European government bond yields have suddenly reversed course, and after a multi-year rally we have seen a historic jump in yields. There is no longer a QE 'scarcity premium' in German bonds and pension funds need to buy less duration when bond yields go up. Put this together with profit-taking, in a situation where the market makers at banks might be less capable of warehousing risk due to tighter regulation, and we have a perfect storm for bonds.
However, there is also a limit to how high yields can go, especially in Europe. We do not believe that the fundamental picture has changed as much as the move higher in yields might indicate. There is also a limit to how long the market can continue to sell-off on positioning. All in all, we do expect the current bond sell-off to stop and EUR yields to stabilise around the current level for the next three to six months.
However, one important factor is the spill-over from the US market, as the first Fed hike moves closer. Hence, given our bearish view on the US market, we see upside for 10-year EUR yields on a 12-month horizon. The ECB is expected to be able to keep yields in the 2y-5y segment in check at the current level and some downside could in fact be seen here.
US yields have also moved higher recently, as the US labour market remains strong, and we continue to expect the Fed to start its hiking cycle September this year followed by a second rate hike in December. Our Fed funds forecast remains well above the forward market, and we project a significant rise in US yields in the 2y-5y segment.
Our forecasts imply that we continue to expect a further widening of the EUR/USD yield spread.
As currency is flowing out of Denmark we now expect Danmarks Nationalbank to hike rates two times this year, leaving the deposit rate at -0.50% year-end.
In Sweden low inflation is expected to trigger a final 10bp rate cut in three months' time.
Norges Bank is expected to cut rates a final time in June, leaving the policy rate at 1.0% for prolonged period of time.
To Read the Entire Report Please Click on the pdf File Below