At the start of this year we had forecast a steady rise in long bond yields, driven by a favourable economic environment and less accommodative monetary policy. The 10-year Bund did rise to 0.75% in February but has fallen below 0.3% in recent weeks. US rates have been rising since the beginning of the year, but the very small difference between short and long-dated rates challenges us.
The recent fall in yields can be explained in by investors' flight to safe havens. Our economists continue to anticipate solid global growth, but the risks to this scenario are growing. Investors are worried about (1) the impact of a trade war on growth, inflation or the exchange rate, (2) tensions on emerging currencies and (3) the rise in political risk in Europe.
The second quarter was the worst one for portfolio investments emerging markets since late 2016. The Institute of International Finance (IIF) points out that “trade tensions, combined with a divergence in economic prospects, have also triggered a marked shift in allocations into US assets and away from other developed markets and emerging markets".
In the Euro area, the normalization of the monetary policy turns out to be slower than expected. The ECB will stop buying bonds at the end of the year but should not raise its key rates until the summer of 2019. The ECB will continue to play an important role on the interest rate markets by reinvesting bonds of its own portfolio maturing (estimation: €180bn in 2019 and €50bn in German debt) and should favour long-dated bonds to keep rates low.
For the time being trade tensions and the resulting threat to global growth outlook supports long term bonds. Greater confidence in growth projections and lower political risk (Eurozone) are the catalysts needed for a rise in rates. Volatility is expected to remain high in this environment, but we expect higher bond yields in the second half of this year.