Yield Forecast Update: Volatility Is back‏

Discussions regarding the Fed's scaling down of asset purchases later in the year have fuelled a sell-off in the core bond markets, which has led to a rise in volatility over the past month.

European markets have not been shielded from the increase in rates, despite a weak economic outlook and the ECB keeping its options open for further easing.

The increased volatility caused tension in the risk markets. The peripheral bond markets mostly underperformed, and there has been a wash-out in the emerging markets bond universe.

Although there are small upticks in European confidence indicators, U.S. data has proved somewhat disappointing lately, confirming our belief in a soft patch in Q2. We expect the macro picture to improve again later in the year - especially in the U.S.

Globally, inflation remains subdued, and inflation expectations have inched lower recently. Given the rise in nominal rates, real interest rates have risen sharply, which is probably not sustainable before the macro picture improves.

International rates

We keep our 3M forecasts broadly unchanged across the board. Hence, we expect rates in EUR and USD to move a little lower over the summer, before resuming a gradual uptrend on a 6-12M horizon. We have lifted our 12M forecasts a little. The forecasts are below forwards, across tenors and time horizons.

It is not our main scenario that the ECB lowers the refi rate further but the option is still on the table. We expect the ECB to react if data softens again.

We expect discussions about tapering off QE purchases to intensify later this year. At the current stage, we believe rates have risen too fast across the curve, and expect a correction lower on a 3M time horizon before the uptrend continues as data improves.

In the U.K., Mark Carney will take over as Bank of England governor and some form of forward guidance seems to be the most likely change in the MPC's stance. We expect this to be published in the August Inflation Report (due August 7).

Scandi rates

In Denmark, the bias is for a 10bp independent hike from Nationalbanken over the coming 12 months. We expect the yield spread to Germany to remain stable.

It will be a close call whether or not the Riksbank cuts in July, as the domestic economy is lukewarm, inflation is low and - not least - inflation and wage expectations are close to record lows. Our main view is for an unchanged repo rate.

In Norway, it is our main view that the rate decision on 20 June will be 'no change', implying that Norges Bank will reiterate the 40% chance of a cut this year.

Next Yield Forecast update is due on 15 August

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