Global Daily – The rally in rates markets is advanced but not over

by: Nick Kounis , Jolien van den Ende , Aline Schuiling , Bill Diviney

Global Rates: Macro environment and central bank easing should remain supportive We have updated our rates forecasts given the downgrades to our global economic scenario and the more pronounced and speedy global monetary easing cycle that looks to be on the way (see our daily notes of the last few days). Our new set of rates forecasts is set out in the table below. We think there is room for the key benchmark yields to fall somewhat further in the near term, with curves generally flattening. At the same time, we think sovereign yield spreads over Germany and asset swap spreads will widen. Later in the year, these trends will reverse, as we expect the global economy to turn from around Q3, and rebound from Q4 onwards. This assumes that the coronavirus is brought under control in most countries in Q2, while we will see significant macro stimulus, which overtime will support growth.

There are a number of considerations behind our projections:

1. We expect a modest global economic recession in the first half of this year. The eurozone should see a technical recession, while the US economy stagnates in our base scenario. Our economic growth forecasts are below consensus, so if we are right, macro and earnings downgrades are on the cards. Later in the year, investors could in contrast be surprised by the speed of the economic upturn.

2. We expect investor sentiment to remain conservative during this period of economic weakness, with credit spreads likely to widen more significantly. Against this background, we would expect asset swap spreads to widen, as they correlate strongly with measures of bank credit risk. At the same time, a step up in the ECB’s QE programme (see below) will also be supportive of this trend.

3. A global monetary easing cycle has already started and is not over yet. We expect the Fed to cut by another 50bp (spread over March and April) and the ECB to announce a stimulus package next week. This stimulus package should include a 10bp deposit rate cut and a step of net asset purchases to EUR 40bn. In addition, the TLTRO programme may well be adjusted to make it more generous in terms of maturity and the collateral accepted. The balance of risks is tilted towards another round of stimulus in the coming months.

4. We judge that our base case for central banks is largely priced in judging by market short rate expectations, but also the fall in term premiums in the US and Germany back to August levels. The latter is indicative of a pricing in of a step up in ECB net asset purchases. Having said that, markets will likely continue to price in more aggressive stimulus as long as macro data weaken and risks remain tilted to the downside. So we think rates can fall somewhat further, though we note as well that the trend is now well advanced.

5. Sovereign yield spreads usually benefit from monetary easing. However, we think that this positive effect will be offset by the weak macro environment and conservative investor sentiment. Hence, our forecast for near term widening. Later in the year, as these drivers reverse, sovereign yield spreads should tighten again.

6. Although we expect the key US and German benchmark yields to rise later in the year, we expect a relatively moderate move. Especially in the eurozone, we think 10y Bund yields will remain deeply negative given ongoing accommodative monetary policy and very weak inflationary pressures. In addition, we judge that neutral rates are on a downward trend, which should also cap the rise in yields. (Nick Kounis, Jolien van den Ende, Floortje Mertens, Aline Schuiling and Bill Diviney)