We assume that the ECB is set to embark on a very careful exit strategy, ending its QE purchases in December 2018 and a very gradual hiking cycle in Q2 19. Importantly, we expect policy rates to remain substantially below pre-crisis levels due to a lower natural rate of interest.
Hence, despite our 12-month forecast now covering December 2018, when the ECB's QE is about to end and when the first, albeit small, rate hike is expected on a six-month horizon, we continue to see only relatively modest upside for both USD and 10Y yields. We expect the 10Y EUR swap rate to rise from 0.8% to 1.20% and the 10Y USD swap rate to rise from 2.40% to 2.70%.
For the next six months we expect 10Y rates to range-trade close to the current level, albeit with a tendency to edge slowly higher.
Markets have nearly priced in two hikes in the US in 2018 but seem to more or less believe that the hiking cycle ends by end-2018 or early 2019. We disagree and think the hiking cycle has a little further to go and see two further hikes in 2019. Hence, we still see a case for a Fed repricing next year in 2019, pushing 2Y yields higher, and we continue to expect a flattening of the 2Y10Y US curve on a 12-month horizon.
In Germany, we expect a modestly steeper yield curve for the 2Y10Y in 2018. We expect the ECB to maintain a tight grip on the short end of the curve in 2018. However, this is not the case for the 10Y segment of the curve, which we expect to be pushed by higher US yields and the end of the QE programme. We have a 12M 0.70% forecast for 10Y German yields.
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