Yields on Canadian government bonds have hovered in a range this year as the global yield sell-off has paused. The yield curve remains in a steepening trend as the Bank of Canada has attempted to keep the possibility of a rate cut on the table, although a recent string of positive employment surprises has made that possibility less likely. Canadian government bond yields are likely to remain range-bound in the near term until more certainty emerges around global economic prospects.
Below is an overview of the Invesco Fixed Income team’s outlook for interest rates in key world economies:
Near-term growth is likely to surprise to the upside, supporting the case for the Fed to raise interest rates further. We believe the Fed will hike interest rates three times in 2017 and could begin as soon as March. A non-press conference hike at the May meeting is also possible. Near-term core inflation should remain stable, but the fiscal policy regime remains uncertain. If fiscal stimulus is implemented amid full employment, inflation risks could rise in the second half of the year. We are looking for opportunities to short U.S. rates, given our view that global growth will likely exceed expectations.
Data continue to indicate a recovery in the euro area in both growth and inflation. We expect a gradual rise in government bond yields in sympathy with the U.S., but we do not expect a sharp sell-off unless the ECB begins to discuss tapering its quantitative easing (QE) program, which we believe is unlikely until after the Dutch and French elections in Q2. The front end of the yield curve remains pinned down by negative interest rates and QE, but we expect the yield curve to steepen as global yields rise.
Onshore 10-year Chinese government bond (CGB) yields and interest-rate swaps recovered strongly in February as liquidity conditions improved with the return of funds to the banking system after the Chinese New Year. Although monetary and regulatory tightening is expected to continue, we believe much of it has been priced in and we expect interest rates to recover further.
10-year Japanese government bond yields continue to trade “around zero.” With oil prices in the ascendancy and the yen weakening (relative to twelve months ago) there is likely to be little pressure on the Bank of Japan to adjust policy further at this time. We expect further adjustments in policy to be closely scrutinized by U.S. officials as they focus on currency movements and seek to bring about a “fairer” marketplace for U.S. corporates and consumers.
We expect the pace of growth to slow over the coming months as the U.K. consumer starts to feel the impact of rising inflation, slowing house price increases and declining savings. Any loss in consumption is unlikely to be offset by rising net exports (driven by weaker sterling). Inflation is likely to push through the 2% threshold set by the Bank of England, but the overshoot is likely to be seen as transitory in nature and should not result in any tightening in policy. Therefore, recent interest rate trading ranges are likely to hold in the near term.
The Reserve Bank of Australia (RBA) held rates at 1.5% in February as expected.1 The statement was rather upbeat based on positive growth and inflation expectations of around 3% and 2%, respectively, for 2017.1 The December trade surplus reached its highest in history with exports increasing by 32% year-over-year.2 Given the apparent strength in the economy, it is highly unlikely, in our view, that the RBA will need to lower the policy rate further. In fact, the market is now expecting that the next move will be higher rates. We expect Australian interest rates to be range bound in the near future and we maintain a neutral stance versus U.S. rates.
With contributions from Rob Waldner, Chief Strategist, James Ong, Senior Macro Strategist, Sean Connery, Portfolio Manager, Scott Case, Portfolio Manager, Josef Portelli, Portfolio Manager, Ken Hu, CIO Asia Pacific, Yi Hu, Senior Credit Analyst and Alex Schwiersch, Portfolio Manager.