The yields of most 10-year developed market government bonds have fallen back a bit today. But the bigger picture is that they have risen over the past month, continuing an upward trend that started in September, as investors have progressively become less dovish on the prospects for monetary policy in most economies. Looking ahead, we generally don’t expect big moves in yields either directions. But we do expect to see some variation in performance given the outlook for monetary policy.
- Germany’s inflation probably rose a bit last month, but remained well below 2% (13.00 GMT)
- We think that the US ISM manufacturing index rose to 50.0 in December (15.00 GMT)
- FOMC minutes are likely to signal that the Fed will remain on hold this year (19.00 GMT)
Key Market Themes
The yields of most 10-year developed market government bonds have fallen back a bit today. But the bigger picture is that they have risen over the past month, continuing an upward trend that started in September, as investors have progressively become less dovish on the prospects for monetary policy in most economies. (See Chart 1.) Looking ahead, we generally don’t expect big moves in yields either directions. But we do expect to see some variation in performance given the outlook for monetary policy.
Chart 1: Changes Since 3rd September 2019 (bp)
Sources: Bloomberg, CE
In part, the recent sell-off in bonds reflects signs of stabilisation in the global economy – the latest PMIs, published today, are mostly up from a month ago, although in the euro-zone they are still consistent with a contraction in economic growth. Growing optimism about a trade deal between the US and China has also given a boost to risky assets at the expense of safe havens like bonds.
Nonetheless, while we think that the global economy will bottom out in the first quarter of this year, we expect the pace of the recovery thereafter to be relatively slow and, perhaps most importantly, spread unevenly across regions. In particular, we expect the US to lead the recovery among developed markets, while we forecast that growth in the euro-zone will slow further. (See here.) We also suspect that investors’ optimism about any boost to growth from trade is misplaced. In our view, the phase-one deal recently agreed between the US and China won’t mark the end of the trade war. (See here.)
With all this in mind, monetary policy is likely to remain highly accommodative for the foreseeable future. As such, we doubt that the sell-off in government bonds of the past couple of months will gather more momentum. To be clear, we are not forecasting a big rally in bonds either, as in most cases our expectations for monetary policy are no longer markedly different from those of investors. Continental Europe and Australia are the key exceptions. This is because in both cases we expect rates there to be cut further. We also forecast that the ECB will increase the pace of its monthly asset purchases and that the RBA will launch quantitative easing for the first time. (See here.) This underpins our view that the yields of 10-year government bonds in Germany and Australia will fall by about 30bp and 80bp respectively, to -0.50% and 0.50%, between now and end-2021. In contrast, we think that yields in the US and Japan will stay roughly unchanged. (See Chart 2.) The “biggest” rise in yields that we forecast is in the UK, but this reflects our view that if necessary the UK will eventually extend the transition period. (See here.) (Simona Gambarini)
Chart 2: Policy Rate At End-2021: CE vs. OIS-Implied & ∆ In 10Y Gov’t Bond Yield By End-2021: CE Forecasts*
Sources: Refinitiv, Bloomberg, CE
Selected Data & Events
ISM Manufacturing Index (Dec)
*m/m(y/y) unless otherwise stated; p = provisional
Key Data & Events
We think that the ISM manufacturing index rose in December, from 48.1 to 50.0. That would be in line with the improvement in the alternative Markit PMI survey and global activity data over recent months. Over the course of 2020, the halt of 737 Max production in January will hurt the already-beleaguered manufacturing sector, but with global growth stabilising, trade tensions easing, and financial conditions loose, activity is likely to improve.
Meanwhile, the minutes from the December FOMC meeting are likely to underline that policymakers intend to keep interest rates on hold for the foreseeable future, even if economic growth and inflation rebound. The minutes might also provide more detail of the Fed’s discussions on how they plan to ensure an ample supply of excess reserves beyond their recent liquidity injections – which helped to prevent a big year-end spike in repo rates. (Michael Pearce)
The euro-zone manufacturing PMI for December was revised up slightly from the flash estimate, but it is still consistent with industrial production contracting by about 3% y/y. What’s more, the Italian and Spanish output indices fell sharply, pointing to even bigger declines in output in those countries. Meanwhile, although Sweden’s manufacturing PMI rose in December to a four-month high, it is still well below 50 and consistent with continued declines in industrial output there. In contrast, Norway’s manufacturing PMI increased to 55.5, more than reversing November’s fall and adding to the evidence that the Norwegian economy remains in comparatively good shape.
In the UK, the manufacturing PMI confirmed that the sector continued to struggle at the end of the year. The December reading was revised marginally higher, but it is still the second lowest in more than seven years. With manufacturing struggling in most of the UK’s trading partners, we doubt that the sector will rebound at the start of 2020, even if Brexit uncertainty has eased a bit. Meanwhile, there have been some tentative signs that the election result and passage of a Brexit deal through Parliament has led to reduced business uncertainty. The Bank of England’s Decision Maker Panel survey showed that Brexit was one of the three most important sources of uncertainty for 53% of firms, down from 55% in June. And the figure may be lower now, as two thirds of responses were received before the general election. (Jessica Hinds & Andrew Wishart)
While the Caixin manufacturing PMI declined to 51.5 last month, it remains unusually strong compared to other data – the official manufacturing PMI, published on Tuesday, held steady at 50.2, and industrial metal prices also point to more subdued activity last month. Admittedly, there are some signs of a genuine improvement recently, especially on the external front. Over the coming months, we think that exports will continue to benefit from recovering global demand and (at the margin) US tariffs rollbacks. But domestic demand will probably cool further. After jumping in November, the official non-manufacturing PMI resumed its recent downward trend last month. With that in mind, we doubt that the planned fiscal stimulus this year will be sufficient to stabilise growth. Therefore, we think that the RRR cut announced on Wednesday will need to be followed by more monetary policy easing than most anticipate in the coming quarters. (Sheana Yue)
Other Emerging Markets
India’s manufacturing PMI rose to a seven-month high of 52.7 in December, suggesting that the sector has recovered from its weakness last year and supporting our view that the recent economic slowdown has now run its course. Given the scale of policy loosening last year, the outlook for local manufacturing is likely to be brighter in 2020. The PMIs for the rest of Emerging Asia also mostly picked up, which is consistent with our view that while regional growth remains weak, it has at least bottomed out. Otherwise, according to the initial estimate published on Thursday, Singapore’s economy grew by just 0.1% q/q annualised in Q4 last year, down from 2.1% in Q3. However, the numbers are based on preliminary data from only the first two months of the quarter and are generally not a very good guide to the final reading.
December’s batch of manufacturing PMIs for Central Europe remained consistent with a further slowdown in industrial production growth there over the coming months, but there are tentative signs that external demand is improving. Meanwhile, Turkey‘s PMI was unchanged at a level suggesting that the economic recovery is unlikely to gather much more momentum, but other indicators paint a more positive picture. (Darren Aw, Gareth Leather & Jason Tuvey)
Published at 16.44 GMT 2nd January 2020.
Editor: John Higgins (+44 20 7811 3912)
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