• Government bond yields to fall further in the near term on Fed delay and more ECB QE
• ECB not ready to step up QE in October, but we think a December move is still likely
• Fed officials signal some wriggle room on 2015 rate hike view, setting scene for 2016 move
Changes to our bond yield forecasts
We expect government bond yields to fall further on both sides of the Atlantic in the near term and to rise more slowly during the course of next year. We see 10y US Treasury yields at 1.9% at year end and 2.6% by the end of next year (previously 2.3% and 2.7%, respectively). Meanwhile, we expect 10y Bund yields to decline to 0.4% by year end before rising to 1% by the end of next year (previously 0.5% and 1.4%).
Fed delay, ECB QE plus to support bonds
The change to our bond yield forecasts follows changes to our monetary policy calls last week. We expect the Fed to delay raising interest rates until 2016, with our base case now for a June lift-off compared to December 2015 previously. Given that markets are still pricing in some probability of a rate hike over the next few months (see chart), a delay should see some further pricing out. This should be supportive for Treasuries. In addition, we expect the ECB to extend its asset purchases beyond September 2016. We had already expected the ECB to raise the level of its monthly purchases (by EUR 20bn a month taking the total to EUR 80bn p/m). A stepping up and extension of QE should be a supportive factor for Bunds in the near term.
The changes reflect downside risks to global growth from China and other emerging markets, low commodity prices and a generally subdued inflation outlook. The Fed’s delay will also put upward pressure on the euro, forcing the ECB to react.
ECB is not yet ready to go in October
Commentary from ECB and Fed officials over recent days suggests they are keeping their options open for now. For instance, Executive Board member Benoit Coeure said that it was ‘premature to discuss’ more QE, though the Governing Council needed ‘to be ready’ to act if necessary. Given that the ECB already projected inflation below its medium term objective in September, and the euro is already above the level it assumed then (1.136 versus 1.10) the central bank’s procrastination could be considered as complacent. Though it seems that the Governing Council wants to see more data to get visibility in to what is happening in emerging economies and commodity markets.
Fed’s Vice Chairman Fischer in no hurry for rate hike
Meanwhile, Fed officials continue to signal that a 2015 hike is their base case, but are also giving themselves wiggle room to delay to 2016 by stressing the increased uncertainty. On Sunday Fed Vice Chair Stanley Fischer noted, during the Group of Thirty Banking Seminar in Peru, that ‘…more time is needed to appraise recent developments in the global economy before beginning normalization of interest rates’. Fischer said that ‘more focus on foreign economic developments in recent FOMC statements was natural given the increasing influence these had on the US economy, both through imports and exports and capital account developments’. According to the Vice Chair, the rate hike this year ‘…was premised on the assumption of continued solid economic growth and further improvement in the labour market, which are key factors in supporting our expectation that inflation will rise to our 2% objective’.
Fed’s Dudley to discuss appropriate level of interest rates
FOMC participants are quite divided on the timing and path of rate hikes. The FOMC’s communication has been somewhat confusing. The tone of FOMC participants in upcoming speeches will be critical to assess whether the Fed’s view of the timing for the first rate hike is shifting. The influential President of the New York Fed, Bill Dudley, a voting member, will speak on Thursday about monetary policy.