The bond market is now priced for strong growth
Long bond yields have continued up in the past week, although the pace of the sell-off
seems to be slowing. Solid macroeconomic data and optimistic sentiment continue to add
pressure on the fixed income market in relatively thin pre-Christmas trading. In the past
week a very strong US retail sales report and solid PMI data for Euroland added further
evidence that the recovery is speeding up again.
The sell-off continues to be driven by the US, but with significant rub-off effects on
Europe. In most European countries 10-year government bond yields are now back at
April or May levels. With the Fed, the ECB and BoE still on hold this has left the curves
significantly steeper.
In the US the steepness of the 2-10 is back at record high levels. Hence, for the sell-off to
continue 2-year yields must also start to move higher. However, that would in turn
involve a more aggressive pricing of Fed hikes. We think that would be inconsistent with
the recent communication from the Fed and most macroeconomic forecasts – including
our own.
Put differently, we think that long bond yields have now priced in a relatively strong
recovery involving growth between 3-3.5% in the US.
New yield forecasts – limited room for higher yields in 2011
This week we published new yield forecasts. We have lifted most of our forecasts for
long bond yields, but do see limited room for higher yields in 2011. With the market
already expecting solid growth, we need either policy tightening or higher inflationary
pressure to push yields significantly higher. Neither are likely to materialise anytime soon
– and in particular not in the US. In fact we think that there remains a good case that once
the market calms down, yields will reverse some of the recent increase.
However, in Europe we see a case for gradually higher 2-year bond yields materialising
already in Q2, as the ECB resumes its normalisation of liquidity measures and eventually
moves toward ordinary policy tightening late next year. This will also tend to add upward
pressure on the long end on a 6-12 month horizon, but it will remain gradual.
Bottom line is that the fixed income markets have now front-loaded their expectations for
growth and delivered all of the increase in rates that we originally anticipated for next
year. This also implies that the market will be sensitive to negative surprises going into
next year. The economies will have to deliver strong growth to justify the current level of
rates.
Short-term focus on US key figures
With the US Treasuries being the main driver of the global fixed income sell-off, nearterm focus will be on US economic data. During Christmas the calendar is relatively light,
but early next year ISM, non-farm payrolls and the FOMC meeting will be key events.
In Europe the last 1Y LTRO worth EUR97bn expires. Last time a 1Y LTRO expired (in
late September) it drained a significant amount of liquidity from the money market
adding upward pressure to money market rates. We see risk of a repeat.
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