The German and US 10-year yields have risen in recent weeks and have returned to levels that have not been reached since 6 and 10 months respectively (at respectively 0.58% and 2.55% on Thursday 11th). Several factors contributed to this rise:
- the adoption in mid-December of the US tax reform. This led market participants to anticipate stronger growth in the US in 2018 and 2019, but also a higher fiscal deficit in the context of the gradual Fed's withdrawal from the Treasury market.
- a slight decrease in long-dated and very long-term bond purchases by the Bank of Japan (BoJ),which has revived discussions about the gradual withdrawal of unconventional monetary policies by central banks. It is important to remember that the BoJ's monthly purchases of JGBs have been slowly but steadily declining since the beginning of 2016.
- the ECB minutes of the December Governing Council that show that the “forward guidance” will be updated gradually,as activity figures improved and as the ECB should avoid “more abrupt or disorderly adjustments at a later stage”. The pace of ECB’s QE has been halved to €30bn/month until September 2018 and it is very likely that the ECB will stop its net asset purchases this year.
- a Bloomberg article alledging that the Chinese authorities were thinking of slowing down or even halting purchases of US Treasury securities,with the idea that they have become relatively less attractive. In October, China held $ 1189 bn, making it by far the largest foreign holder (1094 bn for Japan). The anti-correlation between long-term rates and the share of Treasury securities held by non-residents has risen sharply in recent years.
- the steady rise in oil prices since mid-June, which pushed up inflation expectations. The US 10-year inflation breakeven has closely followed the evolution of oil prices and has just returned above the 2% mark, which had not happened since March.
Note that the rise in long-term rates was held back during the week by the anonymous statements by Canadian government officials that the Canadian government was increasingly convinced that the US would withdraw from NAFTA. On the top of that, Canada has also filed a WTO complaint against its neighbour. Thus, the theme of the trade war will remain in 2018.
Overall, we anticipate that long-term rates will continue to rise this year, even if the upside is becoming weaker for US yields.