SNB: what were you thinking?
It would have been great to be a fly on the wall at the SNB when senior officials were watching the CHF sky-rocketing after they abandoned the cap against the euro. It may have been increasingly difficult for the SNB to swim against the tide given the prospect of ECB QE. Nevertheless, it seems to us that the move represents a major miscalculation by the SNB (see FX Watch: the SNB’s bombshell’ for more details on this).
Losing credibility and deflation
It was a bad day at the office. First of all, the SNB has put its credibility at stake. The market will think twice if the SNB announces again that it is committed to doing something. Second, the sharp rise in the CHF risks another bout of falling consumer prices.
Further CHF strength and more pressure on EUR/USD
We expect to see further CHF strength over time against the euro. In addition, given less intervention to buy euros in particular, we also expect further downward pressure on EUR/USD on top of the other negatives.
Asian giants use scope for monetary easing …
Central banks of the large Asian economies continue to ease monetary policy, with falling prices of oil and other commodities driving inflation (expectations) down (also see our Asia Watch, Cheap oil a blessing for Asia, published yesterday). On Thursday, the Reserve Bank of India (RBI) joined the Asian easing camp. Previously, Japan has used large-scale quantitative easing, China cut policy rates in November, and used other monetary tools as well, and South Korea lowered its policy rate to a record low in October.
… with the RBI following its East Asian counterparts
The RBI lowered its benchmark rate by 25 bps, to 7.75% in an unannounced interim meeting and cut some other policy rates too. The timing of the move was surprising, but we had expected the RBI to cut rates soon. With inflation being pushed down by falling commodity prices – trickling down into core inflation as well – the difference between the repo rate and CPI had risen to 300 bps. The RBI already signaled a shift to an easing bias in late 2014. The RBI had been on hold since January 2014, after having prudently hiked rates during the Fed tapering-related turmoil in 2013 and early 2014.
Further easing to come
Going forward, we expect further ‘measured’ easing in China, India and South Korea and also see some room for easing in a number of smaller countries. In general, though, the room for easing is constrained by possible contagion from Fed rate hikes foreseen from mid-2015 onwards.