In light of our revised forecasts for long-term US Treasury yields, we have raised our forecasts for the yields of 10-year government bonds in most other developed markets. But in most cases we doubt they will rise by as much as yields in the US.
- In light of our revised forecasts for long-term US Treasury yields, we have raised our forecasts for the yields of 10-year government bonds in most other developed markets. But in most cases we doubt they will rise by as much as yields in the US.
- We recently revised up our forecasts for the 10-year Treasury yield for end-2021 and end-2022 to 2.25% and 2.50%, respectively. (See here.) The change was motivated by two developments. First, the passage of the large fiscal stimulus package by the Biden administration suggests that it is both willing, and able, to pursue an extremely loose fiscal stance that will give a major boost to the US economy over the next couple of years. Second, it has become clear that the Federal Reserve now sees little need to push back on rising long-term yields, even if this results in somewhat tighter financial conditions.
- If we are right that yields in the US will continue to rise, that would probably put some upward pressure on long-term yields elsewhere. After all, yields around the world rose sharply during the February bond market sell-off, even though it was primarily caused by the US fiscal stimulus package. But we think that long-term yields elsewhere will generally continue to rise by less than in the US, for several reasons.
- First, we think prospects for economic growth are, for the most part, not as strong outside the US, thanks in part to less fiscal support and patchier vaccine rollouts. We expect this to result in less upward pressure on long-term yields than we anticipate in the US.
- Second, in some cases we think central banks will be more keen than the Fed to ensure long-term yields remain low even as their economies recover, potentially making use of existing asset purchase programmes to do so if necessary. In Japan, for one, we think there is little chance of the BoJ achieving its inflation goals on a sustained basis in the near term, which means we don’t think it will abandon its 0% target for the 10-year JGB yield any time soon.
- Meanwhile, the ECB has already indicated its discomfort with rising yields, and increased its rate of asset purchases to combat them. As the domestic economic recovery begins in earnest, we suspect that the central bank will eventually allow the yields of “core” government bonds to rise a little further. But we doubt they will rise by much, and we expect the ECB to ensure that the spreads between the yields of “peripheral” bonds and core bonds narrow further.
- Third, we think that investors are, in several cases, overestimating how much monetary policy tightening there will be. In Australia, Canada, and Sweden, for example, pricing in OIS markets suggests a good chance of policy rate hikes over the next two years. (See Chart 1.) But with inflation likely to remain below central banks’ targets in most of these places (especially once one-off effects related to the pandemic wash out) and fiscal policy not likely to be nearly as expansive as it is in the US, we doubt they will be quite so hasty to tighten policy. (See here, here & here.)
- There are, however, some cases where we do think long-term yields will rise by a similar amount as yields in the US. In Norway and New Zealand, we broadly agree with market pricing suggesting rate hikes are on the way. (See here & here.) After all, these countries were hit somewhat less hard by the pandemic than many others, and as such have smaller output gaps. And while the UK was more affected by the pandemic, we think that the BoE’s promise not to hike until it is “achieving the 2% inflation target sustainably” will lead to a prolonged period of above-target inflation, which we expect to eventually result in long-term gilt yields rising by a similar amount to yields in the US. (See here.)
- Chart 2 summarises the implications of these assessments for our 10-year government bond yield forecasts for the end of this year and next.
Chart 1: OIS-Implied & CE Forecast Policy Rates By
Chart 2: 10-Year Government Bond Yields Including CE Forecasts (%)
Sources: Bloomberg, Refinitiv, Capital Economics
Thomas Mathews, Markets Economist, firstname.lastname@example.org