Rising yields are on the menu for 2018 if the global consensus forecast of growth, inflation and monetary policy normalisation play out, according to AMP Capital NZ chief economist, Bevan Graham.
In an article penned last week, Graham says AMP concurs with the general investor expectations of rising inflation egged on by solid growth and the gradual reduction of ‘unconventional’ central bank support.
He says the early 2018 increase in US 10-year Treasury yields – which topped 2 per cent for the first time in almost a decade – should be more sustainable that a similar blip upwards at the start of last year.
“Of course, last year yields then drifted lower as inflation went through a mid-year soft patch,” Graham says. “In our view, higher US bond yields this year are supported by the fundamentals.”
December 2017 data indicated US core inflation was running at an annualised 2.5 per cent, above market expectations of about 2 per cent, the article says.
Meanwhile, the US Federal Reserve has room to move with rate hikes – with three baked in for 2018 – as full employment and the current base rate of 1.5 per cent “well below neutral (currently thought to be 2.75%)”.
“Of course we need to acknowledge yet again that no-one actually knows where neutral is now, which is why much of the recent move higher in yields has been at the shorter-end of the Treasury curve as the market has moved to agree with the FOMC [Federal Open Market Committee] that three hikes are likely this year,” Graham says. “The longer end is still sceptical about just how big a problem inflation is going to be and hence the flattening of the yield curve.”
Additionally, the FOMC will reduce its balance sheet – inflated post-GFC to prop up markets under ‘quantitative easing’ programs – by about US$250 billion during 2018. ‘Quantitative tightening’ combined with a likely increase in US government debt issue to cover newly-rising deficits would “support higher yields in 2018”.
“… though we expect this to remain gradual,” the AMP Capital article says.
Other central banks “including, surprisingly, Japan” were also poised to withdraw monetary stimulus putting further pressure on global debt markets, Graham says.
However, NZ rates should stay on hold for most of this year “if not into 2019”, he says.
Market consensus views on rising rates could be blurred, though, if growth or inflation data hits a “weak patch” in 2018.
“And while we don’t worry too much about the market’s ability or willingness to absorb increased Treasury supply this year, higher yields will be necessary to clear the market,” Graham says. “Rumours last week of China looking to reduce its purchases of Treasuries, later refuted by a Government official, shows the market’s sensitivity to the supply issue.”