Many factors have contributed to the move lower in yields over the summer. The fall in commodity prices has pushed long-term inflation expectations lower and the concern about China has spurred safe-haven buying especially in US Treasuries. The ECB has also continued its QE purchases unabated and finally the discussion from the spring regarding a scarcity premium in bunds has re-emerged. Given that the ECB is not allowed to buy bonds with a yield below -0.20 and many investors favour a positive yield, the ECB and investors are forced to buy bonds further out on the curve, adding further momentum to the downward pressure on yields.
Many of the factors above could continue potentially continue for the rest of the year. We would label such a scenario 'Scarcity Premium vol. 2.0'. A test of zero for 10Y bund yields would not be unlikely , especially if, contrary to our macro view, the Fed put rate hikes on hold due to the deflationary effects of lower commodity prices and the devaluation of the yuan.
However, in our baseline scenario, we keep a very modest upward profile for 10Y German yields , as we expect (1) a Fed hike in September, (2) that oil prices will bottom out over the coming months and (3) that the market will put focus on higher eurozone headline inflation in Q4 and (4) that the Chinese economy and the weaker yuan will not derail the economic recovery in the eurozone and the US.
We expect somewhat higher US yields in Q4 15 and 2016 as, according to our forecasts, the Fed will hike rates by 25bp each quarter in 2016. We expect 2Y and 5Y yields in the eurozone to stay very low throughout the forecast horizon. The ECB can still keep these in check.
We expect a steepening of the German curve 2Y10Y and 5Y10Y due mainly to the spill over from the US in the long end. The opposite is expected in the US, as the market can still price in hikes in the policy sensitive 2-5Y segment of the curve and as still-low inflation and foreign demand keep a lid on 10Y yields.
As currency is flowing out of Denmark, we still expect Danmarks Nationalbank to hike rates twice on a 6M horizon, leaving the deposit rate at -0.50%. In Sweden, we expect a final rate cut before year-end. Finally, despite the lower oil price, we expect Norges Bank to be on hold for the rest of 2015 but the risk is clearly skewed towards a rate cut .
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